# 36 | Terra v Maker: War of the Worlds
Conquering Living Space Ain't the Big Deal, That Comes With Keeping It
On Sunday, October 30, 1938, America received news of gas explosions happening on Mars, followed by those of a strange meteorite landing in New Jersey. Reporters rushed to the site to find a metal cylinder that unscrewed letting horrific monsters emerge from its insides. The brave policemen who approached the strange beings waving a flag of truce were brutally obliterated by an extraterrestrial heat ray. What happened later is unclear, at least until five great machines waded the Hudson to reach New York City, pushing thousands to dive like rats into the East River in a desperate attempt to flee an invaded Manhattan.
When Orson Welles left the Mercury Theatre and the rehearsal of Danton’s Death that night, what he found in Time Square was an outraged nation on the verge of a world war, emotionally unprepared to fight a galactic one. Whether the Martian invasion of Earth was fictional rather than real didn't really matter at the time - it was fear and not truth to have paralysing effects. Whether the story of the ironic misunderstanding of a radio broadcasting for a chronicle of the end of the human race is itself fictional rather than real doesn’t matter today either - it is myth and not truth to retain historical consequences.
The self-referencing effects happening between story-telling and story-making are difficult to explore for historians, especially when they accept that the same characters acting in the play are fully aware of them. We live a chaotic system that keeps influencing itself, a chaotic system of the second degree at least. It is the East against the West, the World against the Meta-World, the Church against a Cult, a Tribe against another. Beliefs run strong in everybody's veins, but keeping the faith flowing isn’t cheap. Starting the War of the Worlds doesn’t take much, surviving it is a completely different story.
Hey, 3pool-Ers, Gimme the Loot
On the 1st of April @ezaan posted on Terra’s forum about the Community’s intentions to partner with Frax and [REDACTED] Cartel in order to boost $UST’s multi-chain usage. He made clear it wasn't April Fools’. And my other writing plans flew off the window.
How did they want to do it? Through a newly-deployed Curve pool named 4pool, composed of $UST, $FRAX, $USDC, and $USDT. Exactly, no $DAI. The deployment would be tested on Fantom and Arbitrum chains first, and then finally activated on mainnet. 4pool would become, per Terra’s intentions, the new benchmark liquidity pool on Curve, ousting the 3pool ($DAI + $USDC + $USDT) that currently has a TVL on Ethereum of USD 3.3b. Starting to appreciate the intricacies of the move requires some level of understanding of the Curve model and of what it entails. We have already written about the so-called Curve Wars on DR - here, so rather than repeating ourselves it is more fun to look at a current Curve snapshot and try to decipher it.
The list above includes all mainnet’s Curve pools above USD 1b TVL. What can we learn from it?
3pool is THE liquidity building block → with USD3.3b of TVL the 3pool is the largest stable-based pool on Curve, and it is used as a base block for other pools like Frax’s, Terra’s, and MIM’s
Pools resemble more parking lots than trading venues → big stable pools show relatively limited trading activity - e.g. 0.42% for 3pool, 0.37% for Frax’s, 1.90% for $UST
3pool-based pools are heavily $CRV subsidised → 3pool-based pools are heavily subsidised through $CRV new issuances - yield can be boosted up to c. 10% via $CRV issuance through long-term locks; it isn’t surprising that Frax and Terra are the largest protocol owners of $CVX, with the power to allocate large portion of newly issued $CVX to their own gauges
Market yields are telling us something → there seems to be a persistent arb for stablecoin issuers that play the Curve game - in other words it doesn’t seem rational for depositors to place their stables in the Curve pools vs. lending them natively or through crypto money markets
Point (4) is particularly important for the rest of our discussion. Let’s look at the $UST example. A $UST (Terra’s stable) holder has the option to deposit his holdings on Anchor and clip c. 19.5% - which seems the most obvious play and in effect has c. 12.4b now sitting in the protocol. $UST represents 50% of the Curve pool, with the rest being composed by $USDC+$USDT+$DAI that have a blended deposit rate of c. 2.5% on (e.g.) Aave. It would be therefore rational for a $UST depositor to place holdings in the pool only if the blended yield is higher than 11.0% - all things equal. The total yield for the pool isn’t so high and sits at < 10%; in addition i) it is composed mainly of $CRV-denominated APY, and ii) it is achievable only through a 4-year lock. It doesn’t make sense. But things look differently if we go one level higher. Through Convex, (indirect) depositors in the Curve pool could achieve c. 14.6% - the delta is roughly coming in $CVX form. With no additional sources of revenues existing at Convex level, the difference between the 14.6% achievable thru Convex and the Curve-native c. 10% is, by applying Occam’s Razor, just some form of leverage. The discussion is different for what concerns the difference between c. 10% (Curve all-in yield) and 0.35% - Curve base yield. To me, it’s a lot of risk substitution plus some market inefficiency. Numbers bounce around, but I hope the diagram below can explain better what I mean.
