# 5 Lessons from $LUNA and $UST By [Arya](https://paragraph.com/@aryaethn) · 2022-05-18 --- This is a summary of a [thread](https://twitter.com/TaschaLabs/status/1526276308119932928?s=20&t=s8jOH29BYZG9J2aGPOrA5w) of tweets that [TaschaLabs](https://twitter.com/TaschaLabs) posted on her Twitter account. TL;DR ----- 1\. Assets that “back” a stablecoin need to have uncorrelated demand 2\. Fast expansion without actual network effect = DEATH 3\. It’s network effect for the reserve asset, not for stablecoin itself, that matters 4\. Small(er) is beautiful; In case of failure you should have a bailout plan 5\. Regulatory standards are a nuisance until they’re not Now if you want to know more about each lesson, please follow up. Stablecoin business ------------------- Almost all stablecoins, regardless of design, involve you, the user, give a stablecoin issuer X amount of assets in exchange for Y amount of a token that’s priced at $1. Another way to look at it. The stablecoin issuer is in the banking business. You deposit variable-priced assets w/ the issuer, get a certificate (i.e. stablecoin token) back that offers 0% interest rate but promises to be always worth $1. Regardless of how profit is collected operationally, stablecoin issuer can potentially turn a profit (i.e. create value-added) in similar manner that insurance companies and/or banks can be profitable: * from risk premium: issuer charging a fee for taking on asset price volatility risk. * from return arbitrage: issuer earning positive yield in dollar terms on deposited assets while paying 0% yield to you 5 Lessons --------- ### 1\. Assets that “back” a stablecoin need to have uncorrelated demand Terra/Luna eco is self-referencing with high degree of reflexivity built in. More minting of $UST increases Luna token price => higher Luna prices allows more $UST to be minted. But reflexivity is huge on way down too. When $UST is lower than $1, more Luna needs to be printed to shrink $UST supply, dampening Luna price. Since there’s limited use case for Luna token aside from backing UST, If de-peg pressure is high enough, Luna price would be pushed to zero as there’s no other demand to help shore up price. One obvious choice is L1/L2 platform tokens, e.g. $BTC, $ETH, $SOL, $AVAX, etc. (This doesn’t include platform token specifically created to “collateralize” an algo stablecoin as in the case of Luna.) L1 tokens are created to secure their own blockchain & spent as transaction fees on their own chain. Both can count as uncorrelated use cases that support demand for these tokens if the chain gains decent traction. ### 2\. Fast expansion without actual network effect = DEATH In its name VCs touted blitzscaling expansion for products to gain market share at all cost as fast as possible. Motivation is usually a combination of gaining scale economy & monopoly advantage. Problem, esp regarding crypto, is it’s easy to confuse ponzi-nomics with real network adoption because of huge reflexivity. In Terra’s case, Anchor, the bank that offered 20% deposit rate on $UST, single-handedly accounted for 80% Terra TVL at one point. Terra’s strategy of subsiding growth of a couple products to gain network adoption did “work” to an extent— it was starting to see more projects built on top— but not enough. The platform’s unsustainable rate of growth & amount of subsidies needed to keep it up far outstripped the pace of actual network effect growth. ### 3\. It’s network effect for the reserve asset, not for stablecoin itself, that matters Much of business development effort for newer stablecoins is focused on getting more adoption for the stablecoin itself— get it into more AMMs, used as DeFi collateral, deploy on multiple chains, etc. E.g. when $UST was bridged to Avalanche economics it was seen as “bullish”. Stablecoin is a utility product. There’s no real network effect for itself that guarantees sticky demand. No matter how big a market cap or user base your stablecoin has, if it de-pegs, game over. The part that stablecoin builders need to work hard on: how to get the token(s) that back the stablecoin to be adopted in as many use cases—ideally unrelated to DeFi—as possible. ### 4\. Small(er) is beautiful JPMorgan, largest US bank, is ~2% of global banking assets. Anchor, largest bank on Terra, was 8% of global DeFi TVL. That is, large stablecoin protocols are way more “systemic” to crypto financial system than large banks to tradFi financial system. Plus the former don’t have any lender of last resort. Too-big-to-fail risk in crypto isn’t limited to USD stablecoin. Lido the liquid staking service, e.g., holds over 90% (yes you read that right) of all liquid staked $ETH in universe, w/ its $stETH token (a $ETH stablecoin) used as collaterals in multiple large DApps. As investor you obvious want whatever you invest in to be huge. But issue is bigger you are, harder it is to find outside capital to rescue you if things go south. Terra tried to find private bailout & failed. ### 5\. Regulatory standards are a nuisance until they’re not Financial assets held by firms, households & governments worldwide are ~$1000 trillion. Crypto is 0.15% of that right now— trivial in the grand scheme. But amount of interest, news & discourse it stirs go much beyond. I have no doubt crypto financial system will grow substantially in coming yrs. But like any child growing into adulthood, there’ll be adjustment & pain. Being adult means realizing one needs to be responsible for own actions. You can’t do whatever the hell you want because your actions have impact on others. E.g. if there’d been a minimal capital/liability ratio requirement in place for Terra, $UST market cap wouldn’t have expanded as fast. Less investors would have ended in tears. --- *Originally published on [Arya](https://paragraph.com/@aryaethn/5-lessons-from-luna-and-ust)*