A new stablecoin issuer is buying billions of dollars in bitcoin. What crypto investors need to know

Published Sun, Apr 3 20229:20 AM EDTUpdated Sun, Apr 3 20229:26 AM EDT

This past week the price of bitcoin climbed above $48,000 for the first time since Dec. 31. In the same week, LUNA, the governance token behind the Ethereum alternative Terra, hit an all-time high. The moves have Terra's big bitcoin buying spree to thank, at least in part. The network has been buying bitcoin since January, and on a daily basis for the past two weeks. It has accumulated about $1.4 billion to date, with a goal of building a $3 billion reserve for its stablecoin, UST. The project's founder Do Kwon has also expressed interest in buying up to $10 billion over time for its reserves. "This buying pressure has definitely helped the price of bitcoin, but the narrative has helped even more," said Arca chief investment officer Jeff Dorman. "The fact that a large stablecoin producer is recognizing the importance of bitcoin as collateral, during a time where people all around the world are realizing their money isn't really their money – Canada citizens, Russian citizens, anyone in the SWIFT system, anyone with money on the London Metal Exchange – is a powerful bull thesis for bitcoin." Terra has accumulated nearly 31,000 BTC to date , making it the third largest holder of bitcoin, behind MicroStrategy and Tesla. The two-year-old UST is also now the fourth largest stablecoin by market cap, behind Tether, USDC and the BUSD stablecoin founded by Paxos and Binance. "UST is a decentralized stablecoin and it's backed by decentralized money," said Natalie Luu, head of ecosystem at Terraform Labs. "We want to make sure UST is as trustless and permissionless as possible. Bitcoin is one of the currencies that maintains the reserve of UST, it's digital gold. By adding bitcoin the largest cryptocurrency in the world as a piece of this reserve, it just furthers our mission as being the largest decentralized money there is." Here's what you need to know about UST, LUNA and why Terra is looking to bitcoin to diversify its reserves. Terra vs. LUNA Terra is a “layer 1” blockchain like Ethereum, Solana, Avalanche and others. They function as the security layer upon which developers can build decentralized applications, which give value to the base layer (in this case, Terra). Terraform Labs launched the Terra blockchain but doesn’t own it outright. Instead, everyone on the network, including Terraform labs, owns a piece of it by holding LUNA, the native token of this particular blockchain. The blockchain powers an ecosystem of real-world applications, Luu said. For example, the Korea-based payments app Chai uses stablecoins and is powered by Terra’s LUNA token. There are more than 100 recently created projects in development that Terraform Labs anticipates will launch over the next year, she added. The Terra stablecoin Terra was built to deploy a suite of algorithmic decentralized stablecoins, meaning it should be able to maintain their pegs using just software, without collateral. They haven’t taken off in crypto; efforts to date have been seen as too idealistic or too early. TerraUSD (UST) is by far the most popular one among the crypto community, according to Michael Rinko, venture associate at AscendEx. The critical issue with centralized stablecoins like Tether and USDC has to do with the composition of reserves. Stablecoin issuers like Tether in theory should have 100% reserves denominated in U.S. dollars on hand if every holder of the stablecoin should want to redeem it for dollars at once. In practice, a very small percentage of tethers reserves is in cash and the company has been famously mysterious about what it invests in. Circle, the company behind the stablecoin USDC, has revealed just 60% of its reserves are in cash . The UST peg Like many currencies, UST is pegged at a 1-to-1 ratio with the dollar. Arbitrage opportunities have been key to maintaining UST’s peg, and investors have taken opportunity of it for big profits, Rinko said. Users can always swap one LUNA for UST and vice versa at a guaranteed price of $1, regardless of the market price of either token at the time. If demand for UST rises and its price goes above $1, LUNA holders can earn risk-free profit by swapping $1 of LUNA to create one UST token, Rinko explained. In this case the UST token would be worth more than $1 and the user would make money on the spread. Similarly, if demand is low for UST and the price falls below $1, UST holders can exchange their UST tokens at a ratio of 1-to-1 for LUNA, which would be worth more because of their scarcity. “Although this arbitrage-based peg model sounds good in theory, and likely works in a perfect world, many worry about the possibility of a ‘bank run’ in a time of panic,” he said. “The Luna Foundation is trying to assuage these concerns by raising bitcoin to diversify their reserves and own assets that are considered less correlated to the Terra ecosystem. It may provide an additional avenue to maintain the peg in contractionary cycles that reduces the reflexivity of the system.”

Chris Ratcliffe | Bloomberg | Getty Images

This past week the price of bitcoin climbed above $48,000 for the first time since Dec. 31. In the same week, LUNA, the governance token behind the Ethereum alternative Terra, hit an all-time high.