As demonstrated by the Terra/Luna failure, the risk is real. Terra/Luna’s failure seems to have demonstrated clearly that once a ‘bank run’ gets going, the death spiral sets in very quickly, then the reserve gets blown out chasing a lost cause: the customer’s and developer’s money gets lost to the bears feeding.
An apt analogy for this is a fighter jet pilot with the ability to eject, but who refuses to eject, because they think they can regain control: way too many pilots have been lost that way.
IMO there needs to be a sensible fail-safe mechanism to ensure that Celo avoids Terra/Luna’s fate, protecting the value of the Celo stable coins to ensure ‘our’ customers and developers never lose money because of a Celo stable coin failure.
IMO solving this problem also helps ensure the Celo ecosystem survives long term.
The following are a few ideas and a couple videos that might help frame the conversation and supply some context.
The hope here is to create a governance proposal from ideas gathered here.
Basics:
Each Celo stable coin should be treated as if represents a legal & moral claim against the Celo reserve for 1 unit of the fiat currency it represents on chain.
The portion of the reserve that is subject to the legal/moral claims of the Celo stable coin holders does not belong to Celo. Instead this ‘money’ should be thought of as ‘customer funds which are held in trust’.
Celo should/does hold a fiduciary duty to protect the ‘money’ that Celo stable coin holders have placed in Celo’s care.
To protect the stable coin holders from the risk of a failure of the Celo protocol, the portion of the reserve that ensures the stable coin holders get their ‘money’ back can not be held in Celo based assets.
It appears that regulation is imminent and almost a given threat that needs to be addressed.
Possible fixes:
A circuit breaker that stops the death spiral and sets up an orderly liquidation
Using time as a variable in transactions to slow things down
If the Celo stable coins are backed by non-Celo assets then setting the trading range (inside the protocol) not to exceed a narrow range ‘0.99 to 1.01’ or even immutably at ‘1:1’ might be a possibility.
Isn’t this similar to what Terra’s limited mint & burn mechanism during the depeg? They throttled the amount of Luna that could be minted by burning UST, so the value of Luna was propped up artificially until the BTc dry powder ran out.
People who understood this dynamic sold all of their Luna before it really went to 0, and only the lunatic retails were left holding the Luna bag after they unthrottled the mint burn, and price discovery ran its course…
During volatility, let’s not intentionally throttle the price discovery process. If you do throttle it, it’s only gonna become information assymetry to the smart money.
Could we eliminate the need for price discovery on the stable coins, say use the Forex exchange as the oracle?
Part of why I’m asking is because I’d like to know what hurdles are in the way of holding fiat in the reserve. And part of my rational is that the EU’s proposed rules may require holding EU fiat or government securities. That’s why I included regulation as one of the basics in the original post.
If Celo has to hold EU assets to remain viable in the EU, then for example, backing the cEUR coin fully with EU based assets could eliminate essentially all risk of de-pegging.
No thoughts on the EU rules, but holding fiat 1:1 to a stable coin is a proven business model, like how Circle USDC is minted & redeemed. It comes at the downside of accessibility though, until a country has a operator acting like Circle for that real world currency, you can’t mint & burn the cStable for that country, unlike today where we can artificially create a cStable and rely on arbitragers to ensure implicitly that the cStable ratios match the real world FX rates (pain in the ass to do, but it’s worth the pain once slippage is big enough).
If our goal is to avoid a death spiral, then I want to put out the opinion that in the final 72 hours of TerraUSD, it was inevitable to become a shit-show and no amount of planning or pegging would have saved it. Instead, I want to focus the attention to 2 years before the crash, when Anchor protocol was launched with the 20% stablecoin yield hype.
