SUMMARY: Given the rapid changes in the UST ecosystem, the on-chain liquidity parameters should be updated to preserve stability, in the following ways:
- Increase BasePool size to 50,000,000 SDR
- Reduce PoolRecoveryPeriod to 36 blocks
The Terra ecosystem continues to scale at rapid clips. At the same time, it has also encountered new stresses. On one hand, the average daily volume is $1.25 billion — as compared to $350 million in a similar analysis conducted eight months ago (link)! Moreover, the total UST float has grown from $2 billion to $10 billion. But at the same time, strong liquidation pressure spilling over from Wonderland, MIM, and others have put the peg under stress in the last few days. It’s time for a fresh look at the on-chain parameters.
Despite the changing circumstances, the primary attack vector has always been the oracle attack, as covered in more depth in our previous proposal. This is where on-chain liquidity derived from the oracle price exceeds the off-chain liquidity used to generate that oracle price. A careful analysis is thus needed to ensure that the additional liquidity meant to stabilize the ecosystem is not drained at the expense of stakers or the broader Terra ecosystem.
We have done such an analysis, and believe that the optimal solution is to increase the base pool size from 32 million SDR to 50 million SDR, and to decrease the refresh period for the pool from 49 blocks to 36 blocks. This will increase the ability to mint or burn LUNA on-chain by 116% (i.e. more than double the status quo), based on our simulations. In particular, we estimate the total capacity for mint/burns to be $293 million, up from $135 million today, per day under this change. Moreover, this does not greatly change the risks arising from oracle attacks, as compared to the status quo.
At the same time, we recommend leaving other parameters untouched — namely the minimum spread should remain fifty basis points and the oracle voting period should remain five blocks. Indeed, we estimate the 99th percentile of the absolute return over a five-block voting period to be almost exactly fifty basis points. This is depicted on the plot below, in which the x-axis is approximately Terra blocks, and the y-axis is the absolute return in the LUNA/UST pair (in basis points).
This proposal should enhance the liquidity of the on-chain mechanism for now, but there are further solutions under development. For instance, we could adjust those other two parameters — the minimum spread and oracle voting period — in tandem. Moreover, we could make the on-chain liquidity a more complex function of off-chain liquidity, rather than utilizing static parameters. But note that this and all other solutions under development continue to view the on-chain mechanism as the means to expand and contract the money supply, and not as a means to facilitate ordinary exchanges. Those latter functions are better served by Terraswap and other venues that provide UST liquidity.