Foundation research

Luna Foundation Guard raises $1 billion to form bitcoin reserve for UST stablecoin

The Luna Foundation Guard (LFG) has raised $1 billion through an over-the-counter sale of LUNA, the native token of the Terra blockchain.

The raise, one of the largest in crypto industry history, was led by Jump Crypto and Three Arrows Capital, with participation from Republic Capital, GSR, Tribe Capital, DeFiance Capital and other investors anonymous.

The playfully named LFG — a non-profit based in Singapore — was installation in January to help grow the Terra ecosystem.

Proceeds from the $1 billion sale will be used to establish a bitcoin-denominated currency reserve for UST, Terra’s largest stablecoin.

UST is a so-called algorithmic stablecoin that has become popular in DeFi ecosystems. Tied to the price of the US dollar, it currently boasts a market capitalization of over $12 billion, a figure that has more than tripled since November last year, according to The Block Research.

LFG said the reserve created through the $1 billion capital injection will effectively act as a “release valve” for UST buyouts; it is designed to ensure that the price of the stablecoin remains pegged to that of the dollar during strong sell-offs in the crypto markets.

How the reserve works

Unlike longer-established stablecoins, such as those issued by Tether and Circle, algorithmic alternatives do not use collateral to maintain their price.

Instead, stablecoins like UST maintain their peg by relying on market incentives.

Here is an explanation of how the mechanism works, taken from the Terra website: “When the demand for Terra is high and the supply is limited, the price of Terra increases. When the demand for Terra is low and the supply is too large, the price of Terra goes down. The protocol ensures that Terra’s supply and demand are always balanced, leading to a stable price.

Users can mint new Terra-based stablecoins – of which UST is the largest – by burning LUNA tokens, and similarly they can burn UST to mint LUNA. They are incentivized by protocol to burn and mint in a way that ensures that $1 of LUNA can always be exchanged for 1 UST, and vice versa.

The reserve was introduced, however, to intervene if sell-offs in crypto markets erode these incentives.

“Reserve assets can be used in cases where prolonged market selling deters buyers from restoring UST parity and deteriorates the Terra Protocol’s open market arbitrage incentives,” LFG said.

The reserve will initially be denominated in bitcoin, which LFG says is less correlated to the Terra ecosystem. There are plans to store the reserve with other uncorrelated assets over time, although it is not yet clear which assets will be used.

The basic premise is that this will ensure that Terra’s arbitrage incentives will remain intact, even if demand for UST drops sharply.

Kanav Kariya, Chairman of Jump Crypto, said the reserve mechanism “is similar to the number of central banks that hold foreign currency reserves to back monetary liabilities and protect against dynamic market conditions.”

The LUNA purchased by Jump and other investors in the $1 billion sale will be locked in for a four-year vesting period, according to LFG’s announcement.

Terraforming DeFi

Singapore-based Terraform Labs, founded by Do Kwon and Daniel Shin in 2018, is the powerhouse behind the Terra blockchain.

The startup is backed by Pantera Capital, Coinbase Ventures, Galaxy Digital, Binance Labs, Dunamu, Huobi Capital, and OKEx. Last year, it raised capital through a symbolic sale of 25 million dollars in January 2021, before raise an additional $150 million for a fund for the DeFi ecosystem in July.

In the United States, Terraform is currently engaged in a legal battle with the Securities and Exchange Commission (SEC). The regulator is investigating whether Terra’s mirror protocol – a platform for trading “mirror assets” linked to stock prices – violated US securities laws.

Terraform countered that the watchdog improperly served Kwon’s subpoenas at a conference in September 2021, arguing that the watchdog lacked the proper skill set to serve the Singapore-based company.

On February 18, a judge in the Southern District of New York granted an SEC request for an order compelling Terraform to comply with the subpoenas.

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© 2022 The Block Crypto, Inc. All rights reserved. This article is provided for informational purposes only. It is not offered or intended for use as legal, tax, investment, financial or other advice.