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Lessons learned from the collapse of USDR?

23-10-13 17:00

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Original Title: "USDR Reflection: More Than 500 Days After the Collapse of UST, We Still Don't Understand Stablecoins"

Original Author: Samuel McCulloch

Translated by: Deep Tide TechFlow

On October 12, 2023, 523 days have passed since the UST collapse, and we still do not understand stablecoins.

USDR is a "stablecoin" with a circulation of 60 million US dollars, most of which is backed by UK real estate mortgages. It quickly dropped from 1 US dollar to 0.5 US dollars in a few hours. This is a typical "run" event, where there is a mismatch between the high liquidity debt of the stablecoin and its low liquidity collateral.

It is issued by Tangible, a market for buying and selling real estate mortgage-backed securities (RWA). On this platform, you can purchase tokenized real estate, watches, wine, and gold with USDR.

Real USD... Not a Better Currency

According to the Tangible documentation, "Real USD (USDR) is a new type of rebase, interest-bearing, over-collateralized stablecoin pegged to the US dollar. USDR is primarily backed by interest-bearing, tokenized real estate mortgages."

All USDR can be exchanged for DAI at a cost of 0.25% and a ratio of 1:1 at any time. The protocol reserves millions of dollars in cash to serve as capital buffers and facilitate redemptions.

When the reserve of 12 million US dollars worth of DAI is depleted and holders begin to sell the token on decentralized exchanges to redeem USDR, a run occurs. Now, USDR holders must wait for the company's financial assets to be allocated or sold to cover the collateral shortfall.

USDR's more interesting aspect is that it is a stablecoin based on an algorithm.

USDR can be minted with TNGBL or DAI at a ratio of 1:1. The protocol imposes a maximum limit of 10% on the amount of USDR generated from TNGBL. Funds collected from the exchange are subsequently used for UK real estate purchases. According to Tangible's documentation, excess collateral above the asset-to-liability ratio is used to purchase more real estate mortgages. However, the Tangible team told us that they have never done so and all excess collateral is reserved as reserves.

Real Estate Support

Tangible provides two reasons for using real estate to support USDR.

First of all, real estate can generate income. Tangible properties are all rental properties, which can generate monthly rent, and these rents will flow back to USDR holders through repurchase.

Tangible only purchases real estate in the UK market, with a yield of 6.39%. In comparison, the yield of a 1-month UK government bond is 5.31%.

Secondly, the team pointed out the long-term effect of "price appreciation" in the real estate industry. They stated that real estate has a "predictable appreciation history" and that "the average selling price of American homes has risen from $27,000 in the first quarter of 1970 to $383,000 in the first quarter of 2020."

Then, they claimed in the document that USDR is a "better currency" because it is a "true store of value" that can protect holders from the impact of inflation due to the long-term rise in housing prices.

Just like we didn't learn any lessons from the 2008 financial crisis.

On-demand and affordable

The biggest lie in the cryptocurrency industry is how the three characteristics of currency are presented. We have all heard countless times that currency has three properties: medium of exchange, unit of account, and store of value. However, these are only related to the denomination.

Bitcoin can become a currency because it preserves value, and platforms integrate it as a payment option. This is true for any commodity. Bitcoin can fluctuate by 5%, 10%, or 15% daily, but this does not diminish its ability as a payment method because the price is relative to the US dollar. They say 1 BTC = 1 BTC.

Debt denominated in US dollars must adhere to higher standards. US dollar stablecoins should be redeemable for 1 US dollar or approximately 1 US dollar under any circumstances.

If it can't, then it's not a US dollar currency.

I say "approximately" because if you accept privately issued currency, there will always be some degree of price sensitivity in our society. Only government-issued currency can be considered insensitive to prices because it enjoys full trust in the currency printing press.

Stablecoins are imitations of the US dollar, and FRAX has now entered this category with the launch of v3. Our stablecoin can be sold for approximately $1 worth of USDC, but there is no guarantee. The mission of the Frax DAO is to maintain a treasury of highly liquid assets to maintain the peg, but situations can always change, and portfolios are prepared for the worst-case scenario.