There are a lot of numbers but here’s the summary.
For the investor → Depositing into Convex meta-pool investors diversify out part of their $LUNA volatility risk in favour of more stable (but less remunerative) $USDC+$USDT+$DAI, and instead amplify yield by levering Curve’s base yield up through Curve’s and Covex’s dilutive issuance. Leverage is marked-to-market through $CRV and $CVX pricing. There is no right or wrong, it is a matter of taste for the investors.
For $UST issuer → Terra (Anchor) makes money through lending out $UST; Anchor is the natural parking lot for $UST but it’s very expensive for Terra to maintain; by diverging part of those flows away from Anchor into Curve’s pool Terra is reducing the cost of its liabilities. It is a very good move for Terra.
Cold Wars and Warm Questions
Terra isn't the only one aiming at Curve to reduce its cost of capital. Do Kwon sustained publicly they control 50% of voting power, which would seem consistent with this $CVX leaderboard, that shows Frax as the largest $CVX holder among protocol - with 16.9%, followed by Terra itself - 13.1%, [REDACTED] - 11.3%, and Olympus - 6.7%. Combined that would give us roughly 48%. If we assume < 100% voting participation the number would be high enough to drive emissions, but things are a bit more complex. @CryptoCondom does a different calculation that points to a maximum 13.8% of voting power for the Terra newly formed cartel. The existence of tactical bribing suggests indeed that Terra doesn’t own structural voting majority of the Curve ecosystem: based on Llama Force Frax and Terra paid c. USD 7.8m and c. USD 5.1m respectively through Votium on bribing fees to allocate themselves the lion share of gauge weights on the 4th of April voting cycle and starve the 3pool. Simultaneously, a proposal to create a 2pool USDC-USDT implementation was voted on Curve, basically aiming at marginalising $DAI from Curve’s liquidity building block.
Reminder: this is not a post about tactical prowess and the complexity of governance mechanisms in DeFi, nor about tribal politics and founder-flexing. What concerns us are structural characteristics of complex systems, and the accumulation and release of forces of diverse nature. Ultimately, it is DR’s conviction it pays off to keep eyes on the ball, silence the world around us, and try to answer simple questions. So here are my questions.
Question 1. Why is Terra’s proposing the 4pool?
Question 2. Why are Frax and [REDACTED] joining in?
Question 3. What could depositors do?
Question 4. What will be the effect on the stablecoins landscape?
Q1 → $UST is the native currency and pillar product of Terra. It is a volatility absorber for $LUNA holders (more on this here) and a core pillar of the whole ecosystem. $UST currently sits comfortably at #4 among stables, behind fully centralised web2.5 $USDT, $USDC, and $BUSD, and at #1 well ahead of $DAI and $FRAX among the decentralised coins. We can put aside arguments on how decentralised $UST actually is. Literature on USD teaches us that there is a disproportionate competitive advantage in being the global reference currency. Most recently this status has been achieved through military superiority but Terra doesn’t have it, so it has to pay to obtain it. But bootstrapping a currency into such role through financial incentivisation is expensive. Of the almost USD 17b worth of $UST currently in circulation, $UST 12.4b are sitting in Anchor’s deposit vaults costing the protocol/ ecosystem a hefty 19.5% - and only $UST 0.7b are in Curve’s dedicated pool. By successfully replacing $DAI’s 1.5b 3pool volume Terra would save c. 300m / year of passive interest, more than enough to justify bribing costs, but not enough to solely compensate the depletion in reserves.
Long way to go, but it is a rational direction for Terra. Especially if we as Do believe that the substitution effect can absorb with time not only $DAI but way more volumes from the centralised counterparties too. But it is no coincidence that it was $DAI the target of his marginalisation efforts: the MakerDAO-minted stable is $UST’s #1 competitor among decentralised currency candidates.
