Bitcoin is now down 50% from its all-time highs set in November.
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Bitcoin investors are panicking as controversial stablecoin terraUSD continues to deviate from its intended $1 peg.
TerraUSD, or UST, dipped below 70 cents for the first time late Monday as holders continued to flee the token in what some have dubbed a “bank run.” According to data from Coinbase, the token fell as low as 62 cents before regaining ground at 90 cents on Tuesday.
Developed in 2018 by Singapore-based Terraform Labs, UST is what is known as an “algorithmic” stablecoin. As part of the Terra blockchain project, it aims to track the value of the dollar, like other stablecoins Tether and USDC.
However, unlike these cryptocurrencies, Terra does not have cash and other assets held in reserve to back its token. Instead, it uses a complex mix of codes – alongside a sister token called Luna – to stabilize prices.
It is important for Bitcoin investors as Luna Foundation Guard, an organization that supports the Terra Project, is sitting on billions of dollars in Bitcoin that could potentially be dumped on the market at any time.
“Every professional crypto investor is keeping an eye on UST today and seeing if it can maintain its peg to the dollar,” said Matt Hougan, Chief Investment Officer at Bitwise Asset Management. “There is clearly significant risk in the market.”
Simply put, the Terra Protocol destroys and creates new units of UST and Luna to match supply. If UST’s price falls below the dollar, it can be withdrawn and traded for Luna, making UST’s supply scarcer and pushing up its price – at least that’s how it should work in theory.
To complicate things further, Terra’s creator Do Kwon bought $3.5 billion worth of bitcoin to provide UST with a backstop during times of crisis. The theory was that UST could eventually be redeemed for Bitcoin instead of Luna, but this is untested and has not yet been put into practice.
On Monday, Kwon’s Luna Foundation Guard announced it would lend $750 Millions of Bitcoin to trading firms to “help protect the UST peg” while another 750 million UST will be loaned out to buy more Bitcoin “when market conditions normalize.”
In a follow-up tweet, the organization said it had withdrawn 37,000 bitcoins — worth over $1 billion at current prices — to lend out. “Very little” of the borrowed bitcoin has been spent, Luna Foundation Guard said, but it is “currently being used to purchase” UST.
Several crypto investors are also concerned that Luna Foundation Guard may have sold or will sell a large chunk of its Bitcoin to shore up UST. Amidst all this uncertainty, the demise of UST sent shockwaves across the crypto market.
Bitcoin, the world’s largest digital currency, briefly fell below $30,000, hitting its lowest price since July 2021. As of 7:00 a.m. ET, Bitcoin was trading at $31,324, down around 5% over the past 24 hours. It is now down more than 50% from its all-time high in November.
Luna, the counterpart of UST, has roughly halved in value over the past 24 hours. It last traded at a price of $32.
“I think the market is expecting forced selling from Terra and the reserve here,” Nic Carter, co-founder of Coin Metrics, told CNBC. “It’s a disaster, but much to be expected. No algorithmic stablecoin has ever succeeded, and this is no exception.”
He added that the problem with UST is that it is largely “faith based”.
“It’s not fully guaranteed, it’s certainly not fully backed by reserves,” he told CNBC. “It was really only supported effectively by confidence in the issuer.”
Terraform Labs has not responded to multiple requests for comment.
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