Terra UST collapse: attack timeline, death spiral and what is salvageable
Thread1,097 words
Explains how the LUNA/UST mint-redeem design enabled a death spiral and reconstructs the attack: borrowed BTC, Curve 3pool liquidity pull, 350m UST dump and LFG BTC sales. Argues the base layer and its protocols are the only remaining value.
Key claims
UST mcap rose from 2bn to almost 19bn in 12 months
Attacker used 350m UST to drain Curve liquidity, UST fell to 0.972 first
About 8bn USD of UST debt outstanding vs LUNA mcap near 200mn
0/ Even tho the $LUNA / $UST drama has already been covered extensively on Twitter, my five cents on what happened and what might be next
Mega-🧵 on @terra_money (0/41) 🌖👇
1/ I haven't been buying the past days as this is likely to have been a coordinated attack on UST peg, most likely with the intention of bringing down @terra_money (or at least just getting filthy rich in the process). Lots of info (& speculation) on this on twitter already
2/ Basically, due to flaws in the design of the $LUNA / $UST model, the attack triggered what is referred to as a $LUNA "death spiral"
3/ $UST is an algorithmic stablecoin, which comes with many advantages compared to centralized (e.g. $USDT) or decentralized but over-collateralized stablecoins (e.g. $DAI)
4/ Algo stablecoins are more scalable and hence ideal for facilitating #DeFi, less censorship-prone than centralized alternatives thanks to decentralization and improve on capital efficiency compared to the over-collateralized model
5/ Unfortunately this also creates risks. In the case of $UST the peg is meant to be stabilized through arbitrage incentives by allowing users...
...to redeem 1 $UST for $1 worth of $LUNA
...or redeem 1 $LUNA for its equivalent value in $UST
6/ Under favorable market conditions in which there is a lot of demand for Terra's stablecoin $UST the $LUNA token hence captures the value created as its supply diminishes and scarcity increases, putting upward pressure on the price
7/ This has been the main driver behind $LUNA's insane PA during the past 12 months (in which $UST mcap rose from 2bn USD to almost 19bn USD).
8/ However, if sentiment towards $UST changes and people want to get out, $LUNA basically acts as a shock absorber for $UST as its supply is inflated with every unit of $UST being redeemed for $LUNA
9/ Redeeming $UST for $LUNA is especially attractive if $UST is trading below its target peg, which is exactly how the system is intended to work in order to stabilize $UST at 1 USD
10/ Unfortunately though, if there is a significant and sudden loss in trust in the system (e.g. due to a $UST de-peg of the magnitude we saw the past few days) and there is a "bank run" on the system by $UST holders, the before-mentioned "death spiral" can be triggered
11/ What that means is that people redeem a lot of $UST, thereby heavily inflating $LUNA supply which causes sell pressure on $LUNA as people are exiting the Terra ecosystem which in turn lowers $LUNA price, which has a tendency to increase fear among $UST holders...
12/ ...and triggering even more $UST redemptions. All of this is amplified by liquidation cascades on Anchor protocol, Terra's largest borrowing/lending protocol and main reason that $UST has utility (20% APY fixed accounts)
13/ But back to how the current $UST drama unfolded. The malicious actor seems to have borrowed 100k $BTC a while back when @LFG_org announced that they will aggressively start to accumulate $BTC reserves to protect the $UST peg (will not go into details here)
14/ The malicious actor subsequently sold their $BTC into LFGs buying, thereby entering a short position. During that time the attacker also accumulated a position of 1bn in $UST
15/ When TFL (TerraForm Labs) was preparing for the launch of @CurveFinance's 4pool by removing $UST liquidity from @CurveFinance's 3pool, the actor used that opportunity to take a first shot at the $UST peg
16/ The liquidity was pulled on 8th of May and then the attacker used 350m USD in $UST to drain the liquidity on Curve. But this only started the de-pegging, bringing $UST price down to 0.972
17/ @LFG_org subsequently began selling $BTC to defend the peg, causing downward pressure on $BTC while the run on $UST was just getting started
18/ This seems to have been exactly what the attacker has been after as the $BTC shorts became profitable and market wide panic started to crash the entire market, incl. $BTC
19/ With the @CurveFinance liquidity drained, the attacker used the remainder of their 1b $UST position to start selling on @binance. As withdrawals from @anchor_protocol turned from concern into panic, the real de-peg started happening as people fled for the exits
20/ Eventually the @terra_money blockchain also got congested (leaving people unable to manage their positions on @anchor_protocol) and centralized exchanges suspended withdrawals of $UST, fueling the bank run panic
21/ Consequently, $UST de-pegged to around 0.6$ and $BTC continued to bleed out. This increased panic among the wider crypto community as no-one knew how much $BTC LFG would actually sell to protect the $UST peg
22/ Subsequently there were liquidations across the board and $LUNA broke down entirely because of the before-mentioned redemption mechanism (not sure if the attacker also shorted $LUNA though)
23/ This is basically what has been happening since, even though it all happened much faster than I would ever have expected. Currently, there are governance proposals being discussed in the #Terra research forum in order to help restore the peg
24/ The most discussed one is to increase the $LUNA minting capacity which is likely to help restore the $UST peg quicker but would also worsen the death spiral problem as $LUNA supply inflates, continuously diluting $LUNA holders
25/ To be honest I'm not really convinced by this as this will not just create exit liquidity out of thin air. Right now $UST basically represents debt on $LUNA's (or the #Terra ecosystem's) value. There's almost 8bn USD of debt outstanding
26/ The @terra_money ecosystem cannot possibly service that debt, it's mathematically impossible as the $LUNA mcap has already diminished to around 200mn USD. So basically, the #Terra protocol has been bankrupted
27/ But still, the #Terra blockchain has some value. It is a technologically strong, Tendermint-based and IBC-enabled chain built using the @cosmos SDK with a lot of infrastructure and a lot of innovative protocols with great UI and UXs (some of the best in #DeFi in my opinion)
28/ Some examples are @astroport_fi, @mars_protocol, @TeamKujira but also @anchor_protocol or @mirror_protocol
$ASTRO $KUJ $MARS $MIR $ANC
29/ Going back to the $UST/debt analogy, the base layer and its protocols are the only things of value right now. Hence I personally think the focus should lie on protecting them. If $LUNA goes to 0, they are all worthless
30/ Sure, one might argue that $UST is also very important to these protocols, but at the end of the day, the base layer can also exist without $UST, while $UST cannot exist without the base layer anyhow
What came next · since 12 May 2022
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