Authored by Dave Chan, Researcher at Huobi Research Institute
Abstract
LFG and Terraform Labs together purchased a total of more than US$ 1.758 billion BTC and US$230
million AVAX into its reserves to back the market value of UST. Earlier, Terraform CEO Do Kwon revealed his
plan to exchange his UST reserve for US$10 billion of BTC in order to back UST’s market value, driving up
Luna burn rate to mint UST.
UST is the most widely adopted decentralized stablecoin. As far as UST adoption goes, the market now
questions whether UST can sustain its 1:1 to peg to the USD. A depegged ratio will greatly undermine Terra’s
confidence together with Luna, causing a potential Luna sell-off.
Therefore, the UST confidence level indicator was developed, quantified and modelled. The purpose of the
indicator is to quantify how much extent UST is financially healthy in order to relieve the worries from investors,
with the consideration of seven factors to quantify market risks and demands.
In section 2 of this report, a leading indicator role by UST confidence level is illustrated. It shows a pullback
using supply dynamics between liquid circulating supply out of illiquid non-circulating supply.
1. Introduction
As at the date of this article, the Luna Foundation Guard and Terraform Labs purchased more than
a net value of US$1.758 billion BTC and US$230 million AVAX respectively, with each holding an
equivalent amount of UST pool to purchase US$100 million AVAX tokens. LFG now has a bitcoin reserve
to UST supply ratio of 0.09973, meaning to which LFG has potential 10x purchasing power over
acquiring more bitcoins to its reserves in the future.
This is one of the elements to incentivize UST utility and cultivate market confidence. Therefore, we
quantified market parameters to model a UST confidence index:
Later in section 2, we will explain the ways to quantify and model UST’s confidence based on 7
factors of demand and risks. But first, we need to understand the relationship between UST and Luna.
Originally, without the reserve, the UST marketcap is backed by Luna burning or selling UST back
to the Luna pool. The marketcap of UST is minted from the burn of an equivalent market value of Luna.
Luna market cap is used to support UST value when market has more supply of UST than demand.
Therefore, Luna’s circulating marketcap is used to support the market value of UST. When UST suffers
from a price depegged ratio of 1:1 UST to USD, UST will be sold to Luna to cover the arbitrage value
and restore 1:1 UST-USD ratio. Luna’s price and confidence is thus also affected by UST’s market
Later in section 2, we will explain the ways to quantify and model UST’s confidence based on 7
factors of demand and risks. But first, we need to understand the relationship between UST and Luna.
Originally, without the reserve, the UST marketcap is backed by Luna burning or selling UST back
to the Luna pool. The marketcap of UST is minted from the burn of an equivalent market value of Luna.
Luna market cap is used to support UST value when market has more supply of UST than demand.
Therefore, Luna’s circulating marketcap is used to support the market value of UST. When UST suffers
from a price depegged ratio of 1:1 UST to USD, UST will be sold to Luna to cover the arbitrage value
and restore 1:1 UST-USD ratio. Luna’s price and confidence is thus also affected by UST’s market confidence.
2. UST Confidence Index Building on Risks and Demand
Explanation:
The use of Terra Luna confidence level index can be used to assess the seven factors mentioned
above based on the demand and supply of UST and Luna’s value as a whole. If there is an increased
demand for burned Luna and UST, the level goes up. This could be considered as a HODL confidence level.
As seen from the charts, UST confidence level indicator acts as a leading indicator before the pull
back of the Luna circulating marketcap twice. It detected aggressive vesting from illiquid staking pool to
liquid circulating supply twice, thereby increasing circulating supply of Luna.
Considering its effectiveness, each of the seven factors within the quantification of the UST
confidence indicator is described below:
s seen from the charts, UST confidence level indicator acts as a leading indicator before the pull
back of the Luna circulating marketcap twice. It detected aggressive vesting from illiquid staking pool to
liquid circulating supply twice, thereby increasing circulating supply of Luna.
Considering its effectiveness, each of the seven factors within the quantification of the UST
confidence indicator is described below:
s seen from the charts, UST confidence level indicator acts as a leading indicator before the pull
back of the Luna circulating marketcap twice. It detected aggressive vesting from illiquid staking pool to
liquid circulating supply twice, thereby increasing circulating supply of Luna.
Considering its effectiveness, each of the seven factors within the quantification of the UST
confidence indicator is described below:
2.1 Factor 1, Factor 2 and Factor 3
Factor 1 assesses the burn demand of Luna in the illiquid vesting pool, based on the perspective of
the whole burn on total Luna supply. This is to assess the confidence on UST with the demand to burn
from illiquid non-circulating supply and if possible, vesting pool from early Luna investors. There we can
assess whether early investors are burning Luna in exchange for UST in order to increase demand for
UST and demands to burn Luna to reduce its supply. The equation for factor 1 is 1- (total supply/ genesis
supply) = (total illiquid and liquid Luna burned) / total supply.
