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UST dollar peg collapses
What has been developing over the weekend and amplified today is the Terra stablecoin (UST) depegging against the US Dollar, with Terra currently trading at $0.85. Many of these market dynamics have been playing out in near real time today as the situation worsens and is likely to change again in the next 24 hours. It started with billions of dollars in UST exiting the high-yield anchor protocol over the weekend and morphing into a full-fledged digital bank run.
UST relies on the LUNA token to maintain its price through algorithmic minting and burning mechanisms. This method creates an arbitrage opportunity if UST deviates from its $1 peg. Traders can burn LUNA and create new UST when the UST price is above $1 and profit. When UST is below $1, UST will be burned and LUNA will be embossed to stabilize the pen. However, as UST took a hit on demand and liquidity, LUNA is down nearly 26% in just one day, while BTC is down nearly 8%.
Why this matters to Bitcoin is because the centralized Luna Foundation Guard (LFG) has accumulated 42,530 Bitcoin ($1.275 billion at a price of $30,000) as reserves to be used in precisely these situations, to defend the UST peg if it stays below $1. And that’s exactly what they’re trying to do now.
In response, the LFG agreed today Lending $750 million in Bitcoin and $750 million in UST to OTC trading firms in efforts to maintain the UST linkage. Later in the day, LFG announced a payout of almost 37,000 BTC for lending to market makers, noting that these are currently being used to buy UST.
The main risk for the market now is that Bitcoin’s biggest buyer in recent months now becomes the market’s biggest forced seller. Market expectations and potential selling certainly played a role in Bitcoin’s historic sell-off today, but it comes at the same time that the broader stock markets have been selling off at the same time. Bitcoin’s correlation with broader stock indices and technology stocks is at all-time highs and has been following the same market dynamics since November 2021.
Following the rise in global interest rates, 40 years of high inflation, deteriorating growth and a macro credit sell-off and unwinding, we have been highlighting this dynamic and the greater market risks for months.