There's some weird stuff going on in the world of cryptocurrencies at the moment.
The company that develops Terra (CRYPTO: LUNA) and TerraUSD (CRYPTO: UST) announced that it would buy up US$10 billion ($13 billion) of Bitcoin (CRYPTO: BTC).
Why is Terraform Labs doing this?
First we need to dig into the mechanism behind Terra and TerraUSD.
Creation of TerraUSD pushes up Terra's value
According to Coinjar head of content Luke Ryan, investors have been stepping over each other to get their hands on TerraUSD because of a guarantee of 20% returns from the decentralised finance (defi) platform Anchor Protocol.
A yield of 20% is understandably tempting to investors who can only reap near-zero from bank deposits and maybe 5% from shares if they're lucky.
But how do you get your hands on TerraUSD?
It needs to be converted from Terra. For each TerraUSD created, one Terra is burned.
"Right now people are minting a huge amount of UST in order to take advantage of Anchor's almost definitely unsustainable 20% returns," Ryan said on the Coinjar blog.
"The UST supply has gone from US$2bn to almost US$16bn since November, resulting in the destruction of hundreds of millions of LUNA tokens – and a corresponding uptick in the LUNA price."
Indeed, Terra has doubled in value since late February.
"Since November (i.e. the start of the bear market), the amount of UST in circulation has gone up 800% and is still increasing by roughly US$100 million per day. At US$16 billion, UST is almost twice as large as Dai (CRYPTO: DAI), the second largest algorithmic stablecoin."
What if this money-making system fails?
That's all fantastic for owners of Terra and TerraUSD. But can this party last forever?
That's where the massive purchase of Bitcoin comes in.
"Let's imagine a mass panic event — say, a large-scale exploit of ANC," said Ryan.
"Overnight, billions of UST are redeemed for LUNA. To prevent the wholesale collapse of the ecosystem, Terra sells an equivalent amount of BTC instead."
In other words, Terraform Labs co-founder and chief executive Do Kwon is spreading the risk of the Terra-TerraUSD-Anchor relationship.
"Functionally it's not that different from the reserve requirement that all banks are subject to," Ryan said.
"The Bitcoin treasury exists to cushion a bank run that could otherwise cause a LUNA-UST death spiral."
TerraUSD is currently in hot demand because of its 20% yield. But if the Anchor Protocol ever decides to end or even reduce that return, mass withdrawals are not out of the question.
That's where the reserve Bitcoin will come into play, to stabilise the value of Terra.
