Terra’s $ 10 Billion Bitcoin Plan: A Systemic Risk for Crypto?

TerraUSD (UST) has quickly become the leading dollar algorithmic stablecoin. To address the fear of losing tape, the protocol is in the middle of a $ 10 billion plan to diversify its government reserves with bitcoin and other digital assets.

Algorithmic stable coins, unlike their centralized counterparts, are not associated with security. Therefore, they are also referred to as unsecured stack coins. The algorithm or protocol underlying these stack coins acts as the “central bank”. Terra uses a token firing mechanism that provides financial incentives for arbitrage to maintain the dollar bond. To further hedge remaining risks, founder Do Kwon has announced $ 10 billion in Bitcoin purchases. Over the past few weeks, the Terra Protocol has already invested $ 1.7 billion in Bitcoin (42,500 BTC) and entered the top 20 Bitcoin holders.

Rapid growth exacerbates risks

Terra blockchain, with its UST stablecoin and several DeFi applications, established itself as one of the fastest growing ecosystems in the crypto space. A large part of the demand comes from the savings protocol Anchor, which provides a very attractive return for stack coins of almost 20% per year. Today, over $ 15 billion in digital assets are deposited on Anchor, making the savings protocol the third largest DeFi application after total value deposited (TVL).

Assets deposited in Anchor Savings Protocol / Source: DeFi Llama

However, the rapid growth of the Terra ecosystem also increases the risk of bond losses. As UST is directly linked to the LUNA token, large price fluctuations can drastically affect the bond. Such a loss of commitment occurred during the general market downturn on May 23, 2021, when the 2 billion USTs were supported with only 1.6 billion USD in LUNA. The bond could only recover when Terraform Labs and other investors bought LUNA and restored the 1: 1 dollar exchange rate. A similar event would be devastating with the current number of deposited assets.

Treasury diversification with Bitcoin

Bitcoin is often referred to by investors as “digital gold”. In combination with several advantages over precious metals, the cryptocurrency has established itself as one of the most efficient value holdings. Against this background, Terra has now also decided to keep part of its reserves in Bitcoin.

These decentralized foreign exchange reserves are intended to support Terra blockchain UST stablecoin and are used to hedge short-term UST repayments. The protocol has already invested $ 1.7 billion in the cryptocurrency in several purchases. This gives Terra the second largest Bitcoin corporate reserves after MicroStrategy ($ 3.9 billion).

A systemic risk to industry

Terra’s billion-dollar purchase offers a hedge for the native stablecoin UST. However, if Terra’s binding mechanism were to fail, part of the Bitcoin reserves would therefore have to be exchanged for US dollars. According to some voices, a potential liquidation of these reserves could thus create a significant risk for the entire crypto industry.

With 10 billion in bitcoin, the Terra Protocol would be the largest bitcoin holder along with pseudonymous founder Satoshi Nakamoto. Sales pressure of this magnitude would inevitably result in large price drops even if the coins did not end up in the open market. Do Kwon is himself aware of this, but seems to interpret it as an advantage for his project.

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