Summary
Formerly titled [Proposal] A Better Way Forward™ => Say NO TO THE FORK. LFG must instead take over the liability for the $UST debt. This proposal doesn’t relate at all to the V2 fork, references to $LUNA and $UST are for $LUNC and $USTC (Terra Classic versions of the tokens)
Terra (Classic) is bankrupt and it needs a bail out.
Motivation
Right the wrongs caused by de-peggening, give a realistic path to recovery for Terra without requiring a hard-fork.
Edit (27/05/22): I still think if Terra Classic were ever going to thrive it, needs to have a long term plan for the $UST debts. On the consideration that LFG is unlikely to take responsibility for the bankruptcy, the community at least should. I’ve also added Iong term lockups of 1-3+ years as another option in the recovery toolbelt along with $UST purging/burning, because I can see how incentives for this are easier to create when you don’t have any backers.
Proposal
I have been envisioning a better path for Terra going forward:
Terra Classic must live on. $UST is bad debt in a bankruptcy and that’s the only way anyone should be looking at it. LFG or some other actor(s) must take charge of the situation by raising capital to buy back bad $UST and purge it (perma-burn for no return). This proposal explains some ways to do that:
- Dapps should not be struggling to figure out the correct $ value of trades because they tend to conflate $/UST, which I believe in part is a bug in the Oracle. I propose that the Oracle module needs a rework. Treat $UST token as a debt token which has a volatile value between 0 and 1 depending on how solvent Terra is, not as a stablecoin pegged at $1 (which it clearly isn’t anymore while mint/burn is disabled and there is 11B in excess supply).
- Terra Classic needs to raise funds to buy back ~11B excess UST.
E.g. buy back over time at ~$0.25/UST = -$2.75bn (edit 27/05/22: 11B UST now only valued at $311M today at UST’s current price of $0.03). This needs to be the first goal of Classic stakeholders, not burning $LUNA which will counterintuitively only serve speculators and market makers who want to offload their $LUNA. $LUNA burning was only good because of its role in the $UST stabilisation mechanism, so we must fix that first. - $UST can be forced back towards its old peg value of $1 if the market could be incentivised to buy $UST at heavy discount then lock up or purge large amounts of $UST from the circulating supply. While there is still far (far) too much UST for it to be worth $1, early lockups should be longer and burning would be a great alternative if it can be incentivised without more $LUNA minting.
- Only after specific conditions indicating solvency have been met according to the updated Oracle module, mint/burn can be re-enabled. My proposal is about patching the vulnerabilities in the mint/burn mechanism which caused the $LUNA gigamint de-peg event. Even better, I’m suggesting that by fixing the mechanism and purging the debt LFG & Terra community created before, we can bring back profitable seignorage and $LUNA burning which is a great mechanism which just needs to be defended appropriately. Fix the problems quietly while your mandate is buying back the $UST debt at pennies on the dollar, then I think you’d see $LUNA come back stronger than ever before.
The Debt Repurposing - $UST gigaburn and lockup phase:
I think dapps have an opportunity to innovate on many different ways to get the community aligned with getting the bad $UST off exchanges and locked up or burned. The only constraint we have is to create incentives for getting rid of $UST other than more $LUNA minting.
Terra Classic stakeholders need to play it smart to acquire the $UST back at a fair discount, and so should work to keep $UST beneath a target acquisition price ($0.25 per UST token was initially used in my calculations) by making markets with soon-to-be burned $UST which they acquired cheaply.
While original $LUNA classic holders will still be diluted heavily, they will have lots of time and opportunity to pick up $LUNA at discount during the $UST burning phase. Since $LUNA supply will be stable at ~7T without burn/mint, we can expect mercenary capital to exit $LUNA during the debt repayment phase, new $LUNA purchasers would not be punished by dilution for allocating to $LUNA while minting is disabled. Airdrops could be targeted at $LUNA holders from prior to the de-peggening if it’s felt that they need more value back.
