Drastic times call for drastic measures. And today, the Luna Foundation Guard (LFG), a non-profit supporting all things Terra (LUNA), has voted to lend $1.5 billion in crypto to protect its native stablecoin.
The organization’s council voted to lend out $750 million in Bitcoin from its reserves and $750 million in TerraUSD (UST) to keep the latter asset pegged to $1.
The organization made the loan to an unnamed “professional market maker,” according to the founder and CEO of Terraform Labs Do Kwon.
The loan has been made in light of UST briefly falling below its dollar peg amid extreme volatility in the crypto markets.
2/ First, *LFG is not trying to exit its bitcoin position*.
The goal is to have this capital in the hands of a professional market maker such that:
1) Buy UST if price < peg2) Buy BTC if price >= peg
thus significantly strengthening the liquidity around UST peg
— Do Kwon 🌕 (@stablekwon) May 9, 2022
On Saturday, the stablecoin fell as low as $0.985. Today, it’s trading at $0.995. These aren’t extreme fluctuations, but they aren’t ideal for a stablecoin.
Thus, the lent capital would be used to buy UST if the asset continues to fall below its peg and sell UST (and buy BTC) if the asset is greater than or equal to its peg.
It is expected that the resulting UST buy pressure would push the stablecoin back towards $1. Conversely, the resulting sell pressure would have the opposite effect in case the token is trading above $1.
Unpacking UST and Luna
Terra’s native UST stablecoin is a unique offering on the market.
Unlike more traditional stablecoins like Tether’s USDT or Circle’s USDC, UST is decentralized and algorithmic.
It’s decentralized in that the token isn’t maintained by a centralized entity or backed by centralized assets (be it cash, bonds, equities, or otherwise).
Instead, UST maintains its stability through a mint-and-burn mechanism using the ecosystem’s staking and governance token LUNA. Here’s how it works.
This mechanism lets people redeem 1 UST (no matter the price of that UST) for $1 worth of LUNA. Each time that swap is made, the UST in question is destroyed (or, in crypto speak, burnt) and removed from circulation. Thus, whenever 1 UST doesn’t equal $1, arbitragers may quickly swap the UST for the $1 in LUNA, selling the LUNA and turning a small profit.
This also makes UST more scarce and, theoretically, lifts its price back to the peg. Additionally, buying UST to take advantage of this trade adds buy pressure which has a similar effect on raising the price.
The mechanism, however, came under immense pressure as users began selling UST en masse in exchange for other stablecoins on the decentralized exchange (DEX) Curve Finance as well as Binance.
At least one report indicates that a single address sold 85 million UST for 84.5 USDC on Curve.
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