The Curve Wars and 4Pool Drama (Part 2)

This is Part 2 of a multi-part series on the Curve Wars and 4Pool drama. It shifts focus onto the growth of UST and its partnership with MIM in the lead-up to 4Pool.

Note: This article is not financial advice. Hubble Protocol does not endorse any of the tokens or platforms mentioned in this article.

Welcome to Part 2 of the 4Pool drama. If you missed Part 1, you can find it here. To recap: the 4Pool was a joint venture between Terra Labs and Frax Finance to create a new Curve base pool that would challenge the 3Pool, and indirectly DAI, for stablecoin liquidity.

Before DAI found its home in the 3Pool, it broke peg repeatedly due to the stresses of the market, yield farming, and a host of other issues in decentralized finance (DeFi). DAI's 3Pool inclusion has often served as evidence that achieving deep liquidity on Curve provides one of the biggest moats protecting decentralized stablecoins against price fluctuations.

By early 2022, DAI was more stable than ever with the help of a 0% fee Peg Stability Module (PSM) that allowed risk-free arbitrage between DAI and several fiat-backed stablecoins. Unfortunately for Curve, the PSM diverted billions of dollars in swaps from 3Pool, and it began looking like DAI had outstayed its welcome with Curve and a set of DeFi users.

The 4Pool was going to challenge DAI's perceived complacency by creating a new base pool that could be paired with other tokens. Half UST and FRAX, half USDC and USDT, the 4Pool would be a huge deal for two algorithmic stablecoins that experienced explosive growth over the previous year.

Incentivizing users to move their liquidity from the 3Pool to the 4Pool with token rewards emissions and bribes would provide UST and FRAX with a multi-billion dollar moat defending their pegs. Once filled to the brim with liquidity, the 4Pool was supposed to herald the dawn of a new era fueled by algorithmic stablecoins.

Focus on Terra: The Rise of UST and Anchor's 20% APY

On May 19, 2021, a flash crash (blamed by some on a Chinese crypto ban and others by a negative tweet from Elon Musk) wiped out nearly half of ETH's value and around a third of BTC's in 12 hours. From May 19 to 24, Terra's LUNA fell from $16 to $4.    

Notice the slight dip in May.

At the time, UST's circulating supply was around $2 billion, and the crash saw UST's price fall to a low of $0.89, floating below peg for nearly a week. Then, according to Terra, on May 27, 2021, the stablecoin managed to "gradually heal over the weekend" back to $1.00 in value.

Before the May 2021 de-pegging event, the circulating supply of UST had surged to over $2 billion in just two months. Anchor, a Terra lending protocol introduced in the middle of 2020, offered a fixed-rate 20% APY on UST deposits, which sped up UST adoption by a significant amount as word spread.

The Defiant expected Anchor's rates to be around 6% on March 22, 2021.

At the beginning of March 2021, UST had a market cap of less than $500 million. By the May flash crash, 1.5 months later, nearly $800 million worth of UST had been deposited on Anchor by users settling for a modest 20% APY when much of the ecosystem claimed annualized returns over 100%.  

As a rapidly successful startup, Terra found itself playing a whole new ballgame, including new rules and physics for scaling UST. May 2021 showed that the parameters and mechanics pegging UST to the dollar didn't hold up to a stress test when scaled. At the behest of Jump Capital, Terra made some adjustments to improve the peg of its algorithmic stablecoin on the rise.  

One change included raising redemption limits for UST and LUNA from $20 million to $135 million. This cap raise was a massive jump from the previous increase of $10 million to $20 million, as can be seen in this list of proposals:

From a proposal to raise minting capacity to $1,200M for restoring UST's broken peg.

Before the Luna Foundation Guard (LFG) began buying BTC as a measure to defend UST's peg, burning UST to mint LUNA was the sole mechanism for restoring its parity with USD. The side-effects of raising the minting cap could increase downward price pressure on LUNA as more of it entered the market during such a process, but how else could the peg for a multi-billion dollar stablecoin be restored?

Why Would Terra Want to Launch a Highly Liquid and Competitive 4Pool?

Why wouldn't Terra want UST to be part of the most liquid stablecoin pool on Curve? Deep liquidity on Curve leads to a more stable peg, and when UST's peg was unstable, LUNA paid the price for the sake of saving UST.

A solution to peg stability that didn't rely on minting LUNA (which was hitting all-time highs again and again) was found in the 4Pool. Instead of inheriting deep liquidity by pairing UST with 3Pool, UST could achieve the deepest stablecoin liquidity in DeFi by becoming the 3Pool.

The stars were beginning to align: DAI was losing favor with the Curve community, and the Curve Wars had reached a point where an incentivized takeover of the 3Pool was made possible by Convex's CVX and bribes. Around half the names in the graphic below were going to pitch in on driving incentives to 4Pool.

Delphi Digital: Terra, Frax, and multiple 4Pool allies held the majority of CVX that controlled Curve.

Additionally, attracting UST liquidity to Curve en masse could help sustain the stablecoin's demand when Anchor planned to reduce its 20% rate. If Anchor didn't reduce its APY, then Terra would have to keep injecting hundreds of millions of dollars into the protocol to keep it afloat.  

In January 2022, Cointelegraph reported that, "In the past 60 days, the total deposit amount [on Anchor] has increased from $2.3 billion to $6.1 billion, while the total borrowed amount only increased from $1.2 billion to $1.5 billion," and Anchor's reserves were depleting.

A heavily incentivized 4Pool could "compete" with Anchor for deposits of UST. Another venue for earning rewards with UST would take some of the burden off of Anchor and, at the same time, provide deep liquidity for both UST and FRAX.  

