The Luna Foundation Guard said Monday it plans to lend $750 million in Bitcoin and $750 million UST to OTC trading firms to “help protect the UST peg” after the stablecoin fell below from its expected parity of $1 early on Sunday.

LFG to deploy $1.5 billion to save UST Peg

In accordance with its mandate, the Luna Foundation Guard stepped in to defend the UST ankle.

LFG, the non-profit responsible for supporting the Terra ecosystem, revealed in a storm of tweets today that it would lend $750 million in Bitcoin and 750 million UST to professional market makers to bring the stablecoin back to its intended parity with the US dollar.

4/ Accordingly, the LFG Council has voted to execute the following:

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

– Lend 750 million UST to accumulate BTC as market conditions normalize.

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

“In line with the LFG’s mandate, the LFG will proactively advocate for the stability of the $UST peg and the wider Terra economy,” the Singapore-based nonprofit wrote on Monday. Terra’s flagship stablecoin slipped from its expected parity of $1 early on Sunday, briefly falling to $0.985 before recovering most of its losses. According to data from CoinGecko, UST is trading at around $0.995 at press time.

According to the announcement, LFG will lend $1.5 billion in Bitcoin and UST to OTC trading firms that will swap capital on both sides of the market to “help protect the UST peg” and accumulate more Bitcoin. as market conditions normalize.

UST is a algorithmic stablecoin which uses a dual-token mechanism with Terra’s native LUNA token. When the UST is trading below the peg, arbitrageurs can burn it to hit $1 worth of LUNA tokens, 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 USTs, increasing supply and bringing the stablecoin closer to its $1 parity.

Due to concerns that this mechanism could potentially lead to a so-called “death spiral” for LUNA, where more and more LUNA is burned to stabilize the UST, Terraform Labs established the foundation in January and started accumulating bitcoin to act as an alternative safety net to the stablecoin. The foundation aims to store a $10 billion Bitcoin reserve and create an on-chain buyback mechanism against UST that will reduce the mechanism’s reliance on LUNA and thus strengthen its stabilization capability.

However, since the on-chain redemption mechanism against Bitcoin is not yet live, Terra co-founder Do Kwon mentioned that the “LFG board has decided to err on the side of caution” and deploy $1.5 billion of capital into the hands of professional market makers who would have to manually arbitrate the UST at the dollar parity. Although Kwon showed confidence in the move, LFG’s decision to sell $750 million worth of Bitcoin in an effort to stabilize the UST in already fragile market conditions put many key industry figures on edge. Commenting on the move, Head of Crypto Information at Bybit Derek Lim, warned that the move could lead to a selloff of Bitcoin, saying:

“It looks like LFG is going to lend $750 million worth of Bitcoin to Jump to sell to protect the peg and buy back at a lower, more attractive price with a total of $1.5 billion. This will add selling pressure. Bitcoin will likely drop before bouncing back as short sellers take profits.

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

Although Terra had a parabolic rally from late 2021 to 2022, concerns over the stability of UST have plagued the industry for over a year now. The decentralized stablecoin suffered a crash similar to the one it experienced yesterday in May 2021. On this occasion, it dropped all the way to $0.96.

Disclosure: At the time of writing this article, the author of this article owned ETH and several other cryptocurrencies. Han Kao is the former CEO of Crypto Briefing and holds shares in the company.