Week 50: Terra Luna, Stablecoins and Quad Witching

Briefing: The Quad Witching is tomorrow, Friday the 17th, and it typically brings volatility in the weeks leading up. It’s a reminder of the massive derivatives market and its effect on market prices. | Stablecoins received a shout-out at the Federal Reserve Press Conference. | The most interesting emerging stablecoin is $UST powered by Terra Luna out of South Korea.

Quad Witching – Friday, December 17th (tomorrow)

We wrote in Week 38 to watch for dramatic sell-offs leading up to the quarterly quad witching dates. The quad witching is the name assigned to the date when four major derivatives markets expire on the same day. In public markets, far more volume flows into bets on the direction of future prices than buying and selling actual underlying investment assets. Excessive derivatives activity eventually leads to blowups, like the Achegos family office blowup in March. Over the short run, this type of derivative activity adds to market price swings.

Stablecoins at the Federal Reserve meeting

On Wednesday (yesterday), Jerome Powell was asked to address stablecoins during the Federal Reserve press conference. He acknowledged that stablecoins are not regulated and could be immediately systematically important. Stablecoins are 1:1 crypto representations of traditional currencies. USDC is a $40 billion cryptocurrency that is fully 1:1 backed by actual US dollars. USDC is easy to regulate because all regulators have to do is confirm the reserve dollars are there, which is more or less public information. Other stablecoins are a bit more complicated, which is the main topic that we’ll explore below.

What is Terra Luna? How does it work, and why is it interesting?

Terra Luna is an independent system that manages the top five stablecoin $UST, where each unit of $UST is worth $1. One of the first questions I hear from people interested in learning more about crypto is, “Cool… but how do I use it? Can I spend it on anything?” In a growing number of cases, the answer is yes, you can use it, and you can spend it. Stablecoins are crypto assets that represent real-world dollars 1:1, and they are a critical piece of crypto infrastructure. Stablecoins help bridge the real world with the innovation happening within crypto.

In South Korea, Chai’s digital payments system is like PayPal or Venmo. Chai’s payments settle instantly 365 days/year and at a fraction of the cost of a typical credit card processor. Chai’s users and merchants don’t interact with any crypto, but their backend is powered entirely by Terra Luna’s blockchain stablecoin system. An estimated 5% of South Koreans use Chai at roughly 2,000 locations, including Nike South Korea.

Terra Luna is the only major crypto ecosystem with a native stablecoin. The way the Terra Luna system works is simple, but the implications are complicated. The supply of the native $LUNA tokens decrease as new $UST stablecoins are created. Therefore the $LUNA token is designed to increase in value as $UST adoption grows. As the platform grows, this mechanism turns $LUNA into a deflationary token, and it has worked so far.

Today $UST holds $8.8 billion in US dollar value, up from $145 million one year ago. As per the design, the price of $LUNA has increased from $0.50 to $65 over the same period. $LUNA token increases in value as the adoption of $UST increases, and vice versa. Dollars do not back $UST, and the $LUNA token is there to absorb any price volatility, for better or worse. US citizens do not have easy access to buy $LUNA (it’s not listed on Coinbase,) but that’s a relatively easy barrier to get around.

What’s interesting about Terra Luna is that it’s grown into a $28 billion experiment supporting an $8.8 billion stablecoin after being founded just three years ago. It’s also one of the largest crypto projects in Asia. Terra Luna is addressing a massive market: currency transfer systems. The real question is whether the $UST stablecoin will survive an inevitable future liquidity crunch.

Suppose $UST adoption continues due to the demand for stablecoins and the rapidly evolving Terra Luna platform. In that case, the price of the $LUNA token will continue its exponential rise as designed. Not a prediction. Terra Luna is a monetary experiment, and no one knows whether it will thrive or burn out. The experimental nature of crypto allows people to test and sometimes be wrong; that’s how we push boundaries and make discoveries.