The Waves ecosystem gained attention in March from the Russian-Ukraine tension, followed by explosive growth. In early April, It all went into a death spiral when alleged being the biggest ponzi scheme in crypto. The native stablecoin USDN depegged to ~ $0.69 during that incident, but depegged again to ~ $0.75 when UST lost peg during May. Although USDN came back to the $0.96 ~ $0.98 area within days after both depeg situations, can we still trust algostables? The Waves team rolled out a series of revival plans to regain faith and capital, but are these plans enough for the system to survive another crisis without depegging? In the end, I’m also going to through two thought experiments based on Vitalik’s recent article to evaluated USDN.
Quick overview of the ecosystem:
Waves: base-layer chain
WAVES: native token of Waves
Neutrino: protocol that issues stablecoins
USDN: stablecoin pegged to 1 USD issued by Neutrino
NSBT: Neutrino’s token
Vires Finance: money market on Waves
VIRES: Vires Finance’s token
For more details on the above protocols or the previous incident, read my previous piece.
The USDN stablecoin has almost been restored twice in the past 3 months, but that doesn’t make it a “stable” coin. Even though it didn’t crash like UST did, USDN fails to peg around $1 during market turmoils like a stablecoin should. As the team stated, it has almost been restored, meaning USDN hasn’t been restored to $1 or even ~$0.99 yet. Some updates on the Waves ecosystem: TVL is down 78% from ATH, WAVES is down 87%, USDN market cap down ~22%, Vires Finance TVL down ~47%, Vires stablecoin pools have > 90% utilization and liquidity cannot be withdrawn. The USDN/3Crv pool remains unbalanced, with ~70% in USDN, far from the ideal 50/50.
The 2 main problems waiting to be solved are 1.) fixing the peg and 2.) solving liquidity issues on the money market. The team has been taking steps and coming up with proposals since the first depeg situation happened in April, now they are rolling out a second phase of their revival plan to further fix the system.
less NSBT required to swap USDN<>WAVES
The arbitrage opportunity between USDN<>WAVES is limited to NSBT stakers (which are gNSBT holders), this limitation weakens the ability for arbitrageurs to fix the peg when price deviates from $1. The team altered the parameters for calculating the swap limit per 24 hours in early April, increasing the amounts users can swap per NSBT staked. This strengthens the peg naturally, but as seen in the UST/LUNA incident, arbitrageurs may not be able to absorb the large sell-off pressure under rapidly deteriorating confidence in the system. Under extreme circumstances, people will lose confidence in the entire system, leaving no incentive to hold either WAVES or USDN, therefore most would sell directly on the market rather than swap USDN<>WAVES to maintain the peg.
introduce new recap token that recapitalizes when USDN is under-collateralized
USDN are minted 1:1 in value by locking WAVES, but currently the backing ratio is about 37.8% (~$515M in deficit), which is severely under-collateralized. In its original design, NSBT are auctioned for WAVES to fill the deficit in collateral. After the backing ratio is above 100%, these NSBT can be liquidated for more than the value they paid for. Similar to purchasing bonds from the treasury for their recapitalization, but the maturity depends on when the backing ratio returns to > 1. However, ~95% of NSBT are staked for the ~50% APR (the lock period is 45 months, you will lose some amount if unstaked earlier) and they couldn’t mint more tokens as it has almost reached the max supply (~2.8M).
They are introducing a new recap token to substitute the current NSBT for recapitalizing when the backing ratio is below 1. Once the new recap token launches, users would be able to exchange their locked NSBT for new recap tokens. They basically have the same utility, but difference in how they share revenue from the platform (not relevant here). However, I believe not many people will be willing to buy this *bond *from Neutrino when the market has lost faith in the system -> WAVES market cap < USDN market cap -> deficit exists so need to issue recap token to recapitalize. Since these “bondholders” would only be able to redeem if the backing ratio returns to 1, people would need to have a lot of faith in the system when the market doesn’t. The recap token has barely any difference from the original design, so I believe it wouldn’t have much effect on strengthening the peg. Even if most NSBT weren’t staked and could be auctioned, they would need almost 10x current NSBT market cap(~$50M) sold to fill the ~$515M in deficit.
