The end of the year is normally a time to relax and prepare for the holiday season, but the final weeks of 2021 saw a cryptocurrency market that showed no signs of slowing down.
One of the headline-grabbing stories related to Terra hit an all-time high in terms of total locked value (TVL), with the project surpassing Binance Smart Chain (BSC) as the second-largest decentralized finance blockchain after Ethereum.. After hitting the USD 20 billion TVL mark on Dec 24, Terra’s TVL dropped to around USD 19.3 billion at the time of writing, according to data from Defi Llama, but this by no means, forms or establishes a bearish signal.
Currently, Terra only has 14 protocols built into the chain, compared to 257 protocols on BSC and 377 on the Ethereum network. Terra’s protocols have been very successful in attracting liquidity, and the recent launch of the Astroport protocol coincides very well with the rapid recovery of Terra’s native government token, LUNA, to a new all-time high on December 26, 2021.
Regarding the TVL in US dollars against LUNA, the former has experienced exponential growth since September 2021, while the latter remains fairly flat during the same period. It is not difficult to see that the contributing factor to the recent rise in the TVL in US dollars is the increase in the price of LUNA itself.
While price increases in the governance token often show investor confidence in the chain and protocols, it also appears to generate more lucrative arbitrage opportunities.
Let’s take a closer look at some of the strategies used to arbitrage between LUNA and its consolidated asset bLUNA.
Why are there spreads in the Terra markets?
LUNA is the governance and participation token of the Terra blockchain, while bLUNA is the token that represents the LUNA with participation and its corresponding block rewards. Since bLUNA is fungible and transferable just like LUNA, it is also traded on Terra’s decentralized exchange.
Like other currency pairs or tokens traded on exchanges, the LUNA / bLUNA pair traded on different decentralized exchanges (DEX) such as TerraSwap, Loop Markets or Astroport may have different prices due to price inefficiency on different platforms. Arbitragers will benefit from buying at a lower price in one protocol and selling at a higher price in another, which will help platforms resolve price inefficiencies and ultimately reach a fair price across all exchanges.
In addition to the common reason for pricing inefficiency, there are other factors specifically related to the nature of bLUNA that cause the LUNA / bLUNA price to differ between protocols.
- bLUNA is priced higher than LUNA in Anchor Protocol. This is because bLUNA, once bonded and minted in Anchor, can only be burned and exchanged to LUNA after 21 days (plus three days of processing time) unless instantly burned.
- Since bLUNA not only represents the value of the LUNA wagered, but also the block rewards for staking during the 21-day blocking period, its value is always higher than LUNA. As shown in the graph below, the price of bLUNA per MOON is slightly below 1 on Anchor most of the time, with three distinct outliers showing that bLUNA turned out to be more valuable at a rate of 0.97 bLUNA per MOON. .
- LUNA is priced higher in DEX than bLUNA most of the time possibly due to:
(1) More users sell bLUNA than those who buy in DEX (therefore bLUNA is worth less) because burning bLUNA in Anchor Protocol takes 21 days if not an instant burn. So if users want to get LUNA back instantly, they have to go to a DEX to sell bLUNA. (For an instant recording of bLUNA on Anchor, the rate is the same as TerraSwap.)
(2) Users typically don’t want bAssets as much as bLUNA unless they need to use them as collateral at Anchor. Anchor currently provides the linkage functionality to swap LUNA for bLUNA at a very close but slightly less than 1 ratio, meaning inverters get just under 1 bLUNA for 1 LUNA. Even though the exchange rate on DEX is better (traders get more than 1 bMON for 1 MOON on DEX), users tend to look for the most convenient way, which is to use the Anchor Bond, to get their bMON for that. they don’t have to switch between different protocols.
How to Capitalize on Terra Arbitrage Opportunities
Based on the explanations of price differences presented above, there are two main ways to arbitrate LUNA and bLUNA.
TerraSwap, Loop Markets and Astroport offer swaps for LUNA / bLUNA. There are often small price differences between these DEXs, creating arbitrage opportunities for traders to buy the pair at a lower rate on one DEX and sell it at a higher rate on another.
The following graph shows the daily average price of LUNA / bLUNA observed of the swaps of different platforms during December 2021. The ratio is the actual amount of bLUNA received (after deduction of fees and slippage) divided by the amount of LUNA offered by the swap. As explained in the previous section, a MOON trades for more than one bMON on DEX due to increased demand for MOON on DEX.
The graph below annualizes the daily arbitrage performance between two of the three DEXs. The best opportunity existed on December 15 between TerraSwap and Loop, with an Annual Percentage Yield (APY) of almost 600%.
Arbitration between DEX and Anchor
Investors could trade LUNA for bLUNA in one of the DEXs offering the highest bLUNA per LUNA, burn bLUNA on Anchor and wait 21 days (plus three days) to recover more LUNA. Note that the Anchor burn has to be a normal “slow” burn; instant burns won’t work because the exchange rate is the same as TerraSwap.
Based on the 24-day annualized performance (21 + three days of Anchor burn processing), the graph below shows the APY of arbitrage between different DEX and Anchor.
LUNA’s liquid staking 8% Lido APY is also added as a risk-free benchmark performance comparison. During the month of December, the highest APY reached 80% on December 27 and has since declined significantly, falling below risk-free returns in the new year.
This could be because Terra’s increased popularity and increased participation in different Terra protocols have helped to streamline pricing across all platforms, reducing pricing inefficiencies and arbitrage opportunities, and consequently creating a fairer price. .
Smart investors are always on the lookout for the next opportunity
As shown in the historically observed swap data from December 2021, there are arbitrage opportunities for the LUNA / bLUNA pair on different protocols on Terra. Traders can choose the riskiest form of arbitrage between different DEX platforms such as TerraSwap, Astroport and Loop Markets, or they can choose the safest form of arbitrage between these DEX and Anchor platforms, given that they are willing to hold bLUNA for 24 days.
The annualized performance of the DEX and Anchor arbitrage strategy performed consistently better than Lido’s risk-free liquid staking in December 2021 until recently, when the performance nearly evaporated on January 1, 2022.
This was possibly due to increased participation and price rationalization in Terra’s protocols. Arbitrage opportunities are likely to reappear again in the future due to volatility in trading volumes and staking or the launch of new DEX protocols.
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