🥛 CHAOS! The Bank Run on UST

Shaan Puri & Ben Levy
May 10, 2022

https://delta.onelink.me/a1Ot/milkroad

GM. This is the Milk Road, where we tell you what’s going on in crypto faster than a nun on rollerblades. 

Sorry for the late send today. Two reasons: 

  1. I’m on family vacation in Hawaii. I’m currently writing this on the bathroom floor so I don’t wake up the kids
  2. Today’s major story is the bank run on UST, and we were waiting for the official update from the team, but rather than wait we're sending now, and will send another email once we get the update.

OK let’s dive into the drama

Estimated read time: 3 minutes and 47 seconds

  • 🌕 Chaos for UST & Luna
  • 🖼️ Azuki NFT Drama
  • 📈 Chart of the Day

CHAOS FOR UST AND LUNA

I’ve been investing in crypto for ~8 years now, and yesterday was one of the craziest days in a long time. 

What Happened? 

$UST - one of the largest stablecoins in the world (worth ~$18B at its peak) got hit with a major attack to try and “break the peg”. 

The attack worked, and the stablecoin broke peg from $1 down to ~$0.64 (uh..not very stable) for most of the day before bouncing back to ~$0.90.

Luna/UST has been a star performer over the past year in crypto. Luna was up as much as ~25X in the past year, and UST became one of the top 5 largest stablecoins in the world. 

But all along, we all wondered…

What happens if there is a bank run? Will it go into a “death spiral”? Critics believed it was inevitable. 

Believers knew it was possible, but the risk reward ratio was still in their favor.  Now - we find out who is right. 

Why This Story Matters:

Three reasons: 

  1. Stablecoins are meant to always stay at $1. Minor fluctuations (like, pennies) are normal, but going down to $0.90, $0.80, $0.70 and finally $0.64 is a nuclear bomb for the project.
  2. This hurts everybody - Forget about the bagholders who own Luna/UST (aka the Milk Road portfolio). To defend the peg, the team behind UST and the investors who back it had to take $1B+ in other collateral (Bitcoin, ETH) and get ready to sell it to try and save UST. This hurts Bitcoin and ETH too with huge sell pressure
  3. This breaks trust - Even if the peg recovers today to $1, many people will lose trust in UST after seeing it attacked and nearly fall. This also gives regulators room to try and put their grubby paws on stablecoins (which they view as a big threat to the dollar, because stablecoins are essentially a digital replacement of the dollar). Janet Yellen already came out and mentioned the need to regulate stablecoins more closely and that we need a regulatory framework for them. 

Why Did It Happen?

Was this random chance? Or a coordinated attack? Like when George Soros bet against the pound to “break the Bank of England” (and profited $1B doing it) 

What triggered the bank run? 

We asked some friends who uh..know things and they believe two things:

  1. This is a coordinated attack
  2. The attacker is likely Citadel (you may remember them as the whales who saved the hedge funds against the Reddit Gamestop short squeeze) 

Citadel is one of the world’s biggest market makers. In 2020, they made $6.7B and $4.1B in EBITDA and hadn’t raised any outside capital previously.

They make about as much money as Nike, Starbucks, and Paypal. Yeeeeesh. This is a dramatic entrance to the crypto game. 

Here’s the Play-By-Play of what went down:

  • The "attacker" cleared out liquidity pools on Curve Finance, which was ~$300M UST
  • Then they started dumping the UST which caused people to panic and sell their UST - this all caused a minor depeg
  • UST backers like Jump and LFG started selling other crypto assets like ETH and BTC to buy UST and bring the peg back
  • That may have been exactly what the attacker wanted because it seems like they were actually shorting BTC (aka betting the price was gonna go down, they anticipated this because they knew LFG would need to sell their BTC to regain peg). Basically - they knew the counterpunch and were going to profit from that too 
  • Mass panic hits and people start selling on exchanges which caused huge congestions
  • Exchanges halted UST and Luna trade until things could stabilize
  • This caused even more panic so people started withdrawing even more UST from Anchor, which caused a bank run for the protocol. Over 50% of all funds were withdrawn in the span of 48 hours

Here’s where we’re at now:

  • UST has come all the way to back to $0.91(still not back $1, but closer)
  • Luna price dropped from ~$90 a few days ago down to ~$24 and now is at $31 at the time of publishing. 
  • Do Kwon tweeted out that an announcement/update is coming shortly. (not published at the time of this writing) 

LUNA has also put two safety nets in place: 

1/ They announced a $1.5B loan from their reserve -  $750M of BTC to over-the-counter trading firms to help protect the peg of UST and $750M worth of UST to accumulate more Bitcoin

2/ They moved another ~$1.4B from their reserve wallet to protect and bring the peg back. 