Factor 2 measures the confidence level in Anchor and measure the level of demand of UST locked
in Anchor reserves and depositors, and to understand if much of UST will come from depositors and
create a large supply to influence the UST peg. The equation is:
[ T marketcap of (Anchor T reserve + Anchor T deposit)] / T marketcap
Based on above charts, Luna suffered from a large price volatility during the period from 10 to 26 January
2022, owing to the market’s lack of confidence on Anchor protocol. Such lowering of confidence level of
UST triggers a massive withdrawal of UST deposit from the market, affecting Luna’s face value and
confidence on the Terra chain. Therefore, the second factor quantifies Anchor protocol’s influence on
UST and Luna price level.
Factor 3 measures how much Luna is needed as a net demand due to staking mechanism - the
(staked Luna supply marketcap – staking rewards) / circ. Luna supply. So, the real demand from staking
less staking reward will be calculated as a portion of a circulating marketcap of Luna, where staked Luna
is the illiquid circulating marketcap inside the net circulating marketcap.
2.2 Factor 4, Factor 5, Factor 6 and Factor 7
Factor 4 estimates the demand on Luna from cross chain activities, mainly from Wormhole. The
equation is defined as Wormhole UST marketcap / UST marketcap, so that the demand for UST across
other blockchain layers is quantified, as a portion of total UST marketcap.
Factor 5 and 6 are used to quantify the potential buybacks of UST or Luna in the event of a liquidity
crisis. The governance proposal will be further discussed in section 3 of this report. Basically, the reason
for acquiring such a large number of BTC and AVAX tokens is to strengthen the peg of UST to USD 1:1
ratio, and to restore the market confidence in Luna and UST in case of a depeg. As mentioned earlier,
LFG and Terraform Labs have acquired up to a net value of US$2 billion BTC and AVAX tokens to restore
from UST’s depeg. The reserve amounted to about US$2 billion can back up 11% of the US$16.7 billion
UST marketcap, or 6.5% of the total of US$30.73 billion Luna marketcap. This means that even if UST
is depegged to 0.9:1 UST to USD ratio, the LFG could slowly buy back the UST from the free market,
until the ratio is restored to 1:1. Apart from that, if UST is algorithmically sold to the Luna pool, Luna
marketcap will decrease while Luna supply increases. LFG could slowly buy back Luna to restore its
market value to the previously bought UST to USD1:1 ratio.
3. Explanation for LFG Holding a Less Volatile Asset to
Back up Confidence of Luna & UST
LFG’s holding Bitcoin has two ways to restore market confidence of Luna and UST. The first is
explained below. In a high volatility market, UST’s supply to market could influence UST’s peg. During a
liquidity crisis, LFG’s could slowly buy back devalued UST back to its original 1:1 ratio with its BTC
reserves, followed by a sell of UST back to bitcoin as a “reserve as arbitrage” after its ratio restoration.
As a result, LFG has gains on arbitrage while restoring UST’s peg value. This is also mentioned as a way
of keeping bitcoin as LFG’s long-term reserve in Jump capital’s governance proposal:
The second way to increase confidence in Terra chain is to buy back Luna or UST using a less
volatile asset to avoid the volatility of Terra’s main asset. The reason to use bitcoin to restore its value is
because, firstly, bitcoin is a less volatile asset than Luna, and can be used as a stabilizing tool to buy
back Luna or UST to instill market confidence. Using bitcoin to buy back UST immediately after its depeg
can prevent Luna being sold at large volatility. While part of the Luna is used to buy back UST, the market
sentiment draws down Luna’s circulating marketcap. Luna loses up to 75% of its market value after the
depeg, therefore it is a more volatile asset than bitcoin. While Luna is the main holding asset for Terra’s
chain, using its main holding asset to buy and sell for UST often and increasing the main asset portfolio’s
volatility would not be advantageous to attracting investors as they look for a more stable price
appreciation. Therefore, using a less volatile asset like bitcoin to buy back UST can avoid Luna’s
maximum price drawdown, thereby restoring Luna’s market confidence and attracting long-term
investors. Holding LUNA long-term would likely increase demand and drive its price up, adding longterm sustainability to its peg to UST. Therefore, using a less volatile asset like BTC to sustain UST’s peg
and cultivate Luna’s confidence will be a great advantage for the Terra chain ecosystem.
4. Advantages and Disadvantages of Holding Assets in
Reserves and Probabilities in the Future
Both Terraform Labs and LFG are holding assets to secure UST and Luna to increase the market’s
confidence. While there are more possibilities for holding onto Terra assets it comes with pros and cons.
