The fast-growing popularity of the TerraUSD stablecoin comes with some risk because of its dependence on algorithms to hold its dollar peg.
“It’s all fun and games if you’re a $5 [billion] or $10 billion market cap stablecoin,” Tether Chief Technology Officer Paolo Ardoino said in an interview with CoinDesk at the Paris Blockchain Week Summit. But that can change the bigger that stablecoin's market cap gets.
UST is now the third-biggest stablecoin on the market after Tether's USDT and Circle's USD coin (USDC), which are still significantly larger in terms of market cap. However, the native stablecoin of the Terra ecosystem has grown rapidly, from $180 million at the beginning of 2021 to over $17 billion in market capitalization as of April 18.
Terraform Labs is the organization behind the UST stablecoin and its LUNA token.
UST keeps its $1 dollar value by using a smart contract-based algorithm to keep the price of UST anchored to $1 by permanently destroying LUNA tokens in order to mint create UST tokens.
As Ardoino sees it, “If you have a liquidation [with an algorithmic stablecoin of UST's size] with this market, you can still handle that. But imagine if you have a $80 [billion] or $100 billion market cap stablecoin like tether that’s [primarily] backed by digital assets. It’s really hard to predict what will happen and [know] if there will be enough liquidity to backstop that immense cascade.”
Why is he even noticing UST considering USDT and USDC are so much bigger, at a market cap of $82 billion and $49 billion, respectively? Maybe because UST has been quickly gaining on the stablecoin leaders, growing 138-fold in 2021.
But with the rewards come risks. Researchers have noted their concerns about algorithmic stablecoins, and some in the crypto community are particularly worried about LUNA. Because of the way the Terra ecosystem is designed, strong market volatility poses a major threat to UST's peg, these researchers say.
Another concern could be that over 67% of the demand for UST comes from Anchor Protocol.
The Anchor protocol, a decentralized savings protocol based on the Terra blockchain, offers a comparably high yield of 19.5% on UST deposits. Terra must therefore maintain that yield. If it doesn’t, UST holders could rapidly try to sell their tokens. In turn, that could raise the risk that there’s not enough liquidity in the market for everyone to exit at the same time, some analysts and traders have argued.
Terra did not immediately respond to a request for comment by CoinDesk.
UST is not the only stablecoin that concerns investors. Ardoino’s own company, Tether, the issuer of the largest stablecoin by market cap, has been the subject of questions about whether it has enough collateral to back the 1:1 dollar peg of USDT.
UST’s growth has also left some crypto traders worried about the future stability of the stablecoin and the risks it poses to the whole crypto market.
But as for Ardoino, “I wish them well.”