The Self-Saving Road from Algorithmic Stablecoin to BTC Reserve Stablecoin Terra

Algorithmic stablecoins have always been a very controversial topic in the industry. Is it really possible to create a digital currency with stable value and not linked to other assets?

In November last year, Ryan Clements, an assistant professor at the University of Calgary School of Law, began his paper titled “ Built to Fail: The Inherent Fragility of Algorithmic Stablecoins ” by stating:

“Algorithmic stablecoins are inherently fragile. These unsecured digital assets attempt to use financial engineering, algorithms and market incentives to anchor the price of a reference asset. They are not stable at all, but are in a state of permanent vulnerability.
The paper argues that , algorithmic stablecoins are fundamentally flawed because they rely on three factors that have historically been shown to be uncontrollable. First, they require a certain level of demand to support operational stability. Second, they rely on having Markets incentivize independent players to engage in price stability arbitrage. Finally, they need reliable price information at all times. None of these factors are deterministic, and all of these factors are historically vulnerable during financial crises or periods of extreme volatility. All All forms of stablecoins require regulatory guidance, including issuer registration requirements, clear classification, collateral custody, transparency safeguards, and risk disclosure and containment measures.
Algorithmic stablecoins in particular require a robust regulatory framework, including risk disclosure and containment Safeguards, currently they serve only speculative DeFi trading applications with little social or financial inclusion value.

In fact, most of the current stability projects have ended bleakly with the ending of “anchoring failure and the currency price plummeting”.

However, Terra (Luna), the most popular computing stability project at present, has shown itself in front of everyone with a very eye-catching performance. Does it really achieve the stable computing stability goal? Or will Terra (Luna) also fail to escape the fate of collapse and eventually become a “Ponzi scheme”?

In Professor Ryan Clements’ paper, he also highlighted the Terra (Luna) project, and the following is his description:

“Terra’s creator, Terraform Labs, has recently received significant backing from venture capital and significant investor interest, and Terra uses its governance token, LUNA, to be issued with U.S. dollars with built-in money supply and economic incentives, including fees and arbitrage opportunities. Algorithmic stablecoins pegged to the Korean won.
These stablecoins are then used as a payment mechanism in the ever-expanding Terraform Labs financial ecosystem, which includes Mirror, a synthetic asset protocol used to create funds tracking U.S. stocks, futures and ETFs, loans and Savings platform Anchor and cooperative payments platform Chai. In addition, Terra plans to add DeFi asset management, other lending protocols, and a decentralized leveraged insurance protocol to this budding ecosystem.
Terra’s stablecoin is a link to emerging financial “infrastructure” “Core”, this includes the aforementioned e-commerce payments, synthetic stocks, exchange-traded funds, derivatives and other financial assets, savings, and lending applications. Terra incentivizes independent traders to buy its stablecoins, and if the stablecoins fall below the peg, In exchange for LUNA. The stability of Terra stablecoins goes beyond DeFi speculation, and considering their many applications in the Terra economy, these algorithmic stablecoins also directly affect the economic prospects of many businesses and consumers.
In order to make this ecosystem possible To be sustainable, the Terra stablecoin and its governance token, LUNA, must have a permanent level of demand. In other words, there must be sufficient arbitrage activity between the two tokens, there must be sufficient transaction fees in the Terra ecosystem, and the network must There must be enough demand for mining in the market. Terra founders claim that the mainstream practice of stablecoins as transaction currencies, and the ability to “stake” them and earn returns, creates “network effects” and long-term incentives to maintain and maintain the ecosystem Therefore ,
Terra’s bet that ‘financial applications using stablecoins on the network will drive perpetual demand’ is uncertain, and historically, Terra stablecoins have also deviate from the peg.In many ways, a developing DeFi financial ecosystem backed by algorithmic stablecoins that has no real collateral or government guarantees, but relies on the perpetual interests of individually motivated market participants to achieve sustainability, it seems It’s like standing dominoes, and once the first one falls, all other dominoes may be affected .

