Original title: "The stablecoin UST fell below 0.7 US dollars, LFG protection has not yet taken effect"

Written by: Jasmine

On May 10, the US dollar stablecoin TerraUSD (UST) broke away from the $1 anchor, and this algorithmic stablecoin running on the Terra public chain is undergoing a test. According to Coingecko data, as of press time, the largest 24-hour drop of UST was 32.6%, and the lowest fell to $0.67.

In order to protect the stability of UST, the non-profit organization of Terra Ecology, Luna Foundation Guard ("LFG") stepped down to protect the market. On May 9, the organization stated that, pursuant to its mandate, it will lend $750 million worth of BTC to OTC trading firms to help protect the UST anchor; it will also borrow $750 million in UST to accumulate when market conditions normalize BTC; traders will trade the above on both sides of the market.

In January of this year, LFG began to reserve other assets such as BTC after its establishment, with the aim of providing multiple encrypted asset endorsements for UST and Terra's stablecoin ecology. Before the UST support plan, LFG's bitcoin holdings reached 80,394 BTC, which was once worth $3.5 billion, making it one of the "big whales" on the BTC rich list.

In the early hours of May 10, about 42,530 BTC was transferred from LFG’s address, worth $1.319 billion. The organization then confirmed on Twitter that it lent BTC to market makers, and the reduced BTC is currently used to purchase UST. 2 hours after LFG's Bitcoin address changed, UST briefly rose to $0.95, but it still failed to stop it from continuing to unpeg downward.

Since May 5, the encrypted asset market has fallen as a whole. BTC, the largest by market value, has fallen by nearly $10,000 within 5 days, with the lowest drop to $29,700. In the sharp decline in the last two days, LFG's plan to use BTC reserves to support UST exacerbated the panic in the market. If BTC continues to fall, how can UST, which relies on it to protect the market, escape from systemic risks?

LFG transfers out Bitcoin UST and falls below $0.7

At 2 am on May 10, the Bitcoin address of Luna Foundation Guard (LFG) transferred 42,530.82 BTC, worth about 1.319 billion U.S. dollars. Two hours later, LFG updated Twitter, and there are currently about 28205.54 BTC in its public Bitcoin address, worth $875 million at the time.

LFG stated in an updated tweet that the decrement from the last withdrawal was 37,000 BTC, similar to the previous deployment, it has been lent to market makers; the recent decrement of BTC is rarely used, but is currently used for Buy UST.

LFG's plan to "protect the UST anchor stability" with Bitcoin reserves seems to be about to start. As the organization described on its official Twitter on May 9, the entire cryptoasset market has experienced significant volatility over the past few days, with UST experiencing significant directional flows over the weekend.

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UST unanchored badly in last two days

The full name of UST is TerraUSD. It is an algorithmic stablecoin anchored to the US dollar running on the Terra public chain. Its supply is expanded by burning the native asset LUNA of the Terra chain. Theoretically, as the demand for UST in the encryption market increases, the price of the stablecoin will be pushed up above $1. At this time, LUNA will be burned to mint UST, and in this way, additional issuance will restore its peg to the US dollar ; and when the supply of UST shrinks and the price falls below $1, UST is burned to mint LUNA, similar to deflation to keep UST pegged to the US dollar.

In the past 6 months, UST's market capitalization has soared from less than $3 billion to more than $18 billion, making it the largest USD-based algorithmic stablecoin. This algorithmic stablecoin system, which relies on market supply and demand and the automatic execution of smart contracts on the chain, has a built-in arbitrage mechanism. In theory, the arbitrage space will allow market participants to enter the economic cycle of maintaining stablecoin supply and demand balance and price stability.

But an accident happened on May 7. First, 85 million UST was transferred from the Terra blockchain via the cross-chain bridge Wormhole to the Ethereum blockchain, and then sold on the decentralized trading application Curve; and from the same Terra chain address Another 108 million UST was sold on the centralized exchange Binance.

A large amount of UST was thrown into the market, and its price also began to deviate from the peg with the US dollar. After the early morning of May 8, the price of UST began to fall below 1 US dollar and remained at around 0.99 US dollars; on the evening of May 9, it began to continue fluctuate downward. The chain reaction happened again on Anchor, the lending app on the Terra chain, where major accounts started withdrawing UST from the app. Since the UST de-anchor, the value of Anchor deposits has been reduced by nearly 1/4, and $3.5 billion in encrypted assets has been withdrawn.

