Pedestrians pass by an exhibition of cryptocurrency bitcoin on February 15, 2022 in Hong Kong, China.
Anthony Quan Getty Images
A multibillion-dollar bet that bitcoin could act as a “reserve currency” for the crypto economy is already being tested as the UST, a controversial stable coin, struggles to maintain its fixed value of $ 1.
The UST fell close to 99 cents over the weekend, fueling fears of potential “banking” that could force Terra, the project behind it, to dive into a $ 3.5 billion bitcoin pile to sustain the token.
Now, the Luna Foundation Guard, an organization founded by inventor Terra Do Kuon, says it will allocate $ 750 million in bitcoins to commercial companies to keep the UST fixed price. But this has not been done to allay investors’ concerns about the implications for bitcoin.
What is UST?
Developed by the Singapore-based Terraform Labs, UST is what is known as an algorithmically stable coin. It aims to perform the function of stable coins such as tether, which track the price of USD, but without any real money kept in reserve to secure it.
Instead, UST – or “terraUSD” – is created by destroying a sister token known as luna, using smart contracts, lines of code written in the blockchain.
“If you have, say, $ 405 and burn one moon, you should be able to cut 405 from UST stablecoins,” said Carol Alexander, a professor of finance at the University of Sussex.
The same is true – the new moon is minted by burning UST and other algorithmic stable coins that Terra supports.
Terra protocols also include arbitration mechanism, where investors can use deviating prices in each of the tokens. For example, too much demand for UST can lead to a price increase of $ 1. This means that traders can convert a $ 1 moon into UST and collect the difference as a profit.
The model is designed to match supply and demand for UST. When the price of UST is too high, consumers are encouraged to burn the moon and create a new UST, increasing the supply of stablecoin while reducing the amount of luna in circulation.
“The moon is becoming scarcer, which makes it more valuable, transferring that value to the UST,” says Alexander.
When the price of UST is too low, the opposite happens – UST burns and the moon is cut. This should, in theory, help stabilize prices.
“This implies normal market conditions,” said David Moreno Darokas, a research analyst at CryptoCompare.
“During periods of high volatility and unilateral buying / selling activity for the UST, the above stabilizer may not be sufficient to maintain the fixation in the short term.”
There have been numerous cases in which the UST has broken away from its $ 1 commitment, raising concerns about the viability of its economic model – especially in a situation where several people are trying to cash their tokens at once.
The last challenge arrived over the weekend. Hundreds of UST millions were sold to Anchor, Terra’s leading lending platform, as well as Curve and Binance, leading to allegations of a “coordinated attack” on Stablecoin.
“Men will literally fail to attack Stablecoin instead of going to therapy,” said Do Kuon, a South Korean crypto-entrepreneur who co-founded Terraform Labs, in a deleted tweet.
To address concerns about the sustainability of the stablecoin, Kuon plans to buy up to $ 10 billion worth of bitcoins through a non-profit organization called the Luna Foundation Guard. These funds would provide a safeguard mechanism in the event of a dramatic drop in the value of the UST.
The idea is for bitcoin to act as a “reserve currency” for Terra’s ecosystem, similar to how central banks hold large amounts of dollars in their foreign exchange reserves.
LFG bought another $ 1.5 billion in bitcoins last week, with total reserves reaching about $ 3.5 billion. However, on Monday, the organization said it was taking steps to “proactively protect the stability” of the UST.
This includes borrowing $ 750 million worth of bitcoins from commercial companies to “protect UST binding”. and another 750 million in UST are lent to buy more bitcoins, “with the normalization of market conditions.”
“In the case of most of these algae stablecoins, we saw that the teams behind the project usually need to intervene – so they are not yet fully decentralized or managed independently,” said Vijay Ayyar, head of corporate development and international cryptocurrency exchange. on the moon.
What does this mean for bitcoin
Investors are worried that bitcoin at the heart of the UST will cause additional pain for the cryptocurrency.
The largest digital coin in the world fell below $ 33,000 on Monday, falling to its lowest level since July 2021. It last traded at around $ 32,921, down 6% in the last 24 hours.
LFG’s intervention will “add to the pressure of sales,” said Derek Lim, head of crypto insights at the Bybit exchange. “BTC is likely to fall lower before bouncing back when short sellers take a profit.
Kuon insisted that LFG “is not trying to get out of its bitcoin position.”
“With the recovery of the markets, we plan to repay the loan in BTC, increasing the amount of our total reserves,” he said.
The plan is to eventually allow UST holders to redeem their tokens in exchange for bitcoins. Bitcoin will play the role that luna usually takes on in a crisis scenario, with arbitrators buying UST and then replacing it with bitcoins at a discount. But this is still weeks of implementation and it is unclear how it will work in practice.
The biggest risk ahead would be another reduction in UST compatibility, forcing LFG to liquidate its bitcoins, said Hendo Verbeek, head of quantitative trading operations at the Faculty Group. This, in turn, could lead to further liquidations of “over-leverage” buyers, according to Verbeck.
“This is a nightmare scenario that seems like a real result of events,” he said.