Isn’t Terraform Labs aware of the risks here? Of course not, on the contrary, as the designers and operators of the system, they are clear about the huge risks involved in the whole system.

Against this backdrop, a noteworthy crypto experiment is underway.

In a nutshell, UST is transitioning from an algorithmic stablecoin pegged to the U.S. dollar to a stablecoin backed by bitcoin as a reserve, but note that this is still a prototype.

TerraUSD (UST for short) is the core of the Terra ecosystem, and its current market value has exceeded $15 billion.

The Self-Saving Road from Algorithmic Stablecoin to BTC Reserve Stablecoin Terra

(Data from

In the entire stablecoin market, the market value of UST is second only to Tether (USDT), USDC and BinanceUSD. However, unlike these centralized stablecoins with fiat currencies as reserves, the additional issuance of UST is achieved by burning the governance token LUNA of the system. Yes, but as Professor Ryan Clements said, even though Terraform Labs has created a huge ecosystem for UST, this approach still comes with huge risks.

So, to mitigate the risk, Terra turned to bitcoin as collateral for UST.

Today, the Luna Foundation reserves more than $3 billion worth of Bitcoin, USDT, and LUNA, and the project founder is slowly converting most of it into Bitcoin.

According to the governance proposal released by Jump Trading in the Terra community‌ , this Bitcoin reserve pool will be used to support UST immediately when UST deviates downward, to avoid de-pegging, and rely on traders to replenish BTC reserves after the crisis is lifted.

The Self-Saving Road from Algorithmic Stablecoin to BTC Reserve Stablecoin Terra

As for the new UST release, the Terra team may also change the practice of burning 100% LUNA.

Instead, Terra may burn 60% of LUNA and use 40% of it to buy Bitcoin.

For example, let’s say I want to mint $10,000 worth of UST. What I burn now is not $10,000 worth of LUNA, but $6,000 worth of LUNA, and the remaining $4,000 worth of LUNA will be used by the Terra team to buy Bitcoin. (Note: this is just a guess at the moment, it has not been confirmed)

This dual strategy will gradually expand the Bitcoin reserves of the Luna Foundation. Of course, compared with the UST with a market value of $15 billion, it is obviously impossible to achieve a 100% reserve guarantee, but theoretically , assuming that the price of Bitcoin can continue to rise, then the value of the BTC reserve of the Luna Foundation may be consistent with the value of UST, or even exceed the value of UST for a long enough time (of course, this is only an idealized conjecture).

So what kind of impact will Terra’s approach bring?

First, Terra is becoming a consistent bitcoin buyer, you can think of Terra as a new demand for bitcoin, and eventually Terra may become one of the organizations with the most bitcoin holdings.

The Self-Saving Road from Algorithmic Stablecoin to BTC Reserve Stablecoin Terra

Secondly, Terra is emphasizing the merits of Bitcoin as a reserve stablecoin, and Do Kwon elaborated on the view that “Bitcoin is the hardest and most decentralized asset in the world”, which creates a symbiotic relationship between UST and BTC, At the same time, it also transfers part of the risk to BTC.

Third, the Terra ecosystem will become an L2 layer of Bitcoin.

Of course, even if Terra can theoretically defuse systemic risks with Bitcoin’s price increase, it must build a secure bridge between Bitcoin and its ecosystem, and we also need to assume that the Terra Foundation will not do evil .

Finally, let’s talk about some personal superficial views:

  1. It is impossible for an algorithmic stablecoin without external collateral to achieve stability. This is just like the reason that “perpetual motion” cannot achieve perpetual motion without the injection of external energy;
  2. It is necessary for Terra to turn to Bitcoin reserves to defuse risks, but its own risks are still very large at present;
  3. Assuming that one day the value of Bitcoins in Terra reserves can approach or even exceed the market value of UST, and can be exchanged well, the entire ecology of Terra will become extremely dominant;
  4. Short-term Terra’s approach helps boost BTC’s market demand, which is a good thing for BTC holders.

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

Like (0)
Donate Buy me a coffee Buy me a coffee
Previous 2022-03-25 10:23
Next 2022-03-25 10:24

Related articles