What happened
Algorithmic stable coin network Terra (LUNC -0.20%) and its LUNA token have seen what many would call a "face-ripping rally" over the past few days. Since hovering around the $50 level to start last week, LUNA has since exploded to nearly $75 per token at the time of writing, good for a gain of approximately 50% on the week. Today alone, Terra has surged 12.3% higher over the past 24 hours at 11:30 a.m. ET, leading all top-10 cryptocurrencies in terms of gains.
Most of Terra's gains came following Wednesday's announcement that Terra's stable coin, TerraUSD (USTC -0.23%) will be backed by a $1 billion Bitcoin reserve. This announcement has profoundly changed LUNA's investment thesis for many crypto enthusiasts, many of whom are taking a bullish view of this token in light of this announcement.
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So what
The mechanism that keeps Terra's algorithmic stablecoin UST stable is rather interesting. Unlike other centralized stable coins, UST isn't backed by U.S. dollars, but is fixed to the U.S. dollar via a minting and burning process for LUNA. If the price of UST falls off its peg and goes lower than $1 per token, UST can be swapped for LUNA (which is minted) and sold for $1, providing arbitrage gains for investors. The inverse is true on the upside, where higher demand for UST means more LUNA is burned, reducing LUNA's supply and increasing its price.
The introduction of this Bitcoin reserve is thought by many to be a key step toward reducing volatility within Terra's ecosystem. That's because Bitcoin is seen as a lower-correlation asset in relation to Terra's existing ecosystem, and users can also swap out UST to Bitcoin if conditions are favorable. Thus, this move should result in an even more stable UST, with this Bitcoin reserve seen as a safety valve in times of significant sell-offs.
Now what
In the race for market share in the stablecoin space, Terra is surging higher as investors seem to believe this algorithmic stability mechanism is feasible over the long term. The introduction of this Bitcoin reserve provides for an increased margin of safety for investors, which is always a good thing. Considering the intense volatility we've seen of late, more stability is better than less. Right now, Terra's UST token appears to be the option of choice, with rising demand for this token likely to affect LUNA positively, should this view hold.
