Delphi Office Hours Call (May 18th, 2022)

Below is the full recording and transcript of the Office Hours call our team did on Wednesday May 18th, 2022.

• Terra/UST (01:18)
• Macro (06:35)
• NFTs (10:29)
• Optimism (14:13)
• Lido (17:53)
• Terra/UST Conversation (21:07)
• Q&A (23:11)

Transcript

00:36 • Nick
Good morning, everybody. Welcome to Delphi Pro Office Hours. Here’s today’s rundown.: we’re first going to talk about the UST and Terra situation and run through what’s happened there. We will answer a lot of the Q & A related to that towards the end, so save those questions and put them in the chats and we will get to those. We’re going to talk about macro and markets and the latest in the state of NFTs. We’re going to talk about the recent Optimism airdrop and what’s happening with that. We’ll also talk about the situation with Lido and stETH. Just put your questions in the chat and we’ll do our best to get to them towards the end. With that, I’m going to hand things over to Duncan to talk about what happened with Terra and UST.

01:25 • Duncan
Last week, Luna and UST fell victim to the algorithmic stablecoin death spiral. I’m going to walk through a recap of the events, and then we can do some Q & A after to try to answer any questions you may have. In the face of an illiquid weekend and unflattering macro backdrop, UST started exiting Anchor on May 7th and it shed 2.3 billion worth of deposits over the weekend. We can assume that UST leaving Anchor is looking to fully exit the system. I think that’s a conservative but a reasonable assumption. $2.3 billion leaving is quite a lot of sell pressure to absorb. UST began to lose its peg slightly, hovering between a dollar and ninety-nine cents. On Monday, May 9th, the situation rapidly accelerated, and an additional five billion worth of UST left Anchor throughout the day.

02:29 • Duncan
If we think about UST leaving Anchor, they have three main options to completely exit the system and swap UST for another form of stablecoin or cryptocurrency. They can use decentralized exchange liquidity, the largest source of which being Curve, which had around 400 million worth of 3CRV to be used as exit liquidity at the time of the depegging. They can sell UST on centralized exchanges with the main markets being Binance and FTX. Users can also use the native Luna mint-burn mechanism to redeem UST for Luna, and I’ll touch on this more in a second. What you have is four hundred million worth of liquidity on Curve. As we all know, the Luna Foundation Guard had around three billion in reserves. You also have the Luna mint-burn mechanism, which by Jump Trading was estimated to handle around 300 million a day.

03:25 • Duncan
That gives you a few billion short of the outflows that we saw leave Anchor. This caused UST to wick down to as low as sixty-one cents on May 9th. This is where the death spiral takes its grip because there’s not enough capital to instantly repeg UST, so it goes into that Luna minting mechanism that I talked about earlier. I saw a lot of people asking, “How does this really work?” I just want to break it down for you in a bit more depth here. Basically, for those who aren’t familiar, when UST is trading above a dollar, then you can use $1 worth of Luna to mint one UST. That’s increasing the UST supply and capturing an arbitrage opportunity. Similarly, when UST is trading below a dollar, you can use one UST to mint $1 worth of Luna, increasing the Luna supply and capturing an arbitrage.

04:26 • Duncan
If UST is trading at 80 cents, you could go buy that on the open market and then come over to this mechanism on Terra and try and get $1 worth of Luna for capturing that twenty cent spread. That’s only how the mechanism works in theory, and there is a capacity to how much volume this mechanism can handle. Going into the depths here: this mechanism is expressed through something called a virtual automated market maker that simulates fifty million worth of stablecoin liquidity and fifty million worth of Luna liquidity; this is what we know as the standard Uni V2 X*Y=K liquidity pool. During normal market conditions, when the pool is balanced fifty-fifty, users should be able to execute their Luna-UST minting and burning at very close to the one UST for $1 worth of Luna rate described earlier.

05:16 • Duncan
During these events, there’s a significant amount of flow in one direction. In this case, I’m redeeming UST worth less than $1 for $1 worth of Luna. This one directional flow drains Luna from the VMM and arbitrageurs then need to wait for liquidity to refill to continue the arbitrage. The VMM, which we don’t have to get into the specifics here, but it basically has a reserve that replenishes every three and a half minutes. That combined with the amount of base liquidity in the VMM acts as a natural limit to the amount of burning-minting that can happen in a brief period of time. Jump Trading has a few proposals on this on the Terra governance forum, if you wish to learn more about this mechanism, but these are the mechanics that led to the Luna and UST collapse and the hyperinflation of Luna. As long as UST is trading below its peg, this mechanism will take hold. That’s why we saw excessive minting of Luna, which leads into the death spiral of people selling off Luna. It just feeds on each other.

06:28 • Nick
Thanks for that, Duncan. As always, we’ll get to some of those questions that I’m sure you have towards the end. Shifting gears, we have Jason to talk about the latest with the macro situation. Jason, what are you seeing?

06:42 • Jason
To be quite honest, nothing has really changed in the grand scheme in terms of macro over the last week or two and since we last spoke here. Just to recap what the big driving factors are to what’s moving both legacy markets and crypto markets: the Fed’s fight with inflation has started to take center stage. We can see that with the dollar strength over the last several months as Kevin has pointed out in numerous reports. We know that as the dollar is increasing in strength, risk assets tend to wane in performance. You see that in the chart that Kevin put together for us from Bloo