After UST showed a de-anchor trend, at noon on May 9th, LFG’s official Twitter stated that, according to the authorization, the board of directors voted to implement the following plan: First, loan BTC worth 750 million US dollars to OTC trading companies , to help protect the UST anchor; second, to loan $750 million in UST to accumulate BTC when market conditions normalize. Traders will trade on both sides of the market to help with both initiatives, eventually maintaining parity (in BTC) for the LFG reserve pool as market conditions gradually stabilize.

In the early hours of May 10, after the BTC transfer from LFG’s Bitcoin address, Coingecko data showed that UST rose to $0.95 for a short time and then continued to drop, falling to a minimum of $0.67 within 24 hours. The last time UST de-anchored significantly was on May 19, 2021. During the sharp drop in the currency market known as "5.19", UST fell to $0.85.

LFG's support plan has yet to restore UST's decline.

LFG's support plan may bring systemic risks

The endless decline of UST happened to be in the environment of the entire encrypted asset market plummeting. Starting from May 5, Bitcoin, the market capitalization leader in the encrypted asset market, has entered another round of downtrends. It failed to stand firm and just broke through the US$40,000, but fell all the way to around US$30,000.

LFG's behavior of storing bitcoins was once optimistic by the encryption circle, and was even regarded as a "bullish" signal, but the increase in holdings did not appear.

In January of this year, Terra Ecosystem established LFG, trying to solve the problem of LUNA’s single-asset regulation of stablecoins by reserving multiple encrypted assets, and provide multi-asset endorsement for the stablecoin system of the Terra chain. The most important asset is Bitcoin. , the ultimate goal of the organization is to reserve $10 billion worth of Bitcoin.

The idea is akin to having Bitcoin act as a "reserve currency" for the Terra ecosystem, in the same way a central bank holds large amounts of U.S. dollars in its foreign exchange reserves.

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Distribution of LFG Reserve Assets

Bitcoin is the largest encrypted asset in LFG reserves, and LFG has become the first well-known organization in the industry to regard Bitcoin as a stable currency endorsement.

However, LFG’s move has also raised doubts—algorithmic stablecoins ultimately rely on a team or organization to intervene to maintain price stability by introducing reserve assets, and its ideal of decentralization is being lost.

And when UST experienced a serious price deviation, when LFG used bitcoin reserves to protect the stability of UST, concerns further occurred-if BTC continues to fall, can LFG's limited bitcoin reserves protect UST? If LFG sells Bitcoin, the market will be further in pain.

Derek Lim, director of crypto insights at Bybit exchange, told CNBC in an interview that LFG's intervention "will increase selling pressure" and that "when short sellers take profits, BTC may go lower before rebounding."

Do Kwon, founder of TerraformLabs, the team behind the Terra blockchain, sought to allay concerns. On May 9, he tweeted that LFG would not exit its Bitcoin position, "As the market recovers, we plan to redeem loans with BTC, increasing our total reserve size."

From Do Kwon's description, LFG's plan allows professional market makers to buy UST when UST is lower than $1, and buy BTC when it is higher than or equal to $1, so as to maintain the balance and stability of UST.

The plan is to let BTC play the role of LUNA in theory. When the market arbitrage space arises, arbitrageurs buy UST and then exchange it for discounted BTC. At present, it is known that LFG has transferred out BTC supply to market makers, and it is not known whether the transaction will be executed, but UST has not resumed anchoring.

It is believed that the biggest risk in the future will be that UST breaks the anchor again, forcing LFG to liquidate its holdings of Bitcoin, which in turn may lead to further market liquidation for "over-leveraged" buyers. The double drop of BTC and UST will not only Let this algorithmic stablecoin fall into a "death spiral", and the DeFi market using UST may also trigger large-scale liquidation, bringing the market into systemic risk.

Risks are emerging. As of press time, when UST was severely de-anchored, BTC also fell again, once falling below $30,000, with a maximum drop of more than 12% in 24 hours.