The first advantage is cross chain security and decentralization if BTC can be bridged to the Terra
chain. Wallets need to be decentralized in a large extent so that the number of bitcoins can be considered
as community- owned. LFG could use smart contracts to hold the portfolio of assets in different wallet
addresses, so as to lower the probability of hack, enhancing cross chain security and decentralization.
The second advantage in holding assets as reserves is that it provides additional liquidity for the
Terra chain, thereby attracting investors and developers. Buying AVAX and Bitcoin at lower prices or
during a bear market allows a chance for the LFG community to take loans after unrealized capital gains
at a margin. Although LFG is a nonprofit organization, Terra participants can also establish a new
proposal on reserve or asset utilization. With respect to realized capital gain, if the community chooses
to sell or liquidate their reserves on a profitable basis, funds can be drawn to invest or used to help
develop other chain’s communities. For example, funds can be drawn to Apollo DAO as decentralized
hedge funds. Both realized or unrealized profit with borrowed loans can also be used to buy back Luna
as a burn demand to store the capital gains into the Terra’s own unique asset – Luna. Such capital can
also be distributed to Luna validators as locked staking rewards with a definite unlock period, say six
months until unlocked, thereby reducing the circulating supply and rewarding Luna validators with locked
rewards or investors with capital gains. Apart from that, using the reserves to buy back Luna could
resolve its supply shock tension. As seen from below figures, circulating supply is burned to less than
half of the total original circulating marketcap to mint skyrocketing UST market value.
It is not sustainable in the long run to let investors realize there is not much Luna to be burned. If
there is less than 10% of the circulating supply of Luna on the market, price could easily be affected
since most of the supply is locked and not available on the market for any selling pressure or buying
behaviors. Luna is now only 40% from the original marketcap to be reduced to less than 10% of the
circulating supply. Therefore, to consider long term minting and burning relationship, Luna marketcap
has to appreciate, so that more UST can be minted before the total circulating supply is reduced to less
than 10%, where whales have a glimpse to use their net worth for future price manipulation. Luna supply
will become more elastic and sustainable, relieving investor’s concern.
Moreover, using reserves as a cashflow generating machine would instill anchor’s confidence,
thereby securing more UST deposit in anchor protocol and sustaining its yield rewards. As seen from
below charts, 20% of the yield rewards amount up to 800% of Anchor’s yield reserve. While keeping the
donation from Terraform Labs’ Luna to provide yield reserve is considered less sustainable long-term,
using LFG’s bitcoin and other tokens such as AVAX or even ATOM & OSMO reserve is seen as a
probable way out to providing 20% anchor yield. As different chains such as AVAX and OSMO is bridged
to Terra, a 63% staking reward on OSMO and 9% staking reward on AVAX could increase market
confidence on Anchor. As 20% of fund withdrawal due to yield reward stands at US$2.4 billion, Do
Kwon’s ambition to acquire up to US$10 billion bitcoins can provide solutions to resolve Anchor’s yield.
As Anchor’s UST deposit begins to flatten, acquiring US$10 billion bitcoins with 50% loan to value ratio
buying 50% OSMO and 50% AVAX can provide a liquid staking yield of 17%. Liquid staking is launched
10
on OSMO and about to be launched in AVAX. Therefore, the 50% loan deposit as staked tokens can be
refunded to LFG immediately, thereby not affecting LFG’s capital to restore UST’s depeg.
On top of liquid staking’s strategy on keeping its firepower to restoring UST 1:1 peg, diversifying
Terra’s reserve to hold other different chain tokens can provide continuous demand over the market,
leading to the appreciation of the capital gains of LFG’s portfolio and other chains. As tokens such as
AVAX and MATIC provide burning mechanism from transaction fees, LFG acquiring such a large amount
of tokens can initiate massive market buybacks on those chains. Therefore, such reduction on market
supply will drive up the capital portfolio of LFG and other chains.
5. Conclusion
The UST’s indicator assists investors in evaluating the market’s current confidence in UST.
Combining with other trading strategies, traders and investors will benefit from this unique asset. Much
of the market dynamics are reflected into the confidence level and investors are advised to utilize their
own skills to harvest the value of the asset.
In addition, Terra’s market confidence and investment opportunities come along with LFG’s and
Terraform Labs’ purchase of BTC, AVAX and possible other assets in the future. Such acquisitions can
provide more liquidity to enhance Luna supply elasticity, diversify Terra’s revenue streams and reserve
risk portfolio to sustain developed Terra protocols and drive market demand for multi chain capital gains
at an enhanced level of security and decentralization.
In the long run, Luna supply becomes more elastic, confidence in Terra is sustained, and more
investors will hop on the Terra chain alongside Terra's unique proposition to be the reserve currency in
a decentralized economy, akin to the Fed's USD
