Pedestrians pass by the Bitcoin cryptocurrency exhibition on February 15, 2022 in Hong Kong, China.
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The multibillion-dollar bet that bitcoin can act as a “reserve currency” for the crypto economy is already being tested as the UST, a controversial stable coin, struggles to maintain its $ 1 bond.
The UST fell close to 99 cents over the weekend, sparking fears of a potential “bank attack” that could force Terra, the project behind it, to dive into a $ 3.5 billion bitcoin pile to support the token.
Now, the Luna Foundation Guard, an organization created by inventor Terra, says it will lend $ 750 million in bitcoin to trading companies to keep the UST price down. But little has been done to allay investor concerns about the implications of bitcoin.
What is UST?
Developed by Singapore-based Terraform Labs, UST is what is known as algorithmic stablecoin. Its goal is to perform the function of stable coins such as tether, which track the price of the US dollar, but without any real cash held in reserve to support it.
Instead, UST – or “terraUSD” – is created by destroying a sister token, known as the moon, using smart contracts, lines of code written in a blockchain.
“If you have, say, $ 405 and burn one moon, you should be able to mint 405 UST stable coins,” explains Carol Alexander, a professor of finance at the University of Sussex.
The same is true the other way around – the new moon was minted by burning UST and other algorithmically stable coins that Terra supports.
Terra’s protocols also contain an arbitration mechanism, where investors can take advantage of deviating prices in each of the tokens. For example, too much demand for UST can cause its price to exceed $ 1. This means that traders can convert the $ 1 moon into UST and insert the difference as a profit.
The model is designed to balance supply and demand for UST. When the price of the UST is too high, users are encouraged to burn the moon and create a new UST, increasing the supply of stable money while reducing the amount of the moon in circulation.
“The moon is getting smaller, 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 is burned and the moon is forged. This should, in theory, help stabilize prices.
“This assumes normal market conditions,” said David Moreno Darocas, a research analyst at CryptoCompare.
“During a period of high volatility and unilateral buying / selling activity for the UST, the upper stabilizer may not be sufficient to maintain fixation in the short term.”
There have been several cases where the UST has broken away from its $ 1 bond, raising concerns about the viability of its economic model – especially when several people are trying to redeem their tokens at once.
The last challenge arrived over the weekend. Hundreds of millions of UST have been sold on Anchor, Terra’s leading lending platform, as well as on Curve and Binance, resulting in accusations of a “coordinated attack” on stablecoin.
“Men will literally unsuccessfully attack stabilcoin instead of going to therapy,” said Do Kwon, a South Korean crypto entrepreneur who co-founded Terraform Labs, in an after-deleted tweet.
To address concerns about the sustainability of its stablecoin, Kwon plans to buy up to $ 10 billion worth of bitcoin through the nonprofit Luna Foundation Guard. These funds would provide a backstop in the event of a dramatic drop in the value of the UST.
The idea is that bitcoin would act as a “reserve currency” for the Terra ecosystem.
LFG bought another $ 1.5 billion in bitcoins last week, bringing its total reserves to about $ 3.5 billion. However, on Monday, the organization said it was taking steps to “proactively defend the stability” of the UST.
This includes lending $ 750 million worth of bitcoins to retailers to “protect the UST connection” and a further $ 750 million in UST loans to buy more bitcoins “as market conditions normalize”.
“In the case of most of these algo-stable coins, we’ve seen that the teams behind the project usually have to get involved – so they’re not yet fully decentralized or managed independently,” said Vijay Ayyar, head of corporate and international cryptocurrency exchange. The moon.
What that means for bitcoin
Investors are worried that UST’s bitcoin support will result in 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 sales pressure,” said Derek Lim, head of crypto insight on the Bybit Stock Exchange. “BTC is likely to fall lower before it returns when retailers make short profits.”
Kwon insisted that LFG “is not trying to leave its bitcoin position”.
“As markets recover, we plan to have our loan redeemed at BTC, increasing the size of our total reserves,” he said.
The plan is to eventually allow UST owners to redeem their tokens in exchange for bitcoin. Bitcoin would play the role typically taken by Luna in a crisis scenario, with arbitrage associates buying UST and then exchanging it for discounted bitcoin. But this is still weeks away from implementation and it is unclear how it will work in practice.
The biggest risk in progress would be another reduction in UST that would force LFG to liquidate its bitcoins, said Hendo Verbeek, head of quantitative trading operations at Faculty Group. This, in turn, could result in further liquidations of customers with “excessive financial indebtedness,” Verbeek believes.
“This is a nightmare scenario that looks like the real outcome of the event,” he said.