Here’s my understanding of how this game played out:
Terra mainnet was launched in 2019 by Terraform Labs (TFL)
Terra launched TerraUSD in 2020, algorithmic stable coin worked fine, and it was meant to facilitate real world payment processing
Except their network wasn’t really gaining any traction in reality, look at Luna price history prior to 2021
So TFL’s investors got anxious and said, Do Kwon, do a better job of making us fat-cats even more obese or else we won’t keep funding your shitty half baked network
TFL needed to pump the network activity, to hype up price of Luna & entice more capital to flow into UST, so they invented Anchor 2021
Anchor yield game promised 20% stable coin returns, and they issued ANC tokens to entice Lunatic stakers to collateralize their staked Luna & borrow out UST (negative subsidized borrow rates from ANC issuance)
UST + Luna staking + Anchor yield games was sufficiently complex that 99% of the lunatics couldn’t connect the dots, so they aped in with their life savings thinking that there was actual real demand for Terra network and real demand for UST
TFL’s quarterly metrics started becoming astronomical due to frenzied inflow of retail capital, their game mechanisms was working as designed, and venture fat cats wanted to double down
UST minting was at an astronomical rate, underlying backing was pure Luna
Fast forward to 2022, someone smart realized that the music is slowing down, and it’s time to stress test the peg and see who’s got hands and whos’s got hands
All smart money knew internally that the underlying demand for Luna & UST was all manufactured from these games created by TFL… so they high tail it out of the network
This is why I say that towards the end of this game, it doesn’t matter what mechanism they put in place, there’s still going to be a shit show cus the fundamental demand for the Terra network & the demand for UST was all artificial.
I don’t really care whether cStables is 1:1 backed by fiat or if it’s some healthy over-collateralized backing of crypto like DAI. Either one is fine IMO and will be stable IF there’s actual real legit demands for Celo network, and there’s real demand for cUSD as a mechanism for true commerce.
So to ensure Celo’s survival, in my view, it’s quite simple: make sure the network actually has real legitimate utility in real life to people transacting on a day-to-day basis, vs artificially inflated demand from some Defi game
I’d like to know more about Celo’s Tobin tax and whether other algorithmic stablecoins have the same or a similar measure in place in order to prevent depegging.
UST had Tobin tax, was useless in prevent depeg if the fundamentals just aren’t there.
Tobin tax != magic depeg prevention wand.
Tobin tax fills up the reserves with more CELO during a crisis.
When a crisis hit cUSD so hard that it depegs, do you think CELO is gonna be worth much at that time?
I 100% agree with this. Organic demand growth is a prerequisite for stability and the stability mechanism itself should never be seen as something that can protect against the collapse of a Ponzi - it won’t.
@markbarendt, Mento 2.0 which we started months ago really is about what you are describing - achieving as much stability as realistically possible on the stability mechanism side w/o the unrealistic goal of being able to absorb the chaos of a full-blown Ponzi explosion like in Terra/Anchor. All work streams we have in Mento 2.0 relate to that. Some examples:
Buy-and-sell improvements add features like on-chain circuit breakers to the current Mento setup.
Borrow-and-repay aims to help with long-term overcollateralization by allowing Mento stable assets to not only be minted via the buy-and-sell functionality that already exists but also via maintaining overcollateralized debt positions
Collateral providers are a way of helping with long-term overcollateralization by incentivizing folks to long-term lock capital in the reserve that can be used by the reserve if needed. It also allows to move cStables to folks in times of crisis that have signed up for the tail risk inherent in stable value assets.
Interaction providers are a way to ensure that transactions on a protocol level actually occur during extreme periods to avoid that the mechanism stops working even though it sets the right incentives economically.
Natural capital reserve assets are not only good for the planet but will in the future also provide a way to back cStables with low-volatility reserve assets w/o the need for backing with other stablecoins like DAI.
Reserve decentralization is important for removing a “single” point of failure and also for reducing regulatory risk.
I understand the want to avoid getting regulated, but the impression I’m getting on-the-street and in-the-hood, is that regulation is coming.
I believe that for any stable coin that wants to be available to the general public, regulation is essentially going to be a given in the next couple years, the Terra/Luna debacle has IMO sealed that fate.
Regulation was already directly affecting the protocol. My impression from the information I’ve been able to glean inside Celo via chats and office hours calls is that one big reason the Mexican Peso isn’t active as a consideration for a stable coin on Celo, is Mexican law.
IMO, from a mission and business perspective, it seems to me that trying to avoid regulation is becoming a bigger risk than participating.
Yes absolutely, regulation certainly is coming! The decentralization efforts are not aiming to avoid any sort of regulation of Mento stable value assets but rather try to put them into a good position for whatever comes from the regulatory side.
My thoughts after the Mento call on Discord today 5-25.
I really like the idea of moving toward an external stable coin backing target of over 100%.