It is worth noting that Tangible implemented a growth strategy on Curve in the first and second quarters of this year. The Llama risk team raised concerns about their mortgage support. Meanwhile, Frax DAO voted to increase the mortgage rate to 100%.

When considering stablecoins, the perspective that must be adopted is "if something happens, the entire national treasury must be sold at a discount, how much can I get back?" If it is not "due as required," then the reference face value is incorrect.

Considering the assets on the Tangible Balance Sheet, we can make the following assumptions:

When the agreement fails, TNGBL tokens have a "similar equity" nature and will be worthless. It cannot add any value to support stablecoins.

The insurance fund and POL held by the team will be extracted to near zero or cut off until redemption to preserve the remaining collateral.

When Tangible sells its properties at a discount to recover funds, they may have to sell at prices below market value due to uncertain market conditions in the future. In addition, the properties are distributed globally, which increases the currency risk of their sale.

1. Asset liquidation: Considering real estate and liquid assets, the current mortgage rate of USDR is 84%.

Assuming that the real estate can be sold without significant discounts, each USDR holder will receive:

0.052 US dollar stablecoin (DAI);

Every stablecoin bill that has been discussed or passed requires all issuers to hold only cash and short-term equivalents, and there is a reason for this. If market conditions deteriorate and investors panic, decoupling/runs are inevitable if you do not have enough liquid capital to redeem. Illiquid debt will increase convexity exponentially. As soon as the market detects any signs of insufficient liquidity, asset prices will immediately be discounted.

At the time of writing this article, the price of USDR is 0.53 US dollars. Even though the team claims that the collateralization rate of these tokens is 84%, the market knows that liquidating the national treasury investment portfolio may take several months, so a corresponding discount has been made.

After this process is completed, USDR will no longer exist. The stablecoin has died after being squeezed out.

Let's be clear... all stablecoins are a form of debt. They are an extremely liquid and interchangeable debt instrument that exists in token form. Tangible believes they can issue debt supported by real estate worth millions of dollars, with zero term risk, accounting for 78% of the total. To some extent, the 30% cash and POL buffer before the collapse is sufficient to provide enough liquidity in the event of a run.

Today's incident has been repeated countless times in traditional finance, and when it is claimed that "measures set up to protect customers are too easy to manipulate to attack the protocol," it shows the essence of the project. Tangible also did not "try new things". The team deliberately targeted illiquid assets to issue redeemable liquid debt tokens. Tangible markets their jargon to non-institutional users who are not worldly-wise.

The reason for the collapse of USDR is frustrating because the Llama risk team has already recorded the risks involved, as they wrote:

In short, Tangible has established several mechanisms to support the peg of USDR. They have envisioned a promising approach (pDAI) to ensure that USDR holders can always redeem USDR for something of equal value. However, most measures are still new and untested, and some measures are completely centralized (such as real estate clearing). Especially in the case of a run, it is questionable whether USDR can maintain its peg. In addition, the project has added complexity and potential weaknesses on multiple dimensions through its wUSDR token and cross-chain integration. These factors are not conducive to the stability of USDR.

However, today we are discussing yet another "stablecoin" failure. This is frustrating because these events are exactly what anti-crypto legislators cite when drafting strict regulations and laws. Tangible's collapse provides more reasons for anti-crypto lobbying, namely why our industry should be shut down.

It's time to eliminate the idea of any stablecoin being supported 100% by anything other than cash or short-term equivalents. Real estate is a good collateral, but allowing 100% loans against home equity in the form of stablecoins is clearly disastrous.

At Frax, we are committed to building a robust stablecoin ecosystem with minimal risk exposure. In the latest v3 release, Frax also uses RWA to provide income for the DAO, but only allows the most liquid assets with the shortest terms: treasury bills, overnight repurchase agreements, US dollars in the Federal Reserve's main account, and selected money market funds. Nothing else.