Hi Terra Community,
I wanted to put forward a novel proposal on how to proceed with the recent LFG (Luna Foundation Guard) raise of $1B in BTC. From what I understand this reserve is currently ‘centralized’ and controlled by the guard. I propose a way to decentralize this reserve and use it for the minting and burning of UST without actually depleting the reserve completely. Thereby resulting in UST being effectively backed not just by Luna but also by BTC and further solidifying its already strong peg.
Here is the proposal.
1- All the BTC is wrapped (maybe through the wormhole bridge) and sent to a cosmwasm/smart contract.
2- Users can send UST to this contract and in exchange get an equivalent amount (in terms of dollar value) of wrapped BTC. UST is effectively burnt once sent to the contract.
3- Users can send BTC to the contract and mint an equivalent amount (in terms of dollar value of UST). This of course requires incorporating into the Terra protocol that this contract has the right to mint UST tokens and needs to go through governance.
With this mechanism we are effectively letting users mint and burn UST against not just Luna but also Bitcoin.
However, there is one problem: The fact that the BTC reserve might run out. To counteract this I propose the following mechanics. For the sake of simplicity assume BTC price is $40k.
Say BTC reserve goes below a certain threshold say less than 10000 BTC is left in the reserve.
1- You can still burn UST by sending it to the contract and redeeming it for BTC but you will get less BTC in return. Say you send 40k UST. Instead of 1 BTC you get 0.99 BTC from the reserve (1 percent less).
2- You can also mint UST by sending BTC to the contract but you will get more UST for it. Say you send 1BTC you will get 40.1k of UST (1 percent more).
This mechanism incentivizes market makers to get the reserve back to normal levels. Moreover, no one can claim that the coin is undercollateralized. Even though in mechanism 2 you are getting more UST for the BTC, this is offset by some person getting less BTC when using mechanism 1. So on aggregate, one can see with a little bit of focus, that all the UST will always be slightly “over-collateralized” when the reserve is in depletion mode and “one-to-one” collateralized when the reserve is full.
Here, by “overcollateralized”, I mean more BTC was spent (in terms of dollar value) to mint the available UST.
Finally, the 1 percent number is just made up and can be replaced by a more graceful transition. I can not come up with a graceful chart without data from market makers.
What about the death spiral and all that?
Common somewhat justified FUD about Terra chain is the death spiral scenario:
Imagine the price of Luna is dropping very fast for whatever reason and UST is below peg for again whatever reason. Then market makers should be buying cheap UST sending it to the protocol to get luna for it and selling the Luna for a profit., Then what can happen is that if the price drop of Luna is fast enough that market makers fail to make a profit. Because by the time they get Luna from the protocol and sell it on the exchange the price of Luna has become even lower. Here the BTC reserve could kick in and take selling pressure off from Luna. Therefore market makers can redeem BTC for UST and restore UST’s peg. But I believe this requires fast access to BTC such that market makers can quickly interact with the smart contract and restore order to the peg. Just having a reserve with no access to it (like it is now) would not allow for something like this.
I sincerely think that this implementation could bring huge adoption to the Terra ecosystem. Especially since the value of Bitcoin has been rather solidified through the past decade. This is more so true than the value of the Luna token itself which carries a lot of intrinsic value but is far less known and widely accepted compared to bitcoin.