Terra’s UST: Do Kwon’s Big Bet On Bitcoin

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8 mins read

Stablecoin issuer Terra aims to acquire US$10 billion in Bitcoin for its reserves. It’s doing so through a series of purchases, and once complete, the holdings should make Terra the largest single holder of Bitcoin – after Satoshi.

Why is the company buying such a biblical amount of Bitcoin? 

Founder Do Kwon announced that the accumulation is part of a plan to open a new monetary era with Bitcoin as a standard. The core idea is not new. Bitcoin, just as gold, is a hard asset and it is encouraging to see entrepreneurs place such a high degree of confidence in Bitcoin. But then, Do Kwon also thinks that Avalanche and other tokens constitute solid collateral. 

The move has created a lot of attention, some fear Kwon’s plans could destabilize his own company’s stablecoin ecosystem. Still others warn of wider devastation, possibly damaging the entire crypto market. 

Building a stronger foundation for UST

Terra is one of the leading emerging Layer 1 blockchains dedicated to DeFi, ranking just behind Ethereum in terms of TVL. The Terra protocol is among the newer players entering the market in the past 2 years, and it has rapidly taken over from Binance Smart Chain, Avalanche, Solana, Fathom, Tron, and Polygon. 

One of the most successful dApps hosted on the Terra chain is Anchor Protocol, a high-yield savings and lending protocol with $16.5 billion in TVL which accounts for just over half of all TVL on Terra. Anchor Protocol’s key appeal is the approximate 19% APY it rewards UST depositors. UST is Terra’s native stablecoin pegged to the USD, and unlike fiat-collateralized stablecoins like USDT and USDC, this is an algorithmic stablecoin. The peg is held using math-based mechanisms applied to the native LUNA token, keeping the stablecoin pegged to the US dollar in theory.

During the last few years, many algorithmic stablecoins have come and gone. They are notoriously difficult to maintain during times of intense volatility, especially in the advent of downwards pressure, which is when they are most in demand by traders looking for a safe haven during crypto storms. However, if an organization were to succeed in launching a successfully stable algo coin, the rewards could be massive as these stablecoins could scale infinitely to keep up with rising demand across DeFi applications and now metaversal economies.

Of course, this picture changes if Bitcoin continues to see adoption and were to be firmly established as a currency and reserve asset in global finance. If such a thing were to happen, there would be no need for fiat-pegged stablecoins, as BTC would be the primordial stablecoin, pegged only unto itself. Like a free floating dollar, so to speak. But better.  

But back to reality. The purchase of BTC has everything to do with that one weakness of algo coins: when times get tough, arbitrage opportunities aren’t always attractive enough to maintain the peg. When that happens, Terra needs to step in to restore the peg as it has done in the past (and so has MakerDAO for DAI, its own algo stablecoin). That’s why the Luna Foundation Guard has been accumulating Bitcoin like it was going out of fashion. The plan is to build up a total of $10 billion in Bitcoin used as a reserve asset, increasing confidence in the UST stablecoin as Terra would have the means to prevent a death spiral from happening.

But nothing is guaranteed of course. It could happen that Bitcoin crashes further over the next few months, followed by a bank run on UST. But as Do Kwon has said in an Unchained interview: “I’m sort of betting that the long-term scenario of Bitcoin going up, and the reserves being strong enough to withstand UST demand drops is the more likely scenario.”

It’s a massive bet that has not gone unnoticed. Receiving both praise, and criticism.

BTC could destroy UST

Several factors would have to coincide in order for BTC to break UST, but that’s not to say it can’t happen. Anchor Protocol is currently one of the biggest reasons for UST demand. A 19% APY for a stablecoin is quite high when looking closer at the borrow-side of the equation. The current APR being offered to borrowers is just 11.81%, and a lender is only sustainable if it collects more interest on its loans than it pays out to deposits. That gap between lender and borrower APY is covered by a reserve fund that has been draining rapidly as the amount locked in Anchor grows. 

As pointed out in a recent critique of UST, If Anchor’s yield drops below the competition, there could be a rush to the exits, during which users would unload their LUNA and UST. Of course, this is where the Bitcoin reserve assets come in, but some have argued this could make things even worse. What if the BTC reserve actually increases the likelihood of a bank run? The reserve could also be seen as an incentive to attack UST in order to scoop up Bitcoin on the downtrend. It would have to be a coordinated attack of several Antarctic blue whales, but it could happen. 

This is one of the reasons why not everyone is supportive of the moves made by Terra. Instead of containing the risk to the Terra ecosystem in case of failure, a death spiral could now affect Bitcoin and all the other cryptocurrencies they have said to purchase in addition. 

It’s a massive big bet on Bitcoin made by Kwon. But, depending on how it is integrated and applied, it could be that the broader crypto market has been made to place a big bet on Terra.


Ben Caselin is the VP Global Marketing and Head of Research and Strategy at AAX, the first crypto exchange to be powered by LSEG Technology and the first exchange to make the switch to the Satoshi Standard.

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