Pedestrians pass a Bitcoin cryptocurrency exhibition on February 15, 2022 in Hong Kong, China.
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A multi-billion dollar bet that bitcoin can serve as a “reserve currency” for the cryptocurrency economy is already being tested as UST, a controversial stablecoin, struggles to maintain its $ 1 peg.
UST fell nearly 99 cents over the weekend, fueling fears of a potential “bank run” that could force Terra, the project behind it, to dive into a $ 3.5 billion stack of bitcoins to support the token.
Now, the Luna Foundation Guard, an organization created by Terra’s inventor, says it will lend $ 750 million in bitcoin to commercial companies to maintain UST’s price. But this did little to presume investor concerns about the implications for bitcoin.
Developed by Singapore-based Terraform Labs, UST is what is known as an algorithmic stablecoin. It aims to perform the function of stablecoins such as tether, which track the price of the American dollarbut cashless actual held in a reserve in support.
Instead, UST – or “terraUSD” – is created by destroying a twin token, known as the moon, using smart contracts, lines of code written into the blockchain.
“If you have, say, $ 405 and burn a moon, you should be able to mint 405 UST stablecoins,” explains Carol Alexander, a finance professor at the University of Sussex.
The same is true vice versa: new luna is minted by burning UST and other algorithmic stablecoins supported by Earth.
Earth protocols are also active arbitration mechanism, where investors can take advantage of the diverted prices in each of the tokens. For example, excessive demand for UST could cause its price to exceed $ 1. This means that traders can convert $ 1 of moon to UST and pocket the difference as a profit.
The model is designed to equalize UST supply and demand. When the price of UST is too high, users are incentivized to burn the moon and create new USTs, increasing the supply of the stablecoin and also decreasing the amount of the moon in circulation.
“The moon gets dimmer, which makes it more valuable, transferring that value to UST,” says Alexander.
When the price of UST is too low, the opposite happens: UST is burned and the moon is minted. This should, in theory, help stabilize prices.
“This assumes normal market conditions,” said David Moreno Darocas, a research analyst at CryptoCompare.
“During periods of high volatility and one-sided buy / sell activity for UST, the above stabilizer may not be sufficient to maintain the short-term anchor.”
There have been several instances where UST has decoupled from its $ 1 anchor, raising concerns about the viability of its business model, particularly in a situation where multiple people attempt to redeem their tokens at the same time.
The latest challenge came over the weekend. Hundreds of millions of FSOs have been sold on Anchor, Terra’s flagship lending platform, as well as Curve and Binance, prompting allegations of a “coordinated attack” on the stablecoin.
“Men will literally attack a stablecoin without success instead of going to therapy,” Do Kwon, the South Korean entrepreneur who co-founded Terraform Labs, said in a tweet.
To address concerns about the sustainability of its stablecoin, Kwon plans to buy up to $ 10 billion worth of bitcoins through a nonprofit called the Luna Foundation Guard. These funds would provide support in the event of a sharp decline in UST’s value.
The idea is that bitcoin would act as a “reserve currency” for the Earth ecosystem.
LFG bought another $ 1.5 billion in bitcoin last week, bringing its total reserves to around $ 3.5 billion. However, on Monday, the organization said it was taking steps to “proactively defend stability” of the FSO.
This includes lending $ 750 million in bitcoin to commercial companies to “protect the UST peg” and another 750 million in UST lending to buy more bitcoins “as market conditions normalize.”
“In the case of most of these Algo stablecoins, we have seen that the teams behind the project usually have to step in, so these are not yet fully decentralized or independently managed,” said Vijay Ayyar, Head of Corporate Development and International at Crypto exchange luno.
Investors are concerned that UST’s bitcoin support will cause further pain for the cryptocurrency.
The largest digital currency in the world it fell below $ 33,000 on Mondayplunging to its lowest level since July 2021. It was last trading at around $ 32,921, down 6% in the past 24 hours.
LFG’s intervention “will increase the selling pressure,” said Derek Lim, head of cryptocurrency information at the Bybit exchange. “BTC will likely go down before bouncing back when short sellers profit.”
Kwon insisted that LFG “is not trying to get out of its bitcoin position”.
“As the markets recover, we expect to have the loan repaid in BTC, increasing the size of our total reserves,” he said.
The plan is to allow UST holders to redeem their tokens in exchange for bitcoin. Bitcoin would play the role normally played by Luna in a crisis scenario, with arbitrators buying UST and then exchanging it for discounted bitcoins. But implementation is still weeks away and it is unclear how it would work in practice.
The biggest risk going forward would be another UST depegging forcing LFG to liquidate its bitcoin holdings, said Hendo Verbeek, head of quantitative trading operations at Faculty Group. This, in turn, could lead to further liquidations of “overly leveraged” buyers, according to Verbeek.
“This is a nightmare scenario that looks like the real outcome of events,” he said.