UST & LUNA: Basic Thing You Need To Know About The Terraform
Few weeks ago the Luna & UST family were being celebrated for their incredible idea on their StableCoin, UST, which is linked to the Luna coin in order for it stable. It’s StableCoin, UST generates a 20% yield when staked which was another really impressive feature of UST. It was supposed to come with a low risk, being an algorithmically backed coin, it seemed like a great decentralized StableCoin to invest in. The mechanism of minting UST is quite different from what you know. You know how other StableCoins is backed by fiat, or how HBD(Hive Backed Dollar) is backed by Hive. UST is quite different, to get 1 UST, $1 worth of Luna will have to get burnt to get/mint 1 UST, so this means that UST is dependent on Luna for its supply. The current price of 1 Luna is equal to $29 this means that you can get 29 UST from 1 Luna.
This is also applicable for trying to get Luna, the mechanism is not just subjected to only when you want to get UST. If you also want to get LUNA, you will need to burn UST to get LUNA. This way you remove the UST burnt off supply and introduce a new set of LUNA into the LUNA supply. Very nice mechanism right? While this process is being executed, there is always a burn to keep it out of circulation. So it goes like this, let’s assume 1 Luna is worth $50 and you want to mint $100 UST, this means that you will have to burn 2 LUNA to get $100 UST or 100 UST. 2 LUNA will be off the supply. Then introducing a new set of UST into the UST supply.
Then later you want to get some LUNA with your UST, you have to burn UST this time to get LUNA. The burnt UST will leave the supply, introducing new set of LUNA into the supply. So if you look at it closely, it’s still the same kind of supply in a way just changing forms, and the quantity differs based on the price. If you minted UST when LUNA was $50 and you want to mint LUNA with UST, now Luna is $30, this means that you will get more Luna this time, increasing the supply a little.
How Is Stability Maintained?
We know that sometimes StableCoin fail to maintain the $1 peg value, this can be due to so many reasons, activities and market fluctuations. It’s not like other fiat backed StableCoins like USDT, USDC and BUSD that are backed by real fiat. Fiat backed StableCoins work this way, $1 fiat is used to get 1 USDT. But in the case of UST, if the price of UST slips below the $1 peg, like $0.97, this means that it’s down by 3 cents. The mechanism can either buy UST with USD to increase the demand and reduce its supply because every time USD is used to purchase UST, the UST bought gets burnt, or more UST will be converted to LUNA driving the demand and reducing the supply. This way, the price of UST will get to a $1 peg.
But if the price of UST is above $1, with a slight change, this means that it’s not maintaining the $1 peg value, the arbitrageurs mechanism starts minting more UST with LUNA thereby increasing the supply of UST which will reduce the price because at this point, supply is more than demand.
Research Source 1
So in a nutshell, to bring back the value of UST when it is below the $1 price peg, more UST needs to be taken out of circulation to drive demand and reduce supply. To also bring the value back to $1 if it is above the $1 peg, more UST will be introduced into circulation to increase supply.
Research Source 2
The Billion Dollar Bitcoin Reserve
Based on the stability fluctuations, investors started getting scared about how sustainable this mechanism is. This is the reason the Luna team started buying bitcoin as a reserve currency that aims to secure the system’s sustainability. The founder of Luna, or rather the founder of Terraform made it a concern to make sure there are enough financial resources represented as reserves to back UST just incase the whole mechanism thing fails them when an unplanned market drop occurs. This Bitcoin reserve can be easily used to back the UST to maintain the $1 peg price.
The Unplanned Market Tank
The crypto market faced a deep tanking this week, which tested the faith and sustainability of this algorithmically based StableCoin UST. It became a matter of chaos this week as both the price of LUNA and UST tanked together both as a matter of the crypto market tank and the increase in the supply of UST. Remember, increased in supply of UST reduces the price. The price of UST started tanking and went down to $0.68. Where is the stability in that? How can you avoid a volatile Altcoin because of its volatility to a stable coin because of its stability and end up getting kicked in the foot by volatility on a stable coin.
Remember there is reserved bitcoin just incase something like this happens. This reserved bitcoin is supposed to back UST price to maintain the $1 peg price. I guess the unprecedented situation happened sooner than they expected. Now it’s time to put those Bitcoin bought few weeks ago into use. This is the only way to save the Terraform. Over $1.5 Billion worth of bitcoin have been sold to try to stabilize the priced UST.