Vulnerability of Stablecoins like cUSD

Dear fellow Celonians,

the total crash of Terra LUNA showed the vulnerability of algorithmic stablecoins. It must be doubted that TerraUSD (UST) will ever regain trust with users.

Can you please explain in what way is cUSD different from UST?
What different securities / mechanisms are already inplemented that will protect cUSD?
What can you do in the future, to ensure that kind of crash can not happen to cUSD and CELO?

Thank you for clearification.

Bab

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Terra Founder writes just now: “As we begin to rebuild UST, we will adjust its mechanism to be collateralized.” This means the algorithmic peg stabilization mechanism of UST failed ultimately.

I think this whole thing will have immense impact on all other not collateralized stablecoins.

What do you think?

Good morning Bab,

It has been a spectacular, and yes worrying to me even as a minnow in this ocean of crypto whales, seeing Luna and UST coming undone. I think that you are onto the underlying issue, trust.

There have been rumors floating about regarding UST’s reserve not being ‘perfect’ for a while. It’s a problem that they were apparently and visibly trying to fix.

The rumor about Celo’s reserve OTOH, is that it is already well over-collateralized, even today in the down market.

Hi Mark!

Thanks for your comment.

Can you give more information on this? Where does Celo state/write about Celo´s “well over-collateralized reserve”?

Thanks.

I’ve been listening in to various office hours calls and such. You could ask here Discord at Celo Support.

Hello @Bab .

The Celo Reserve does have collateral backing cStables. CeloReserve.org is a good way to track this.

In short, at the current level of BTC, ETH and Celo - the outstanding amount of stables has multiples of collateral - a significant difference to Terra. However, there is no guarantee that stables are safe in all market conditions. There is risk. Personally, I do not hold nor recommend holding any more than a tiny amount of cStables (or any stables for that matter).

What would happen in the case of further drops in crypto price has been the subject of much discussion. See here for some threads:

Generally, my personal view is that Celo has been a lot more conservative than platforms like Terra - both in providing collateral for stables, and having a much slower growth in supply of cStables. Still, there are risks. There are not simple solutions. Mento 2.0 includes plans for some improvements. I continue to see this as a high risk and priority for Celo to address.

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Terra’s stablecoin issuance rate far outstripped their growth of non-Luna reserves.
They ran the game too hot and too fast.

If you look at cUSD’s issuance rate and the growth of the collateral reserve, you’ll see that it’s more organic and both cUSD and the diversified reserves are growing (and being rebalanced) in a healthier rate.

There’s no imaginary yield game like Anchor on Celo, so cUSD isn’t being minted like crazy as a result. Instead, users on Celo mostly just hold cUSD to transact with, not to speculate with. When you have the primary usecase of a stable coin going towards actual transactions, vs a speculative yield game, the coin is less vulnerable to being inflated & subsequently breaking past the reserve.

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Also their mint & burn equivalent of Mento has a built-in throttle that effectively made it impossible for their own stable algo to work once UST was on the order of billions when their burn mechanism was throttled to millions.

UST scaled way faster than their “mento-equivalent”'s safety parameters, so the algo itself was ineffective.

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Here are my recommendations on steps forward: https://twitter.com/Pinotio_DeFi/status/1524740731218321409?s=20&t=xghQnNppezJ6OnZGj1lrXQ

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Hi @Bab! Welcome to the Forum and thanks for bringing this up.

Wanted to add that there will be an AMA all about the Mento Protocol and cStables today at 9am PT | 12pm EST on Twitter to learn more and ask questions about this. Everyone is invited to join:

Thank you very much for your insights and clearification.

The present Reserve Ratio of 2,67 seems somewhat reassuring.

  • How far is the automated reserve liquidation mechanism?
  • When bying BTC, ETH when prices are high and selling when they are very low, who pays for the loss? I guess the BTC and ETH have been payed for with CELO originally? But it does not seem like a good Idea from a business point of view to buy high and sell low.

To me this mechanism of selling Crypto-assets when there is a Crypto-crash to back cStables has diffenten disadvantages.

  • It can influence other systems like DAI. If different projects use stables like DAI for reserves it could influence the stability of DAI system when reserves are liquidated.
  • When selling BTC and ETH in a crash situation it will burden the anyway strained market even more and pull BTC and ETH even lower, with all the cascading effects on the other crypto coins / projects.

Why not back cStables with a mixture of:

  • Crypto
  • DAI
  • physical Gold
  • non US-Dollar Fiat

That would give much more stability in a variety of market conditions.

To limit reserve to just crypto is vulnerable in a crypto-crash situation, especially if the automated reserve liquidation mechanism sold all assets, then cStables would depeg and the same fate like UST could follow. I think there is a variety of possiblities that could crash crypto-market even more than seen now (due to attacks, due to technical failure, due to coordinated attack on electrical grids ect. pp).

What do you think about my concerns?

What was the reason for the 0,9666 value decline of cUSD last night?

Greetings

Bab

Hey Bab,

It’s an interesting idea, but one of the issues with using traditional assets like fiat or commodities like Gold in the reserve to back cStables is that it decreases transparency and introduces censorship risk. You’d need an account with a financial institution and frequent audits, which introduces centralization. It starts to look like the Tether model.

Someone freaked out, panic sold a bunch of cUSD thinking it was under collateralized like UST, and decided to give the cUSD market makers a nice little bonus trading the spread.

Many of the cUSD market maker bots on the CEX don’t actually understand cUSD reserves / the mento mint/burn mechanism, etc… they’re just spread trading and when they see the overall market sentiment edge down, the market making algo obviously want to derisk and move along with the momentum.

CEX <-> DEX trading systems that actually go on-chain and trade against the reserve also have safety limits in place as well, so when a big order comes through, it might take a few blocks (5s per block) for any arbitrage to play out and level out the prices.

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