Terra's LUNA Jumps 15% as UST Stablecoin Gets $1B Bitcoin Reserve

LUNA's fortunes are closely tied to UST. The stablecoin's creation is facilitated by burning LUNA.

Feb 23, 2022 at 11:26 a.m. UTC
Updated Feb 23, 2022 at 3:46 p.m. UTC

Omkar Godbole is the senior reporter on CoinDesk's Markets team.

Buoyed by positive news flow, LUNA, the native token of the smart contract blockchain Terra, has become the best-performing major cryptocurrency in the last 24 hours.

The cryptocurrency has risen nearly 15%, topping the $55 mark, outshining crypto market leader bitcoin's near 4% rise by a significant margin, CoinDesk data show. Other notable gainers on the list of coins with at least $1 billion market value are blockchain-like public network Hedera's HBAR token, up 14.5%, and Avalanche's AVAX cryptocurrency, up 12%.

LUNA's leadership perhaps stems from Singapore-based non-profit organization Luna Foundation Guard's (LFG) decision to create a bitcoin-denominated reserve as an additional layer of security for UST – Terra's decentralized stablecoin, whose value is pegged 1:1 to the U.S. dollar.

LFG announced on Tuesday that it had raised $1 billion through private token sales to build the bitcoin reserve and the buyers will lock up the coins for a four-year vesting period. The funding round was led by the likes of Jump Crypto and Three Arrows Capital.

"Raising a BTC reserve is a smart move and may result in lesser fluctuations of UST during future bouts of market volatility," Matthew Dibb, chief operating officer and co-founder of Stack Funds, said. "Ideally, LFG would take steps to keep the reserve 100% on-chain for transparency rather than through centralized means, however, the price action of Luna since the announcement has been largely promising in restoring confidence to the Terra ecosystem."

Pseudonymous decentralized finance researcher Westie tweeted that the deal is extremely important for Terra's stability, LUNA's value capture.

Increased stability might bring more robust demand for UST, resulting in reduced LUNA supply. LUNA's fortunes are closely tied to UST as the stablecoin's creation is facilitated by burning LUNA. In other words, to mint 1 UST, $1 worth of LUNA must be taken out of circulation.

According to the data tracking website CoinGecko, UST's market capitalization has surged from roughly $300 million to over $12 billion in one year, establishing the dollar-pegged digital asset as the fourth-biggest stablecoin worldwide. Meanwhile, LUNA has chalked up a near sixfold rally in the past 12 months.

Why BTC reserve?

Unlike tether and other centralized stablecoins, UST isn't backed by dollars and its peg is maintained by allowing users to alter UST and LUNA supplies.

Here is how it works: Terra's swap function allows users to always swap $1 worth of Luna for 1 UST, and vice versa, according to the official blog. So when UST trades at $0.98, users can buy one UST for $0.98 and then swap the same for $1 of LUNA through Terra's swap function and sell LUNA in the market. The protocol burns one UST and mints LUNA, driving UST's supply lower and putting upward pressure on UST's price.

On the other hand, if UST trades at $1.02, LUNA holders can swap $1 worth of LUNA for 1 UST through the swap function and sell the UST in the market at $1.02, pocketing the difference. In the process, the protocol burns LUNA and mints UST, increasing the stablecoin's supply and putting downward pressure on the peg.

The mechanism is rewarding during bull runs but can be detrimental during a market crash when there is less incentive to mint either of the two coins to keep the peg intact, as explained in a Twitter thread by Westie.

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Pseudonymous DeFi researcher Westie's Twitter thread

The bitcoin reserve is expected to mitigate that risk to some extent, given the top cryptocurrency is less correlated to Terra's ecosystem and arbitrageurs can swap UST to bitcoin to support UST's peg. In a press release, the Luna Foundation Guard said that moving forward, it may introduce other major non-correlated assets within the market to the reserve.

"The fund will serve as a "release valve" for UST redemptions during selloffs [periods of significant UST demand contraction]," Ilan Solot, a partner at the Tagus Capital Multi-Strategy Fund, said in an email.

"The UST Forex Reserve further strengthens confidence in the peg of the market's leading decentralized stablecoin UST," Kanav Kariya, president of Jump Crypto, said in a press release. "It can be used to help protect the peg of the UST stablecoin in stressful conditions. This is similar to how many central banks hold reserves of foreign currencies to back monetary liabilities and protect against dynamic market conditions."

Looking ahead, the investor optimism from LFG's reserve announcement, coupled with signs of risk reset in the broader market and the impending launch of Mars Protocol's lockdrop, could keep LUNA better bid.

"Lockdrop allows users to lock UST into Mars' Red Bank in exchange for a distribution of $MARS tokens that are claimable once the protocol launches," analytics firm Delphi Digital said in a daily market update. The protocol goes live today, and users will have until Friday to participate in the lockdrop.

"Mars (an advanced money market protocol) is (finally) launching, with $18.5 million of UST locked up for Phase 1 of the token distribution," Tagus's Solot said.

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Omkar Godbole is the senior reporter on CoinDesk's Markets team.

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Omkar Godbole is the senior reporter on CoinDesk's Markets team.

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