DeFi Users Fret ‘Contagion’ Risk Amid Possible Stablecoin Depegging

A scandal has rocked investor faith in a popular stablecoin, and as users rush to exit, the clamor is threatening to throw the asset off its dollar peg.

Even worse, however, some observers worry that one stablecoin losing its peg could have a “contagion” effect, diminishing the value of multiple stablecoin assets as well.

On Thursday, popular on-chain analyst zachXBT revealed on Twitter that the pseudonymous CFO of DeFi project Wonderland was in fact Michael Patryn, the co-founder of the notorious fraudulent Canadian crypto exchange QuadrigaCX.

Read more: How Did a Former Quadriga Exec End Up Running a DeFi Protocol? Wonderland Founder Explains

The revelation pushed the price of Wonderland’s TIME as much as 40% lower on the day, and investors have likewise been fleeing from Popsicle Finance and Abracadabra, a pair of projects also run by Wonderland lead Daniele Sestagalli.

Abracadabra’s MIM algorithmic stablecoin is among the victims of the crisis in confidence, with users fleeing Curve pools for the asset that is popular among yield farmers. The ensuing low liquidity has briefly pushed MIM off its dollar peg on Curve throughout the day.

This, in turn, has thrown Terra’s UST stablecoin into flux In addition to a MIM-UST Curve pool linking the assets, Abracadabra offers a “degenbox” product that allows for leveraged yield farming with deposits into UST – a dynamic that means MIM is heavily collateralized with UST.

According to semi-anonymous Curve core contributor Charlie, this creates a potentially dangerous link where if one of these stablecoins falter, the other will, in turn.

In an interview with CoinDesk, Charlie said that while Thursday’s events have tested the peg of each stablecoin, both have thus far withstood the volatility.

Wavering peg

According to Charlie, Thursday’s stablecoin volatility is due to investors running for the exits.

“People in the Curve pools have the choice to withdraw their liquidity from the pool in one coin, and that’s what we’re seeing now – a lot of people withdrawing to coins that aren’t UST or MIM,” he said.

Indeed, major liquidity providers, such as crypto investment firm Alameda Research, have moved to withdraw liquidity from Curve pools in the past twelve hours. On-chain analysts noted that Alameda unwound a $500 million position Thursday evening, and the amount of liquidity in the UST-MIM pool on the Ethereum mainnet has halved since Thursday morning to $230 million at the time of writing.

$MIM $UST pool still 1:1 but farmers have pulled 40% of liquidity this morning ($530M -> $300M) from that @CurveFinance pool. Something to keep an eye on.

Before 0xSifu news
$300M $UST, $229M $MIM

After 0xSifu news
$176M $UST, $127M $MIM pic.twitter.com/7aYgZLdViW

— FreddieRaynolds (@FreddieRaynolds) January 27, 2022

During a brief flash crash Thursday evening, the MIM-3pool reserves were just a $40 million in USDC/DAI/USDT for $1.2 billion in MIM (down from a near-even $1.3 billion to $1.3 billion split on Tuesday), causing a depegging that bled over to UST.

“UST, because it’s backing is so much MIM it’s essentially pegged to it, so the dip that Alameda just caused a few minutes ago, it means UST comes down with MIM,” said Charlie of the relation.

However, there are incentive-based stabilization mechanisms for the assets that so far have held up under the strain of major liquidity providers withdrawing.

According to Charlie, if users deposit 3pool stablecoins into Curve when MIM or UST are depegged from a dollar price, the timing grants the users a “bonus” to their position.

Likewise, users can withdraw MIM or UST and redeem the tokens on Terra or Abracadara, which always treats their value as $1, giving them a bonus on redemption if the assets are unpegged.

“These mechanisms are enticing for liquidity providers who want to take the other side of that trade,” said Charlie.

Contagion contained

While some observers following the asset peg saga have expressed worry that UST and MIM could serve as a “contagion” that destabilizes other pools on Curve, Charlie said that the current likelihood of the volatility expanding beyond MIM and UST appears low.

“So far, on the hard dips we’ve seen it didn’t seem to affect the other stablecoins. If anything, people are running away from MIM and UST and to other stablecoins,” he said.

He added that the core Curve team has been discussing contagion “quite extensively” throughout the day, but at the moment their concerns are concentrated on the MIM and UST pools.

“When the day started I didn’t think it would get this bad, but it did, and so far things are holding up okay,” he concluded.

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