Sorting out what's what in crypto can be as confusing as grandmothers trying to figure out which doohickey is a Nintendo and which is an Xbox. "Which one has the little Italian man and the princess?"
There's a lot to figure out about decentralized finance (DeFi), but there shouldn't be any confusion as to why USDH and UST are completely different stablecoins. They stand on opposite ends of a very clear spectrum.
In the past, we addressed “Why USDH” and listed the strengths of Hubble's Solana-native censorship-resistant crypto-backed stablecoin. However, we didn’t fully zone in on the differences between Hubble’s USDH and Terra’s UST, so this article will cover the issue more in-depth.
Collateralized Debt Positions and Minting USDH Through Borrowing
USDH is minted by users who deposit collateral on Hubble. Depositing tokens and borrowing against their value is the only way USDH can be minted, either through a borrowing vault (DeFi Treasury, cToken, or kToken) or via the Peg Stability Module (PSM).
- There are zero mechanisms for creating USDH “out of thin air” without being backed by collateral that can be retrieved by burning USDH.
- There's no mechanism to burn another token, like LUNA, to create an additional USDH supply.
- If USDH is minted and enters circulation, there is always some non-Hubble crypto asset that can be withdrawn by users or liquidated.
The system USDH relies on had its first stress test during the May 2022 meltdown, and it succeeded despite Solana's degraded performance in the midst of a black swan event. In the end, USDH remained fully backed by crypto assets throughout one of the worst storms DeFi has ever seen.
USDH Doesn't Have a Seingorage Token Model Whatsoever
Hubble's system is a far cry from the seignorage token model employed by Terra to mint UST. On Terra’s platform, users could burn LUNA, a token that was supposed to fluctuate in value, to mint UST, a token whose value was supposed to remain stable, and this back and forth was supposed to keep UST pegged to 1 USD.
When UST rose above $1.00, users could burn LUNA for expensive UST and exchange it on the market for a profit. Vice versa, when UST was below $1.00, users could burn UST for $1.00 of LUNA.
When UST de-pegged by just two cents, it set off an epic bank run, and users had few options to exit their positions in UST but LUNA. There was very low liquidity on exchanges for UST, since the majority of circulating UST was deposited on Anchor to earn an APY subsidized by donations of LUNA.
While demand for UST was increasing, LUNA reached new all-time highs as it was burned to mint UST. When users found UST's liquidity had dried up on nearly every market, the next option was to burn UST to mint LUNA, and this process battered LUNA's price, rendering the system useless, and initiating a death spiral.
Hubble uses zero features resembling a seignorage token to mint USDH or stabilize its price. Nearly every stablecoin that has relied on a seignorage token, sometimes called a volatility token, has been laid to rest in the stablecoin cemetery, and this model is recognized by many as flawed.
Why Collateralization Matters for USDH
Do Kwon and the Luna Foundation Guard (LFG) realized late in the game that having collateral backing UST would be a good idea, so they began stockpiling BTC and other tokens. The problem was, having a treasury full of crypto isn’t the same thing as having collateral backing a stablecoin.
There was no direct link on-chain between the existence of UST and the BTC in the LFG’s wallets. It’s pretty much the same system as Olympus DAO and Wonderland claiming their tokens had a price floor that would be defended with assets in their treasury—it’s a human that may have to wake up at 3 AM to start buying back their project’s tokens.
The collateral backing USDH is managed by smart contracts, not a Hubble intern with a crypto wallet ready to deploy capital if anything happens. Calling USDH a crypto-backed stablecoin really means it’s backed by crypto, and it’s backed by more crypto value than the value of USDH in circulation.
More on Collateralization and USDH’s Constant Demand
The tokens accepted to mint USDH includes some of crypto's biggest and most liquid assets. So, if someone borrows more USDH than their maximum loan-to-value (LTV) ratio, which is 80% for tokens in the DeFi treasury, their account will be liquidated:
- Collateral tokens are seized to repay the loan.
- USDH is burned to account for the unpaid debt.
- There is never more USDH in the ecosystem than can be supported by collateral
The fact that Hubble holds users’ collateral until they repay their USDH loan means that USDH has a hard time falling very far below its peg:
- If USDH falls below $1.00, to maybe $0.98, users with USDH loans will buy cheap USDH from the market and get a 2% discount on their loan repayment.
- As users buy USDH off the market to cheaply repay loans, they help bring the price of USDH back up to $1.00 as USDH becomes more scarce.
USDH Allows Users to Safely Unwind Positions
There is very little chance users are not going to repay their loans to get back their collateral, so there is always going to be demand for USDH on the market.
- As UST began dep-pegging to $0.98, panic drove users to sell their UST instead of scoop it up, because there was no incentive to acquire UST as both the stablecoin and LUNA death spiraled to zero.
- As long as there is USDH on the market, there is collateral held in Hubble’s smart contracts. If there is no USDH, then there may be no collateral held in Hubble.
Theoretically, USDH could disappear from the market entirely if every user repaid their loan and took back their collateral, which means USDH’s crypto-backed model can be safely unwound. There is always value available for users to retrieve when they want to exit their position in USDH.
Thought Experiment Time
You have 100 USDH in your wallet. For some catastrophic reason, USDH’s price falls to $0.50. Your choices are:
- A. Panic and swap your USDH for $50
- B. Wait for users with loans to buy 50% off USDH from the market and push USDH back up to $1.00.
- C. Pay off your own loan for 50% off.
- Option A is the worst decision possible, especially if you've acquired USDH from the market.
- Option C is an incredible deal if you're borrowing USDH.
- Enough users choosing Option C makes Option B possible.
Other Major Differences Between USDH and UST
- USDH has many use cases, and it has become the most paired Solana-native stablecoin on the network's decentralized exchanges (DEXs). The main use case for UST was earning 20% APY on Anchor, which ended up being a huge problem. USDH is spreading and increasing its liquidity far and wide.
- USDH is protected by cap limits that safeguard the token against massive movements and exploits. UST was geared toward explosive growth with massive cap limits; USDH has been geared toward sustainable growth.
- USDH generates sustainable yield from Stability Fees, and Hubble isn't turning HBB into USDH to reward users for depositing USDH. A large part of the 20% APY on Anchor was sustained by LUNA donations from Terra, not economic activity, which is the source of rewards for Stability Vault depositors.
Additional Resources on USDH Sustainability
Thanks for joining Hubble on this explication of the differences between USDH and UST. We're obsessed with stablecoins and fostering sustainable DeFi products, and we hope you'll check out some of our other posts that touch on such issues:
- Why Decentralized Stablecoins Matter (Part 1)
- Why Decentralized Stablecoins Matter (Part 2)
- Capital Efficiency in Stablecoin Design
- How Capital Efficient is USDH?
- Deep Dive: Stablecoins and Hubble's USDH
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