Oct 4, 2021
How does UST work?
The Basics of UST
UST is the US dollar of the Terra ecosystem. While the dollar can change in value due to market forces, its value generally remains stable over long time frames. Thus, sellers are happy to receive it and buyers are comfortable spending it. Some other currencies are not so stable.
UST operates similarly to the US dollar: it is designed to remain stable in value. Terra employs a fixed exchange rate or “peg” that keeps UST locked to the value of the US dollar. In other words, 1 UST is worth 1 USD (US dollar).
Where Does The Yield Come From?
The 20% yield that Angel Protocol provides comes from the Anchor Protocol. Like other financial institutions, Anchor enables people to take out a loan. To do this, they must pay borrowing fees and provide collateral in the form of LUNA — the major crypto-currency of the Terra ecosystem¹.
To take out a loan for 1 unit on Anchor, borrowers must supply at least 2 units worth of LUNA collateral.
Since 1 unit of LUNA produces a 12% yield, 2 units enable 24% yield in total. Of this yield, 4% helps fund the Anchor Protocol; the remainder produces the 20% yield on Anchor that enables Angel Protocol’s charitable endowments².
How UST Retains Value
UST maintains stability through a simple swap mechanism: 1 UST can be exchanged for 1 dollar’s worth of LUNA at any time. If UST becomes less valuable than $1.00, buyers can scoop it up and use the swap mechanism to sell it for $1.00, enabling them to make a profit³. As buyers do this, demand for UST causes the price to go up again until it reaches $1 USD. These economic incentives act rapidly to maintain UST’s stability.
But What About Risk?
The US dollar holds value because people believe that others will accept it. UST (and LUNA) operate similarly — on the premise that people will want Terra’s currency. Even in a very severe whole market price crash in May 2021 that also affected the price of LUNA, the UST-to-USD peg quickly reasserted itself. In sum: both Anchor Protocol and UST have weathered severe stresses and continue to function as intended to this day.
As more applications are created that use the Terra ecosystem, there is more demand for UST and more demand for LUNA. Driving the initial demand for UST is a South-Korean payment system called Chai that has over 2 million users signed up and processes over 100,000 transactions a day.
Usage such as that for that one application shows the demand is there. The number of applications is on a growth trajectory. For example, it is possible now to use UST to buy vouchers that allow you to carry out shopping online and in stores worldwide.
As more merchants accept UST, more users will pay for goods and services with it, incentivizing even more merchants to accept it as payment. The result is a virtuous circle that strengthens confidence in UST’s fundamentals and broadens the user base. Together, these factors increase liquidity and further empower UST’s stabilizing mechanisms to preserve the peg with the US dollar
¹ Ethereum tokens, or ETH, can also be used as collateral.
² Do Kwon, https://twitter.com/stablekwon/status/1371371963046797312?lang=en
³ “Stablecoin — Price Stabilization”. https://docs.terra.money/stablecoin.html#price-stabilization
