Will Terra’s Bitcoin Bet Work?

Can Bitcoin become a good reserve asset?  

Luna Foundation Guard, the folks responsible for building reserves for the Terra (UST) stablecoin, – the world’s third most valuable stablecoin, certainly seem to think so. They recently bought $1.5 billion worth of bitcoin for their reserves. That figure brings the total amount of bitcoin backing the stablecoin to $3.5 billion. The stablecoin was reported to be holding $1.4 billion worth of bitcoin on its books in April.   

The ostensible reason behind the purchase is to maintain a peg to the US dollar. But there’s more to it. Terra’s purchase helps boost demand and liquidity for Bitcoin during a time when its price is declining. Terra also gains from the transaction because it increases the stablecoin’s supply, and that of its governance Luna, available to traders. The transaction was conducted as an OTC swap with Genesis Trading, one of the biggest trading firms within the cryptocurrency ecosystem.   

The Perils of Holding Crypto Reserves

Holding a volatile asset like bitcoin on its reserve books is a risky proposition for Terra because it transfers the cryptocurrency’s volatility onto the stablecoin’s reserve portfolio. When the price of bitcoin falls, as it often does, it will be forced to spend more to shore up its reserves.

MakerDao, a pioneer among algorithmic stablecoins, is well experienced with the mechanics of such adjustments. Its stablecoin Dai has repeatedly lost its peg to the US dollar, when the price of main reserve asset Ethereum’s Ether has crashed. During the last instance, it was forced to diversify its holdings by bringing on USDC – a stablecoin backed by reserves of the US dollar – into its reserve portfolio. Not surprisingly, the move was a controversial one because USDC is backed by Circle, a centralized entity, in a decentralized ecosystem.

As for Terra, its founder Do Kwon has previously said that he wants to purchase up to $10 billion worth of bitcoin. “It’s making a strong directional bet that keeping a lot of those foreign reserves in the form of a digital native currency is going to be a winning recipe,” he told CNBC.

That bet, however, is going in the wrong direction currently what with bitcoin’s plummeting price. The cryptocurrency’s price has moved in tandem with that of sliding mainstream assets. As of this writing, the cryptocurrency is down by approximately 24% from its price at the start of this year. Meanwhile, the price of Avalanche’s AVAX, the other token in Terra and Luna’s reserves, is down by nearly 50% from the year’s start. LFG also has Terra as part of its reserves. In the past, however, the foundation has quickly “dumped” Terra for Luna to boost its value.