Terra cares about sustainability and expansion, and the Curve hack is only point one in Terra’s Reasonable Strats Part Five. They argue it’s about liquidity, but I reply it’s about the cost of liabilities, mainly. Caveat for the chart above: calculations are cash-based and ignore on the one hand $ANC incentivisation and on the other the opportunity costs of holding significant amount of money immobilised in the Curve<>Convex ecosystem. Still, I don’t think it would significantly change the picture, assuming investors would continue willingly to play the Curve game and wouldn’t mind shifting their holdings in favour of $UST. The stickiness of $USDT’s success story tells us currency holders aren’t picky about governance concerns.
Q2 → Let’s clear the easy one first. It isn’t difficult to explain why the [REDACTED] Cartel found attractive to create a larger cartel with the most powerful players in the field. [R] is a meta-governance protocol that intends to attract value to extract even more value through governance mechanisms that promote concentration - hence, partnering with large players enhances their impact. If you are a mercenary paid only following victory it makes sense to partner with the strong side. Frax deserves a more comprehensive answer that can only be partially covered here - DR will soon dedicate a deep-dive to Frax. Of the $FRAX c. 2.8b outstanding, 14.5% is not collateralised (i.e. backed by protocol equity in the form of $FXS) with the rest being collateralised by whitelisted assets. The Curve AMO represents 75% of the collatearlised portion. In simple terms, the AMO (Algoritmic Market Operations) is a venue through which Frax will run open market operations to manage its peg and collateralisation level. Expanding the Curve-based AMO to the 4pool would mean few things for Frax: (i) increase the Curve War loot that can be used as collateral with constructive effects on $FXS (the equity token) price, (ii) insert $UST in the asset pool backing the currency, (iii) more liquidity / less slippage for pegging, (iv) great marketing. I like (iii) and (iv), I am not sure how sustainable (i) is, and I am very nervous about (ii). To me, $FRAX is a beautifully elegant way to add (a little bit of) algorithmic leverage on top of overcollateralised or centralised stables, if $UST becomes a large portion of that backing it would be difficult to control all-in leverage for $FRAX in my opinion.
Q3 → We have argued above that for $UST holders moving funds from Anchor deposits into subsidised Curve pools is equivalent to a risk shift. In more detail, to me this means reducing the long exposure on $LUNA in favour of (humongous) leverage built on top Curve’s base (0.4%) APY, with the benefit of extra TradFi-like collateralisation embedded in the $USDT and $USDC 4pool component. A good proxy of the value the market is putting on such levered yield is given by $CVX market cap movements. Whether this is rational or shortsighted is not for me to say, but looking at Uniswap v3 expansion in USD stable trading I am not sure how sustainable the castle will be, although profitable bribing can go on for a long time looking at Terra’s incentive to keep the liquidity there on Curve - Uniswap doesn’t have similar bribing mechanisms. Adding to the mix that a successful $UST shift from Anchor to Curve assumes absolute indifference of $USDT and especially $USDC between $DAI and $UST, I am not sure how good of a trade this is for investor. Personally I have never been a good market timer, and being leverage extremely time-sensitive this is not a trade for me.
Q4 → MakerDAO has been Do’s public target for a while, and for the reasons we have described above. But the minter of $DAI hasn’t reacted to Terra’s moves. It is arguable, as stated by @jofo_real in his recent brilliant post, that $DAI has developed over time valuable (and cheap) alternatives to sustain its trading fungibility through Uniswap v3 and the PSM - Maker’s 1-to-1 zero-slippage between $DAI and $USDC and, in a much smaller amount, $USDP. While the tight relationship between Maker and centralised minters such as $USDC (currently c. 4.7b out of c. 15.2b total collateral sitting behind $DAI is $USDC) has been under scrutiny recently, it is undeniable that the availability of such liquidity venue will provide significant protection for Maker during the War of the Worlds. Ultimately, however, the struggle to become the decentralised reserve currency of DeFi is a first-past-the-post one. Maker and Terra face each other equipped with divergent competitive advantages: Maker would benefit from a slow-moving conflict of attrition while Terra might intend to suck the air out of $DAI’s sails and relegate it into insignificance as soon as possible. Looked through those lens rhetorics make sense. Interestingly it might ultimately be the old-school corporate called Circle thorough $USDC, a key ally of both Maker (as part of the PSM) and Terra (as part of the prospective 4pool) to be the one deciding the struggle. God bless decentralisation.