Terra Solvency Rating (TSR), Market and Oracle Modules v2.0, $LUNA buyback
Many Lunatics seem to think that we have to pivot everything because the system failed under intense pressure (coordinated governance attack). I prefer changing things minimally, since Terra ecosystem worked great 99.9% of the time. The goal should just be to patch the vulnerabilities which were actually exploited in the end causing the de-peg event.
i.e. Mint / burn is what distinguished Terra, we shouldn’t be aiming to do away with it completely! However, giga dilution of $LUNA equity should never have been possible. I propose adding a Terra Solvency Rating (TSR) to the Oracle module which aims to detect insolvency from unexpected exit liquidity on or off chain.
TSR falling below 100 would trigger another debt repayment phase where excess $UST supply would have to be re-purchased and burned. New $LUNA or $UST could be minted again only when peg is close enough to $1 for TSR>=100. Therefore $LUNA value does not go to zero by dilution when Terra is insolvent, the insolvency death spiral is patched because excessive $LUNA minting cannot occur when solvency is low.
I think protocol developers are better placed than me to discuss implementation details for TSR, but I’m knowledgeable enough to be sure that building it is absolutely possible if we still have brilliant devs around to help.
$LUNA burns to mint $UST were always brilliant with few drawbacks for Terra, an extemely profitable and successful seignorage mechanism which prevented $UST from trading >$1. We can and should re-use this when the $UST burn phase is completed (i.e. debts are repaid) and the system is regaining stability where $UST can find its peg back at $1. However it would be prudent to only allow minting of new $UST when the oracle reports a solvency rating of >=100.
(edit 27/05/22): When I originally wrote this proposal, I wanted to stop the fork so that LFG could take responsibility of the mess they created here.
Now it has become clear that it will not be them who have to follow any mandate, but whichever mad person(s) wants to buy Terra Classic.
For this to work, stakeholders need to be incentivised to buy back $UST and either lock it up long term / or burn it when solvency is low (i.e. when $UST is not worth $1).
To prevent the $UST death spiral happening again, stakeholders would need to be incentivised to lock up exogenous collaterals in contracts which help to backstop the $UST peg. LFG was on the right track trying to back their reserves with exogenous collateral ($BTC buys), but it should have been a diverse portfolio of collaterals, some being interest bearing staking instruments similar to what Anchor was building for their Borrow dapp, some not. A key unsolved challenge is still that this lockup feature needs to be done with audited smart contracts, rather than trusting some centralized actor like LFG.
This would be a space for dapp innovation, in particular I think longer term lockups with the option of functional $UST borrowing against the true value of your collaterals. I say this because Anchor Borrow at this time only allows you to borrow as much UST as the $ value of your bonded assets making it effectively useless - could new borrowing dapps be built once the Oracle is updated to account for $UST as a volatile token?
Rather than repeating the mistake of publicly announcing huge purchases, focus on quietly bidding on a diversified basket of quality apex assets to build a reserve backstop, at fair value or discount (no more free lunch for frontrunners). Of these reserve assets, $LUNA shouldn’t exceed an allocation of (e.g.) 5%, and it would be liquid and ready to use to mint $UST when it trades above $1 (and solvency is 100).
Reserves held by Terra are weighted into the TSR; this incentivises stakeholders to follow up on their secondary mandate to lock up a portfolio of apex collaterals in a Terra Classic reserve while profiting consistently from seignorage and remaining highly solvent. This closes the final loophole by making $UST far more resistant to extreme $LUNA volatility.
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You see guys, it is going to take a lot of hard work to shake off the big whale $LUNA bags that have been getting huge amounts of coins for scraps. That is why it’s necessary to have a slow and brutal debt repayment phase during which $LUNA whales will distribute their $LUNA back into the community’s hands.
With newfound confidence instilled by Terra’s commitment to a UST debt repayment plan, community could again realistically speculate on $LUNA making long term gains while still priced at handsome discounts from exiting whales, knowing that the reserve will be buying $LUNA for seignorage - this is all made possible by first buying back and locking up or burning bad $UST.
Feedback welcome.