A week ago, this wallet had ~$4B in all crypto reserve assets. Now, the reserve wallet has NO bitcoin left (it’s all been moved to a Binance wallet to be sold) and only has ~$195M in other crypto left. 

Sounds scary, but at the same time - this is the point of the reserve. To protect the health of the project in case of a death spiral. If UST depegs, they can sell these assets to buy more UST and save the day.

Here’s what smart people are saying about the whole episode: 

The absolute best summary of the situation comes from Jon Wu. The thread has nearly 20,000 likes because it is such a good breakdown of the whole situation.  You can read it here.

Sam Bankman Fried, the founder of FTX: Just as the outside view skeptics predicted, during a large market move a stablecoin blew out.  

“Stablecoins can serve some useful purposes, but if you zoom out, right, and you say this is a stablecoin, backed by volatile assets, what’s gonna happen in a big move. Right? Like you know how this is gonna play out.”

Raoul Pal, macro investor & friend of the Milk Road: UST looks like they stepped away from support. That gets the shorts hot to trot! But when everyone is all in on the short side, they are the vulnerable ones, not the peg. I have no idea how it plays out and have no skin in the game but I see that the LFG held off from using reserves and that is smart. The drama is probably not over. It's a hunch…

Emin Gun Sirer, CEO of Avalabs (the company building Avalanche): 

My thoughts and takeaways today:

1. We need a decentralized stablecoin. Fiat-backed stables are subject to legal seizure and capture. A decentralized economy needs a decentralized stablecoin whose backing store cannot be frozen or confiscated.

2. If there'll be a decentralized stablecoin that succeeds, it'll be the one with the biggest value and the most battle-tested team. 

Let that sink in. It's not a game where johnny-come-lately has a chance.

3. Overall, the UST depegging played out exactly as we saw in past historical cases. I'm even more bearish on all copycats, and bullish on UST once the dust settles down.”

4. The bounce back is a great arbitrage opportunity. The dynamic that gives rise to a bank run executes in reverse on the way back.

The Milk Road’s Take: 

Disclosure, we invested about ~$200k into Luna at a ~$40 price point last year. And hold some small amount on anchor earning yield.

This has always been a big risk. What happens in a bank run? 

Can it survive a death spiral? Our take was never “will it happen” but “what will happen…when it happens?”

How resilient would it be? Would the $4B worth of crypto in the reserve be enough to defend? Will public trust be shaken or gone forever? 

My prediction (not financial advice, just a personal prediction): 

  1. The peg will return to $1 soon
  2. But regaining public trust will take a long time, and maybe never happen. As they say, trust is earned in drops and lost in buckets. Many people will be shaken by this. 
  3. You will hear many stories in the next few days about traders making a LOT of money on the bounceback trade (eg. people buying UST last night when it was $0.64 made some profit)

We are going to be watching closely to see what Do Kwon and the Luna Foundation Guard say when they tweet out their update later today. 

A LAUGH TO MAKE IT ALL BETTER

Don’t worry, UST is fully backed…

AZUKI NFT DRAMA

You know what they say in PR 101.  Drop bad news behind bigger and badder news. 

While UST was in a downward spiral, Azuki (a top 5 NFT project) opened up the kimono to share who was behind the project.

The issue was Zagabond basically admitted that he was the founder of 3 projects before this that have: 

  1. Rug pulled it’s backers (abandoned the project and left those who invested holding the bag) 
  2. He faked being a girl for one of them to get traction

Just another day in crypto, a dude acting like a girl to sell an NFT. 

The market responded by dropping the floor price from 20E --> 12E on Azukis.

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CHART OF THE DAY

MEME OF THE DAY

Couldn’t agree more. 

See ya tomorrow!

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DISCLAIMER: 

None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.

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