Here’s how Terra traders use arbitrage to profit from LUNA and bLUNA

The end of the year is usually a time to cool off and prepare for the holiday season, but the last few weeks of 2021 have seen the cryptocurrency market show no signs of resting.

One of the stories that grabbed the headlines related to Terra reaching an all-time high by Total Locked Value (TVL), the project has overtaken Binance Smart Chain (BSC) as the second largest decentralized finance blockchain after Ethereum. After hitting the $20 billion TVL mark on December 24, Terra’s TVL volume has fallen to about $19.3 billion at the time of writing according to data from Defi Llama, but this is by no means a bearish sign.

Top 5 total value locked to the top 5 block chains. Source: Devi Lama

Currently, Terra has only 14 protocols built on the chain, compared to 257 on the BSC and 377 on the Ethereum network. Terra protocols have been attracting liquidity with great success, and the latest Astroport protocol launch coincides well with the rapid rise of Terra’s original governance token, LUNA, to a new all-time high on December 26, 2021.

Looking at TVL in US dollars against LUNA, the former has seen exponential growth since September 2021 while the latter has remained quite flat over the same period. It is not difficult to see that the contributing factor to the recent increase in the value of TVL in US dollars is the increase in the price of LUNA itself.

Terra TVL in US dollars (left) to LUNA (right). Source: Devi Lama

While price increases in the Governance Token often demonstrate investor confidence in the chain and protocols, they also appear to produce more profitable arbitrage opportunities.

Let’s take a closer look at some of the strategies used to arbitrate between LUNA and its encumbered bLUNA.

LUNA price vs Luna/bLuna premium in percentage. source: Flipside encryption

Why are there spreads in Terra Markets?

LUNA is the governance and betting token of the Terra blockchain, while bLUNA is the token representing the tethered LUNA and its corresponding block rewards. Since bLUNA is exchangeable and transferable just like LUNA, it is also traded on the decentralized Terra exchange.

Like other exchange-traded currency pairs or tokens, a LUNA/bLUNA pair traded on different Decentralized Exchanges (DEX) such as TerraSwap, Loop Markets or Astroport may have different prices due to price inefficiencies across different platforms. Arbitrageurs will benefit from buying at a lower price on one protocol and selling at a higher price on the other, which helps the platforms to solve price inefficiencies and eventually reach a fair price across all exchanges.

Besides the common reason for pricing inefficiency, there are other factors specifically related to the nature of bLUNA that make LUNA/bLUNA price different across protocols.

  • bLUNA is priced higher than LUNA on the anchor protocol. This is because bLUNA, once attached and hammered onto the anchor, cannot be burned and replaced back to LUNA after 21 days (plus the three days of curing time) unless it is an immediate burn.
  • As bLUNA represents not only the accumulated LUNA value but also the block rewards from storage during the 21-day closing period, its value is always higher than LUNA. As shown in the chart below, bLUNA per LUNA price just under 1 on Anchor most of the time, with three outliers showing that bLUNA was more valuable at an average of 0.97 bLUNA per LUNA.
Anchor bLUNA Hourly rate per LUNA less than 1. Source: Flipside encryption
Anchor bLUNA The hourly rate per LUNA is always lower than 1. Source: Flipside encryption
  • LUNA is priced higher in DEXs than bLUNA most of the time probably because:

(1) More users are selling bLUNA than buying on DEX (hence bLUNA value is lower) because bLUNA burn on Anchor protocol takes 21 days if not instant burn. So, if users want to restore LUNA immediately, they should go to DEX to sell bLUNA. (For an instant bLUNA burn on the anchor, the rate is the same as TerraSwap.)

(2) Users usually do not want bAssets assets such as bLUNA unless they need to use them as collateral on Anchor. Currently, Anchor provides a correlation function to substitute LUNA against bLUNA in a ratio very close to 1 but just under 1 – that is, investors receive just under 1 bLUNA for 1 LUNA. Although the exchange rate for DEXs is better (traders get more than 1 bLUNA for 1 LUNA on DEXs), users tend to look for the most convenient way, using the Anchor Bond, to get their bLUNA so they don’t have to switch between protocols different.

How to take advantage of arbitrage opportunities in Terra

Based on the price difference explanations given earlier, there are two main methods for arbitrage LUNA and bLUNA.

TerraSwap, Loop Markets, and Astroport all offer swaps for the LUNA/bLUNA device. Small spreads often exist across these DEXs, creating arbitrage opportunities for traders to buy the pair at a lower price on one DEX and sell at a higher price on another.

LUNA/bLUNA price comparison via DEXs. source: Flipside encryption

The chart below shows the average daily price of a LUNA/bLUNA device observed through swaps from different platforms during December 2021. The ratio is the actual amount of bLUNA received (minus fees and slip) divided by the amount of LUNA offered for the swap. As described in the previous section, a LUNA device swaps more than one bLUNA on DEXs due to the increased demand for LUNA on DEXs.

The chart below annually gives the daily arbitrage return between any two of the three DEXs. The best opportunity was on December 15th between TerraSwap and Loop, with an annualized return (APY) of nearly 600%.

LUNA/bLUNA pair arbitrage between different DEXs. source: Flipside encryption

Arbitration between DEXs and Anchor

Investors can exchange LUNA for bLUNA on one of the DEXs offering the highest level of bLUNA per LUNA, burn bLUNA on Anchor, and wait 21 days (plus three days) to get more LUNA back. Note that the burn on the anchor should be a normal “slow” burn; Instant burn will not work because the exchange rate is the same as TerraSwap.

Based on 24-day annual yield (21 + three days of anchor burnout), the chart below shows the APY of arbitrage between the various DEXs and Anchor.

Judging between DEXs and Anchor APY vs. LUNA Staking APY. source: Flipside encryption

Lido’s APY of 8% of LUNA Liquid Staking has been added as a risk-free benchmark return comparison. During December, the highest APY reached 80% on December 27, and since then, it has fallen significantly, falling below the risk-free return in the new year.

This could be due to the increased popularity of Terra and more involvement in the various Terra protocols that have helped rationalize pricing across platforms, reduce pricing inefficiencies and arbitrage opportunities and thus create a fairer price.

Smart investors are always watching for the next opportunity

As shown in the historically observed swap data in December 2021, LUNA/bLUNA arbitrage opportunities exist across various protocols on Terra. Traders can choose the riskiest method of arbitrage between different DEX platforms such as TerraSwap, Astroport and Loop Markets, or they can choose the safest method of arbitrage between these DEX platforms and Anchor, since they are willing to hold bLUNA for 24 days.

The annual return from the DEX and Anchor arbitrage strategy was consistently better than the risk-free liquid Lido in December 2021 until only recently when the return nearly evaporated on January 1, 2022.

This may have been due to increased participation and price rationalization in the Terra protocols. Arbitrage opportunities are likely to re-emerge in the future due to fluctuations in trade and participation volumes or from the launch of new DEX protocols.

The opinions and opinions expressed here are solely those of the author and do not necessarily reflect the views of Every investment and trading move involves risks, you should do your own research when making a decision.