Terra’s LFG to Deploy $1.5B to “Protect the UST Peg”

The Luna Foundation Guard said Monday that it plans to lend $750 million in Bitcoin and 750 million UST to over-the-counter trading firms to “help protect the UST peg” after the stablecoin slipped below its intended $1 parity early Sunday.

LFG to Deploy $1.5B to Save UST Peg

As per its mandate, the Luna Foundation Guard has sprung to action to defend the UST peg.

LFG, the non-profit organization tasked with supporting the Terra ecosystem, revealed in a tweet storm today that it would loan $750 million in Bitcoin and 750 million UST to professional market makers to bring the stablecoin back to its intended parity with the U.S. dollar. 

4/ As a result, the LFG Council has voted to execute the following:

– Loan $750M worth of BTC to OTC trading firms to help protect the UST peg.

– Loan 750M UST to accumulate BTC as market conditions normalize.

— LFG | Luna Foundation Guard (@LFG_org) May 9, 2022

“Per the LFG’s mandate, the LFG will proactively defend the stability of the $UST peg & broader Terra economy,” the Singapore-based non-profit wrote early Monday. Terra’s flagship stablecoin slid from its intended $1 parity early Sunday, briefly dropping to $0.985 before recouping most of its losses. Per CoinGecko data, UST is trading at around $0.995 at press time.

According to the announcement, LFG will loan $1.5 billion in Bitcoin and UST to over-the-counter trading firms who will trade the capital on both sides of the market to “help protect the UST peg” and accumulate more Bitcoin as market conditions normalize. 

UST is an algorithmic stablecoin that uses a dual token mechanism with Terra’s native token LUNA. When UST trades below peg, arbitrageurs can burn it to mint $1 worth of LUNA tokens, thus decreasing the supply and bringing the stablecoin closer to its $1 target. When it trades above the peg, arbitrageurs can burn an equivalent dollar amount of LUNA to mint new UST, thus increasing the supply and bringing the stablecoin closer to its $1 parity.

Due to fears that this mechanism could potentially lead to a so-called “death spiral” for LUNA, where ever-more LUNA is burnt to stabilize UST, Terraform Labs established the foundation in January and started accumulating Bitcoin to act as an alternative backstop to the stablecoin. The foundation is aiming to stockpile a $10 billion Bitcoin reserve and create an on-chain redeeming mechanism against UST that will reduce the mechanism’s reliance on LUNA and thus bolster its stabilizing ability.

However, because the on-chain redeeming mechanism against Bitcoin isn’t live yet, Terra co-founder Do Kwon said that the “LFG council decided to err on the side of caution” and deploy $1.5 billion worth of capital in the hands of professional market makers that would have to arbitrage UST back to dollar parity manually. Although Kwon has shown confidence in the move, LFG’s decision to sell $750 million worth of Bitcoin in a bid to stabilize UST amid already shaky market conditions has put many key industry figures on edge. Commenting on the move, the head of crypto insights at Bybit Derek Lim, warned that the move could lead to a Bitcoin sell-off, saying:

“Looks like LFG is going to loan $750 million worth of Bitcoin to Jump to sell to protect the peg and buy back at a lower, more attractive price with the total of $1.5 billion. This will add to the selling pressure. Bitcoin will likely go lower before it bounces back when short-sellers take profit.”

Sanctor Capital’s Han Kao added that the market is already “seeing a direct correlation and negative impact on Bitcoin’s price” from UST’s stability issues. “When UST depegged 50 basis points yesterday, Bitcoin dropped 5%,” he said, pointing to a wallet that had deployed $200 million to buy UST. That wallet, Kao suggested, likely belongs to Jump Capital, the same market-making firm that bailed Wormhole out when it got hacked for $322 million in February. Jump’s president Kanav Kariyathat sits on the board of LFG. 

Though Terra enjoyed a parabolic rally from late 2021 and into 2022, concerns surrounding UST’s stability have been rife across the industry for more than a year now. The decentralized stablecoin suffered a similar crash to the one it experienced yesterday in May 2021. On that occasion, it dipped as low as $0.96.

Disclosure: At the time of writing, the author of this piece owned ETH and several other cryptocurrencies.