Tuesday, September 26

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

Pedestrians walk past a display of cryptocurrency Bitcoin on February 15, 2022 in Hong Kong, China.

Anthony Kuan | Getty Images

A multibillion-dollar bet that bitcoin can act as a “reserve currency” for the crypto economy is already being tested as UST, a controversial stablecoin, struggles to maintain its $1 peg.

UST dropped close to 99 cents over the weekend, fueling fears of a potential “bank run” that could force Terra, the project behind it, to dip into a $3.5 billion pile of bitcoin to support the token.

Now, the Luna Foundation Guard, an organization created by Terra’s inventor, says it will lend out $750 million in bitcoin to trading firms to hold UST’s price peg. But that’s done little to assume investors’ concerns about the implications for bitcoin.

What is UST?

Developed by Singapore-based Terraform Labs, UST is what’s known as an algorithmic stablecoin. It aims to carry out the function of stablecoins like tether, which track the price of the US 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 moon, 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, where investors can exploit deviating prices in each of the tokens. For example, too much demand for UST may result in its price topping $1. That means traders can convert $1 worth of money into UST, and pocket the difference as profit.

Also Read  Boris Johnson says Putin has crossed red line into barbarism

The model is designed to even out supply and demand for UST. When the price of UST is too high, users are incentivized to burn luna and create new UST, increasing the stablecoin’s supply while also decreasing the amount of luna in circulation.

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

When UST’s price is too low, the reverse happens — UST gets burned and luna is minted. That should, in theory, help stabilize prices.

the problem

“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 peg in the short-term.”

There have been multiple instances where UST has decoupled from its $1 peg, raising concerns about the viability of its economic model — particularly in a situation when several people try to redeem their tokens at once.

The latest challenge arrived over the weekend. Hundreds of millions of UST was sold on Anchor, Terra’s flagship lending platform, as well as Curve and Binance, resulting in 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, said in a since-deleted tweet.

‘Reserve currency’

To address concerns about the sustainability of its stablecoin, Kwon plans to buy up to $10 billion worth of bitcoin through a nonprofit called Luna Foundation Guard. These funds would provide a backstop in case of a dramatic fall in the value of UST.

What it means for bitcoin


Leave a Reply

Your email address will not be published. Required fields are marked *