Bitcoin investors are panicking as the terraUSD stablecoin continues to drift away from its intended $1 peg.
Late Monday, TerraUSD, or UST, fell below 70 cents for the first time, as holders fled the token in what some have dubbed a “bank run.” According to Coinbase data, the coin plummeted as low as 62 cents before rebounding ground and trading at 90 cents on Tuesday.
UST is a “algorithmic” stablecoin that was created by Terraform Labs in Singapore in 2018. It’s part of the Terra blockchain project and, like tether and USDC, is designed to monitor the value of the dollar.
Terra, unlike previous cryptocurrencies, does not have a reserve of cash or other assets to back its token. Instead, it uses a sophisticated mix of programming to keep prices stable, along with a sister token called luna.
It’s crucial for bitcoin investors since the Luna Foundation Guard, which supports the Terra project, holds billions of dollars in bitcoin that could be dumped on the market at any time.
″Every professional investor in crypto has one eye on UST today, watching to see if it can maintain its peg to the dollar,” said Matt Hougan, chief investment officer at Bitwise Asset Management. “There’s clearly significant risk in the market.”
To put it another way, the Terra protocol adjusts supply by destroying and creating new UST and luna units. When the price of UST falls below the dollar, it can be removed from circulation and traded for luna, reducing UST supply and raising its price – at least, that’s how it should operate in principle.
To make matters even more complicated, Terra’s inventor Do Kwon purchased $3.5 billion in bitcoin as a backstop for UST in times of crisis. The theory was that UST may ultimately be exchanged for bitcoin rather than luna, however this has yet to be proven.
Kwon’s Luna Foundation Guard said on Monday that it will lend $750 million in bitcoin to trading businesses to “help protect the UST peg,” with an additional 750 million UST given out to buy more bitcoin “when market conditions stabilise.”
The company added in a follow-up tweet that it has withdrawn 37,000 bitcoins, which are currently worth over $1 billion at current rates, to give out. According to Luna Foundation Guard, “very little” of the borrowed bitcoins has been spent, but it is “now being used to buy” UST.
Several cryptocurrency investors are also concerned that Luna Foundation Guard may have sold, or will sell, a significant chunk of its bitcoin to keep UST afloat. UST’s collapse has sent shockwaves throughout the crypto community amid all of this uncertainty.
Bitcoin, the world’s most popular digital currency, dipped below $30,000 for the first time since July 2021. Bitcoin was trading at $31,324 at 7:00 a.m. ET, down almost 5% in the last 24 hours. It’s already down more than 50% from its all-time peak in November.
In the last 24 hours, the value of Luna, UST’s equivalent, has roughly half. It was recently trading at $32 per share.
Binance, the world’s largest crypto exchange by market capitalization, has temporarily halted withdrawals of both UST and luna “because to a significant volume of outstanding withdrawal transactions,” claiming network congestion.
Binance said it would “continue to monitor” network issues and has resumed withdrawals.
“I think the market is expecting some forced selling here on the part of Terra and the reserve,” Nic Carter, co-founder of Coin Metrics, said. “It is a calamity but very expected. No algorithmic stablecoin has ever succeeded and this is no exception.”
He went on to say that the issue with UST is that it is mostly “based on faith.”
“It’s not fully guaranteed, it’s certainly not fully backed by reserves,” he told CNBC. “It was really just backed by faith in the issuer effectively.”
(Adapted from CNBC.com)