Why MIM’s Lack of Liquidity Could Possibly Destabilize UST

MIM, the native stablecoin of Abracadabra, a DeFi lending platform, has been on a roller coaster recently. Last week, after MIM holders unloaded a large portion of their holdings, the stablecoin briefly broke its peg. While MIM managed to recover, its main source of liquidity—Curve’s MIM-3CRV pool—is currently composed of 90.51% MIM and 9.49% 3CRV, which is not good.

These issues around MIM have stirred up discussions about a possible contagion effect on UST, Terra’s decentralized stablecoin. That is because a large amount of UST (aUST more specifically) is used as collateral to borrow MIM, which can be used to earn 100%+ APY rates. 

Understanding Abracadabra’s Strategic Program Degenbox

Degenbox is a strategic program by Abracadabra that aims to enable the acceptance of non-interest-bearing tokens and turn them into yield-generating assets. To achieve this goal, Degenbox utilizes performance-enhancing strategies automatically.

The program has been quite successful since its launch, particularly since it promises unconventional APY rates. In order to start earning with Degenbox, users need to deposit UST tokens which will be used as collateral to borrow MIM. Subsequently, Degenbox bridges the UST with Terra Blockchain. In this stage, 85% of the deposited UST will be bridged while the remaining 15% will be left to ensure seamless withdrawals. 

The UST tokens on Terra will be provided to Anchor Protocol, a savings protocol that pays a fixed yield of roughly 20%. Notably, users will receive aUST tokens in return for their deposited UST tokens in Anchor Protocol. Then, the aUST tokens are bridged back to Ethereum and deposited into the Degenbox contract where they will start earning leveraged yields.

Here is a nice infographic illustrating this process. 

Impact of Declining Anchor Yield on UST Peg

As noted above, 85% of deposited UST tokens will be provided to Anchor Protocol which will, in turn, give aUST tokens. However, the protocol has recently witnessed a steep decline in its yield reserves, which can indirectly impact the UST peg. 

It is worth noting that as long as the Anchor protocol yield reserves are not entirely depleted there is no risk to UST peg. But if the protocol’s yield reserves are depleted, there are three possible scenarios, according to a recent report by the Crypto Risk Assessments.

In the hyperoptimistic scenario, if yields drop by as low as 1% to 3% APR and sustain those levels, the market would consider UST low risk and would not witness significant liquidity exits.

In a more realistic scenario, when yield drops below a certain threshold, large accounts will close their lending positions. As liquidity exits the protocol the total deposited collateral reduces and borrowing yield increases. The APR would climb a little and more liquidity would come back in and drop the yield. This way, there would be an oscillation around an equilibrium APR N%. 

And in a pessimistic scenario, when yield drops below some APR threshold more liquidity might exit the protocol. The fleeing liquidity, in the form of UST tokens, is more probable to exchange for other stablecoins or crypto-assets, which could affect the UST peg. 

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UST Peg Slightly Affected By Abracadabra Saga

Last week, popular on-chain analyst zachXBT took it to Twitter to reveal that 0xSifu, the pseudonymous chief financial officer of Wonderland was actually Michael Patryn, a former convict who had co-founded the defunct Canadian exchange QuadrigaCX which collapsed in 2019. 

Following the revelation, investors started dumping Wonderland’s TIME, which plunged by as much as 40% on the day. Investors also started fleeing liquidity from Abracadabra, a project run by Wonderland lead Daniele Sestagalli, which adversely affected Abracadabra’s MIM algorithmic stablecoin. The low liquidity harmed MIM’s peg on Curve throughout the day.

Over the initial period of contagion, UST’s price merely dropped by $0.995, which is not significant. This implies that UST has a considerable strong peg, which is derived from its deep liquidity and lively arbitrageurs. Despite this, if all of the farmers in Abracadabra offload their UST in a very short period, there is a great possibility that it would lose its USD peg. 

Do you think Abracadabra and its Degenbox strategic program are smart investments? Let us know in the comments below.