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Luna said that the Forex Reserve will help it prevent the risk of a “bank scenario” scenario associated with algorithmic stablecoin. The reason for choosing the BTC denominated Forex Reserve is that it is less correlated to the Terra ecosystem.
While the cryptocurrency market continues to remain choppy, the Luna Foundation Guard has an important announcement to make. On Tuesday, February 22, the Luna Foundation Guard announced raising $1 billion via an over-the-counter (OTC) sale of LUNA, the Terra blockchain’s native cryptocurrency.
Sharing further details, the Luna Foundation said that Crypto and Three Arrows Capital Led the $1 billion fundraising in addition to participation from other players like Republic Capital, DeFiance Capital, GSR, Tribe Capital, and others.
The Luna foundation announced that the proceeds of the fundraise would go towards “establishing a Bitcoin-denominated Forex Reserve for UST,” a stablecoin in the Terra ecosystem.
The UST is an algorithmic stablecoin of the Terra blockchain that is quite popular in the DeFi ecosystems. Pegged to the US Dollar, the UST is currently the fourth-largest stablecoin with a market cap of $12.2 billion. Over the last few months, the UST valuations have been on a steep rise and have tripled since November 2021.
Understanding the Working of UST and the Reserve
Traditional stablecoins from Tether (USDT) and Circle (USDC) have collateral in physical USD to maintain their price. However, algorithmic alternatives like the UST use a different mechanism. Thus, stablecoins like the UST maintain their peg by relying on market incentives. As per the explanation on Terra’s 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 decreases. The protocol ensures the supply and demand of Terra is always balanced, leading to a stable price”.
However, one of the common problems with the algorithmic stablecoin is its reflexive nature. There’s a hypothetical risk of a “bank run” scenario wherein the demand of selling these stablecoins outstrips the supply ultimately resulting in a compounded decrease in both native tokens. In this case, an additional reserve can protect the Terra ecosystem.
As Terra explains:
“Although the widespread adoption of UST as a consistently stable asset through market volatility should already refute this, a decentralized Reserve can provide an additional avenue to maintain the peg in contractionary cycles that reduces the reflexivity of the system.”
The reason for choosing the Forex Reserve denomination in Bitcoin (BTC) was that it’s less correlated to the Terra ecosystem. The Luna Foundation Guard is a non-profit based out of Singapore. Launched in January, it supports the growth of the Terra ecosystem and improves the sustainability of its stablecoins.