Enter the Degenbox and UST's Ramped Up Presence on Curve

Much of the blame for Anchor's dwindling reserves can be placed on the launch of Abracadabra's Degenbox. The Degenbox was an automated cross-chain stablecoin leverage strategy that looped MIM borrows against aUST (Anchor's receipt token) back into Anchor as UST for up to 8x on 20% APY.

Coincidentally, the launch of the Degenbox strategy happens to align with one of UST's fastest growth spurts. That sharp tick on the graph is the difference between a UST market cap of $2.9 and $7.2 billion:

A key mechanism in Degenbox's operations was the addition of an incentivized MIM-UST pool on Curve. For the loop to work, MIM borrowed against aUST on Abracadara had to be swapped back into UST somewhere, and the steps to make these swaps possible were taken in early October 2021.

Sifu mode?

Terra began driving liquidity to Curve after the Degenbox went live. On November 30, a Terra team member submitted: Proposal to significantly increase liquidity on Ethereum Curve UST pools through the use of Votium, Convex, and Tokemak.

The proposal noted that there was only $15 million of liquidity in the Wormhole UST-3CRV pool. Therefore, a goal of achieving $500 million in TVL for this Curve pool was set in this proposal, a 33x in the pool's growth.

Then, one week later (December 8), another proposal landed on Terra's forum that was more pointedly aimed at boosting MIM-UST: Increase Liquidity on Ethereum Curve Part 2: The MIM and FRAX Partnerships. Here, we can see the first signs of a 4Pool brewing:

On Ethereum, the largest source of stablecoin liquidity comes from the Curve 3Pool (3CRV) which has over 4B in combined liquidity between DAI, USDC, and USDT. The most important note here is that all three of these are relatively centralized stablecoins. Over the past three months, we have seen a rapid increase in stablecoin market share by decentralized stablecoins; UST market cap has grown from 2.5B to 8.3B, Abracadabra’s MIM 0 to 3.7B, and FRAX 0.68B to 1.3B.
To create sufficient liquidity between the most prominent decentralized stablecoins in crypto, the Terra community should enter into strategic partnerships with MIM and FRAX. Strong liquidity between these three stables is important as defi begins to transition from centralized to decentralized primitives throughout all chains and applications.

As a result of the partnership between UST and MIM, the Curve MIM-UST pool reached $1 billion in TVL and remained balanced nearly 50/50 for the entire month of January. MIM and UST seemed prepared to take over DeFi!

For Curve, the synergy between UST and MIM was a boon. When the Degenbox pumped swaps through MIM-UST, Curve began collecting additional fees, and everyone liked that.

The image above, clipped from a Crypto Risks Assessments report on Degenbox and the risks it posed to Curve, shows that $122,448 was collected by the Curve community on one $300 million swap through Degenbox.

Accusations of Impropriety, an Old Name Resurfaces, and the Loss of UST's Moat on Curve

The Crypto Risks Assessessments report asserted, "Strategies like Abracadabra Degenbox's Viking Attack and potentially other products will eventually deplete Anchor yields." As mentioned before, Anchor's reserves were depleting at a noticeable rate.

Image borrowed from Crypto Risks Assessments.

The Anchor community, separate from the Terra community, began discussing the issue at length in a post titled "Anchor Earn vs Borrow. growing chasm." The Degenbox was considered a "parasite on the system," and users were puzzled about why Terra played along.

On January 4, one user alleged that the Degenbox wasn't just a tool for leveraging cross-chain yield on stablecoins. Perhaps the "Viking Attack" on Anchor—and the liquidity it created on Curve—allowed Terra to fund Project Dawn, a massive capital expenditure based on LUNA reserves, without sending off any alarms.

These allegations resurfaced on Twitter at the end of January, first from @fozzydiablo and again in June from the highly visible Terra critic @Fatmanterra. While FatMan's accusations must be taken with a grain of salt, the whistleblower does make a very salient point about the effect of the MIM-UST pool strengthening UST's peg:

Do Kwon denied funneling $2.7 billion through Abracadabra's elaborate strategy, but another bombshell allegation that couldn't be rejected ended the Degenbox. One of the brains behind Degenbox, known by the pseudonym Sifu, was the infamous Michael Patryn, Co-founder of QuadrigaCX.

This was incredibly bad news for the UST and MIM partnership. Sestagalli, the head of Abracadabra, had tweeted how the MIM-UST pool would "enable Sifu mode" back in October 2021, and now it appeared that the Degenbox was inspired by one of crypto's biggest fraudsters.  

By the end of January, with Degenbox firing on all pistons and the MIM-UST pool at $1 billion in TVL, "Sifu mode" was swiftly abandoned, MIM briefly de-pegged as users fled from their positions, and the Curve community watched as it broke a record for highest daily volume.

According to DeFi Llama, on January 27, Anchor's TVL was $8.8 billion. By January 31, four days later, its TVL was reduced to $6.8 billion. After that, it took less than a month (just 23 days) to regain the TVL lost by Degenbox's collapse, and from that point, deposits into Anchor were increasing weekly.

UST was doing fine in the aftermath, and the market caps for MIM and UST tell two entirely different stories after Sifu's outing. First, after riding a steady plateau through January, MIM's market cap nearly falls off the chart, and UST's s begins climbing ever higher.

Although they had spent months in collaboration, it looked like MIM was no longer a viable option for pairing with UST and FRAX to help "transition from centralized to decentralized primitives throughout all chains and applications."

To Be Continued in Part 3

In Part 3 of this series, we leave MIM behind as FRAX plays a bigger role in the Curve ecosystem. The story of the 4Pool also reaches its climax, which involves the de-pegging of UST and what happened after that, which will be explored more than the de-pegging event itself.

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