What is terraUSD (UST) and how does it affect bitcoin?

What is terraUSD (UST) and how does it affect bitcoin?

A multibillion-dollar wager that bitcoin can act as a “reserve currency” for the crypto financial system is already being examined as UST, a controversial stablecoin, struggles to keep up its $1 peg.

UST dropped near 99 cents over the weekend, fueling fears of a possible “bank run” that might drive Terra, the undertaking behind it, to dip right into a $3.5 billion pile of bitcoin to help the token.

Now, the Luna Basis Guard, a corporation created by Terra’s inventor, says it will lend out $750 million in bitcoin to buying and selling corporations to carry UST’s value peg. However that is executed little to assuage traders’ issues in regards to the implications for bitcoin.

What is UST?

Developed by Singapore-based Terraform Labs, UST is what’s often known as an algorithmic stablecoin. It goals to hold out the perform of stablecoins like tether, which observe the worth of the U.S. dollar, but without any actual cash held in a reserve to back it.

Instead, UST — or “terraUSD” — is created by destroying a sister token, known as luna, using smart contracts, lines of code written into the blockchain.

“If you’ve got, say, $405, and you burn one luna, you should be able to mint 405 of the UST stablecoin,” Carol Alexander, professor of finance at the University of Sussex, explains.

The same applies vice versa — new luna is minted by burning UST and other algorithmic stablecoins that Terra supports.

Terra’s protocols also feature an arbitrage mechanism, the place traders can exploit deviating costs in every of the tokens. For instance, an excessive amount of demand for UST might lead to its value topping $1. Which means merchants can convert $1 value of luna into UST, and pocket the distinction as revenue.

The mannequin is designed to even out provide and demand for UST. When the worth of UST is too excessive, customers are incentivized to burn luna and create new UST, growing the stablecoin’s provide whereas additionally reducing the quantity of luna in circulation.

“The luna becomes more scarce, which makes it more valuable, transferring that value into UST,” Alexander says.

When UST’s value is too low, the reverse occurs — UST will get burned and luna is minted. That ought to, in concept, assist stabilize costs.

The issue

“This assumes normal market conditions,” mentioned David Moreno Darocas, a analysis 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 peg in the short-term.”

There have been a number of cases the place UST has decoupled from its $1 peg, elevating issues in regards to the viability of its financial mannequin — notably in a state of affairs when a number of individuals attempt to redeem their tokens without delay.

The newest problem arrived over the weekend. Lots of of thousands and thousands of UST was bought on Anchor, Terra’s flagship lending platform, in addition to Curve and Binance, leading to accusations of a “coordinated attack” on the stablecoin.

“Men will literally attack a stablecoin unsuccessfully instead of going to therapy,” Do Kwon, the South Korean crypto entrepreneur who co-founded Terraform Labs, mentioned in a since-deleted tweet.

‘Reserve foreign money’

To handle issues over the sustainability of its stablecoin, Kwon plans to purchase as much as $10 billion value of bitcoin by means of a nonprofit known as Luna Basis Guard. These funds would supply a backstop in case of a dramatic fall within the worth of UST.

The thought is that bitcoin would act because the “reserve currency” for the Terra ecosystem.

LFG bought another $1.5 billion in bitcoin last week, taking its total reserves to about $3.5 billion. However, on Monday, the organization said it is taking steps to “proactively defend the stability” of UST.

That includes lending $750 million worth of bitcoin to trading firms to “protect the UST peg” and a further 750 million in UST being lent out to buy more bitcoin “as market conditions normalize.”

“In the case of most of these algo stablecoins, we have seen that the teams behind the project usually need to step in — so these are not fully decentralized or managed independently yet,” said Vijay Ayyar, head of corporate development and international at crypto exchange Luno.

What it means for bitcoin

Investors are worried that UST’s bitcoin underpinning will result in further pain for the cryptocurrency.

The world’s largest digital coin dropped below $33,000 on Monday, slumping to its lowest level since July 2021. It was last trading at about $32,921, down 6% in the last 24 hours.

LFG’s intervention “will add to the selling pressure,” said Derek Lim, head of crypto insights at the Bybit exchange. “BTC will likely go lower before it bounces back when short-sellers take profit.”

Kwon insisted LFG is “not trying to exit its bitcoin position.”

“As markets recover, we plan to have the loan redeemed to us in BTC, increasing the size of our total reserves,” he said.

The plan is to eventually allow UST holders to redeem their tokens in exchange for bitcoin. Bitcoin would play the role normally taken by luna in a crisis scenario, with arbitrageurs buying UST and then swapping it for discounted bitcoin. But this is still weeks away from being implemented, and it’s unclear how it would work in practice.

The biggest risk moving forward would be another depegging of UST forcing LFG to liquidate its bitcoin holdings, said Hendo Verbeek, head of quantitative trading operations at Faculty Group. That could, in turn, result in further liquidations of “over-leveraged” buyers, according to Verbeek.

“This is a nightmare scenario which looks like a real outcome of events,” he said.

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