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Strategist explains why Terra (LUNA) could trigger a widespread sell-off in the cryptocurrency market

Bitcoin (BTC) operates down 8.5% on the afternoon of this Thursday, 5. Trading at $ 36,419, the lowest value since February 24, the largest cryptocurrency on the market gives clear signs that the bottom of the current bearish cycle is yet to be pursued.

Holding at this level until the market closes, it is possible that Bitcoin will post its second worst daily performance in 2022. On January 21, the BTC price accumulated losses of 10.4% – the worst 24 hours of the year so far. .

Bitcoin Daily Chart 2022. Source: Trading View

Not even the Luna Foundation Guard (LFG) purchase of $1.5 billion worth of Bitcoin announced on Thursday was able to cushion the sharp drop in the price of BTC or LUNA, a token native to the Terra ecosystem.

Now, with the new acquisition of 37,863 BTC, LFG’s reserves amount to $3.5 billion in Bitcoin, whose main function is to guarantee the stability of TerraUSD (UST), the stablecoin algorithm of the Earth ecosystem, in case of extreme events.

However, macroeconomics expert and Bitcoin maximalist Lyn Alden warned in comments posted on Twitter that an eventual need to use the LFG’s Bitcoin reserve to sustain the UST’s parity to the dollar could trigger a widespread market sell-off.

The event visualized by Alden would start from an eventual sharp devaluation of the LUNA due to the structural conditions of the market in a bearish cycle. In this case, she suggested that a 30% devaluation, in the same proportions that Fantom (FTM) faced last week, would be enough to trigger a domino effect capable of provoking a wide capitulation of the market.

The comment was accompanied by a table that shows the decrease in the proportion between UST and LUNA in circulation throughout this year. According to the strategist, this is an indicator that there are greater risks that there will be a rush by investors to redeem their USTs for LUNA, Bitcoin or even fiat currencies, forcing LFG to intervene in the market to guarantee the parity of its stablecoinespecially using BTC reserves

By dumping a large amount of Bitcoin onto the market, the LFG could potentiate selling pressure on the asset. As the dominant cryptocurrency, Bitcoin’s performance almost always determines the broader market behavior. And if so, it could lead to capitulation, Alden explained.

If Luna sees a similar price decline to Fantom or some of these other heavily shaken cryptos, the UST parity would be at risk.

If the UST parity is at risk, the LFG would have to sell its Bitcoin reserves in an already weakened market. This type of event can result in a cycle capitulation moment.

— Lyn Alden (@LynAldenContact)

Algorithmic stablecoin fragility

By design, the UST’s correlation with the dollar is maintained through a mechanism that allows 1 UST to be exchanged for $1 in LUNA at any time. When the UST drops below $1, traders can buy it on the open market and then exchange it for $1 on LUNA, profiting from the trade while helping to stabilize the price of the stablecoin at $1.

According to Alden, such a mechanism would have low resilience in times of market stress, precisely because of the lack of collateralized assets capable of sustaining the UST’s parity with the dollar.

I see a lot of people saying that LUNA/UST will be finished as soon as UST MC > LUNA MC.

This is not the case.

As the price of $LUNA falls, minting/burning becomes more sensitive to changes in demand for $UST, but does not pose a significant risk to parity.

– Harry (@CryptoHarry_)

Unlike a crypto-collateralized stablecoin, there is no specific threshold for an eventual breach of the UST. However, if the LUNA decreases relative to the UST, the probability of an algorithmic bank run increases.

And then there’s the unsustainable Anchor ticking time bomb, but that’s another matter.

— Lyn Alden (@LynAldenContact)

Do Kwon and the LFG team recognized this vulnerability and, precisely because of that, decided to create a Bitcoin reserve fund to guarantee the stability of the Earth ecosystem.

Anchor Protocol

The market demand for UST is also driven by the APY (annual yield percentage) of approximately 20% that until recently was offered by the Anchor Protocol for deposits made with the stablecoin. Since Sunday, the yield index has become dynamic in an attempt to maintain the sustainability of the protocol.

Even so, it remains high enough to remain attractive to investors, although it is practically unanimous in the market that at some point it will have to be significantly reduced. This is exactly the “time bomb” mentioned by Alden in his post.

The strategist raises doubts about the fate of the UST, once the Anchor Protocol reduces the returns offered to investors to the point of being surpassed by competitors.

Anchor’s dynamic interest rate was adjusted for the first time today. It will adjust at a steady rate. So I’m not sure it’s fair to call it a ticking time bomb. TFL will ensure that funds do not run out before this fee is fully adjusted.

indigo (@indigo_loti)

The ticking time bomb is not about how well managed the decline in income.

It’s about what will happen structurally to UST demand when the main driver of demand (the artificially high Anchor yields) no longer exists.

— Lyn Alden (@LynAldenContact)

the newly announced stablecoins Tron (TRX) and Near Protocol (NEAR), for example, promise to provide investors with returns equal to or greater than the stablecoin da Terra has offered so far, as Cointelegraph recently reported.

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