Given the ‘active management’ required by the real people involved in the multi-sig needed to manage Celo’s Reserve, it seems prudent that a management range for that ‘bucket of value’ be set over 100%. I’m going to suggest that range be something akin to: a minimum of 105% and a maximum of 115% of the value of all outstanding Celo Stable coins.
In the short term, until an on chain circuit breaker can be implemented, I do think that a ‘governance instruction’ should be crafted that instructs all the appropriate responsible persons to act as a ‘circuit breaker’ and monitor the status of the reserve the ensure that the non-Celo based assets (BTC, ETH, Dai, …) do not fall below 150% of the value of all the outstanding Celo Stable coins in circulation. At that point the reserve should be ‘locked’ and held for the sole purposes making Celo stable coin holders ‘whole’. The reason for choosing 150% is to ensure there is money available to cover all the overhead costs involved in getting the stable coin holders paid in full.
As discussed I am suggesting that in all marketing and reporting about the status of the reserve that there be made a distinction between Celo and non-Celo assets so that a hard distinction can be made from the Terra/Luna reserve in that at Celo ‘outside’ assets alone can cover Celo’s obligation to the Celo stable coin holders.
While Dai IMO is a reasonable interim tool for maintaining the 1:1ish ratio, I think Celo’s reserve needs to work diligently toward holding a significant amount assets that are not correlated to the rise or fall of any crypto project and that are proportionally and directly correlated to the real world currencies of the countries where Celo offers stable coins.
I agree that the Mento reserve needs to hold real world assets. If the Celo blockchain is a country or an independent economy, the Celo dollar and the other Celo stable assets are its currencies. The Celo reserve is the forex reserves needed to defend the currency.
If we look at other countries that manage a peg to the US dollar, such as Singapore or Hongkong, a very large portion of their reserve assets is in US treasuries. This is because in times of stress or macro economic shock, exactly when these economies are seeing outflows, US treasuries tend to rally as rate cuts are priced in and a “flight to quality” happens.
When the Celo blockchain is seeing inflows due to more use cases for the Celo dollar or whatever it is, that’s the time when the Celo reserve should be buying US treasuries.
One way to implement this is 1) a company buys US treasuries at primary auction and tokenises it on the Celo blockchain. 1 token corresponds to 1 usd of face value of the treasury asset. 2) An investment policy dictates the duration risk Mento is able to take on. I think it would make sense to buy only short duration bills and reinvest them 3) The tokens can ONLY be transferred to the Celo reserve. An attestation service like that for TrueFi verifies the US treasuries held on account.
When outflows happen, the volatile crypto assets are liquidated first. Leaving the treasuries last. Treasuries should cover at a minimum 100% of cUSD and other mento stable assets.
It may be against the ethos of maximum decentralisation and avoiding regulation, but it is the only way to absolutely guarantee the value of 1 cUSD. Even bank deposits have bank credit risk and that is why large money market funds/pension funds have a limit to how much cash they will leave on deposit with a bank. I think the moral obligation to Celo stablecoin holders and users compels us to at least seriously consider these changes.
I think I found another domino in the crypto mix that demonstrates a bit more the house-of-cards concept of using other stable coins to back the Celo stable coins. Lido Finance. This vulnerability relates to the cross chain staking of ETH. Lido’s stETH lost it’s peg (to ETH) for a short period when Terra/Luna was crashing because it was unknown if the stETH that had been used as collateral on AAVE and more concerning for Celo at Maker DAO to mint DAI could ever be redeemed for the real underlying asset. See video, at ~5:50 the connection is made to Maker Dao, the problem gets fleshed out in the concerns chapter, starting at ~20:18 https://youtu.be/VQ_uvak1JPw?t=1162
Hi! Thinking about ReFi and holding assets with claims on RWAs (real world assets). What about a dual-tier reserve with illiquid assets used for (a) over-collateralization (not saleable against Mento smart contract) and (b) windup payouts (to payout pro rata to small stableholders in the event of collapse, as it would take months to liquidate)?
When thinking about a death spiral we should also think about protecting RWAs (unmined copper, forests, coral) from market fluctuations.
Looking forward to your thoughts and I’m happy to elaborate further.
or else we won’t keep funding your shitty half baked network
hands and whos’s got 
hands