~$600M of liquidity has been withdrawn from Vires Finance since the alleged manipulation was exposed and stablecoin depegged in April. Currently there is still ~$563M debt in stablecoin pools (~$25M in USDN, ~$249M in USDT, ~$289M in USDC), in which the utilizations are above 90%. Depositors were and have been unable to withdraw their funds, even if liquidity is paid back they were mostly withdrawn immediately by bots. The following 3 plans are meant to restrain the withdrawal ability of bots, and prevent bank run situations like the previous ones. The third one would be locking liquidity positions to receive VIRES as rewards, this would decrease users’ ability to withdraw funds under extreme circumstances. The team mentioned $20M has been locked after a day of inception, this would account for merely ~1.6% of total value in the protocol. These are ways to mitigate sudden withdrawals based on fear or lack of confidence, but the fundamental issue may still lie in strengthening the USDN peg and restoring confidence in this ecosystem.
Begin buying and locking CRV tokens with 45% of the WAVES staking profits from Neutrino, and vote to incentivize the USDN/3Crv pool
This would deepen USDN liquidity, which mitigates imbalance pool situations when large amounts of USDN are sold-off. The team stated the goal of locking 1–3% of CRV to have sufficient voting power in the distribution of rewards. However, I believe most people wouldn’t deposit into imbalanced pools even if the APY is high.
This proposal would allow Sasha Ivanov (founder of Waves) to take over the debt position of a few whale accounts with a total ~$400M. Sasha will then liquidate their collateral, sell USDN on the market and return liquidity back to Vires for users to withdraw. The large amounts of USDN have to be sold in stages without crashing the price, which would be handled by Sasha and his team. Although liquidity would be withdrawn once it returns to the protocol, this would probably bring Vires back to a more healthy state.
Vitalik recently published a piece on evaluating automated stablecoins, perhaps as a reminder of the fundamentals of these “algorithmic stablecoins” after the LUNA crash. The following are two thought experiments that he would go through when evaluating whether an automated stablecoin is truly “stable” or not. In the article, he used UST and RAI as examples for the 2 experiments. (RAI is a non-pegged stablecoin with ETH as collateral)
Can the stablecoin, even in theory, safely “wind down” to zero users?
He mentioned traditional companies shutdown all the time without really hurting their customers, but in the crypto world users lose huge amounts of funds when a protocol/project collapses. I’m going to go through two scenarios, both causing demand to decrease in USDN, but one has a larger impact on WAVES, the other hits USDN more.
1.) If WAVES market cap drops more than USDN -> the deficit between USDN and WAVES market cap increases -> NSBT/new recap tokens are auctioned off for WAVES at a discount to fill the deficit -> less circulating WAVES
This circumstance is under the premise that people have enough confidence in the system to purchase *debt *from Neutrino. If not, there wouldn’t be a “death spiral” like the UST case, but USDN would stay undercollateralized like the current status (~37.8% backing ratio).
2.) If USDN market cap drops more than WAVES, and USDN < $1 -> smart contract detects an excess of reserves -> generates a corresponding amount of USDN to buy back the NSBT liquidation orders -> increase USDN supply -> USDN price drops further until no liquidation orders are in queue
If there are enough NSBT liquidation orders in queue, USDN would go down even further. USDN will be overcollateralized, but restoring the peg would still rely on USDN<>WAVES arbitrage opportunities.
2. What happens if you try to peg the stablecoin to an index that goes up 20% per year?
The second thought experiment is to evaluate the sustainability of these stablecoins, whether they would be able to track a hypothetical index that goes up 20% a year. The two possibilities that Vitalik laid out for this to happen:
1.) It charges some kind of negative interest rate on holders that equilibrates to basically cancel out the USD-denominated growth rate built into the index.
2.) It turns into a Ponzi, giving stablecoin holders amazing returns for some time until one day it suddenly collapses with a bang.
UST belongs to the second and RAI belongs to the first, USDN would belong to the second as well. Vitalik is suggesting a negative interest rate to be able to respond to zero interest rate situations.
I would say USDN doesn’t really pass these thought experiments, and as the previous two depeg incidents show, USDN isn’t stable during extreme events.
I think the Luna crash gave us a lesson, to examine algostables with extreme circumstances and of their fundamental design. The Waves team has put a lot of effort into this revival plan, but only faith of the market in the system could save the peg, rather than the stability mechanism (arbitrage) they designed. The overall plan could bring the ecosystem back to healthy and stable states, but I believe it’s not sufficient for USDN to survive another crisis without depegging. (None of this is financial advice)