The Pomp Podcast - #877 The $10 Billion Bitcoin Bet On Stablecoins

Starting point is 00:00:00 What's up, everyone? This is Anthony Pompliano. Most of you know me as Pomp. You're listening to the Pomp Podcast, simply the best podcast out there. Now let's kick this thing off. Today's episode is about a $10 billion Bitcoin bet on stablecoins. We dive into Terra and UST's plans to back their stablecoin with Bitcoin. I really hope that you enjoyed this episode. But before we get into it, I want to first tell you about our sponsors. First up is LMAX Digital, the number one institutional crypto exchange. They offer clients the deepest pool of crypto liquidity on the planet, underscored by a 100% uptime track record through volatility spikes. They leverage LMAX Group's liquidity relationships and ultra-low latency technology.

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Starting point is 00:03:32 Algorithmic stable coins elicit intellectual curiosity from people across disciplines. Whether you are coming from the technology industry, finance, or academia, creating a digital currency that holds stable value without being pegged to another asset is a fascinating problem. The value of this type of asset is obvious, but no one has been able to figure it out. In November, Ryan Clements published a paper titled Built to Fail, the Inherent Fragility of Algorithmic Stablecoins, where he argued the following, quote, algorithmic stablecoins are inherently fragile. These uncollateralized digital assets, which attempt to peg the price of a reference asset using financial engineering, algorithms, and market incentives are not stable

Starting point is 00:04:12 at all but exist in a state of perpetual vulnerability. Iterations to date have struggled to maintain a stable peg, and some have failed catastrophically. This article argues that algorithmic stablecoins are fundamentally flawed because they rely on three factors which history has shown to be impossible to control. First, they require a support level of demand for operational stability. Second, they rely on independent actors with market incentives to perform price stabilizing arbitrage. And finally, they require reliable price information at all times. None of these factors are certain, and all of them have proven to be historically tenuous in the context of financial crisis or periods of extreme volatility, end quote. So this is

Starting point is 00:04:54 important context because there's an experiment underway in crypto that is worth paying attention to. Terra is undergoing a transition from a dollar peg stablecoin to a Bitcoin-backed stablecoin. There's a lot to unpack here, so let's start from the top. Terra is described as a public blockchain protocol deploying a suite of algorithmic, decentralized stablecoins, which underpin a thriving ecosystem that brings DeFi to the masses. The stablecoin at the heart of this ecosystem, TerraUSD, or UST as it's known, sits at more than $15 billion in market cap. This is the fourth largest stablecoin in the market behind Tether, USDC, and Binance USD. Based on a recent conversation with members of the Terra community, there's approximately $100 million to $200 million of new demand for UST per day.

Starting point is 00:05:43 Not only is UST large, but it is growing quickly too. The other asset that you need to know about is Luna. This is the native staking token to the Terra ecosystem. The purpose of Luna is to absorb the price volatility of the fiat peg stablecoins, along with use in governance, mining, and staking. A simple framework to evaluate Luna is that the more Terra is used, the more Luna is worth. So here's how UST gets created today. If someone wants UST, they have to burn Luna. For every $1 of UST that the person seeks, they have to burn $1 of Luna.

Starting point is 00:06:22 This burn mechanism is similar to a stock buyback. It contracts the supply of Luna and is used as a mechanism to keep UST pegged to the US dollar at the preset value of $1. This is obviously not a simple mechanism, though, and the complexity can create significant challenges. Many of these challenges were highlighted in Ryan Clement's paper that we talked about at the start of this letter. So what is Terra going to do differently with UST moving forward? They're going to back UST with Bitcoin. There's approximately $3 billion in Bitcoin, Tether, and Luna sitting in the Luna Foundation reserves today. They are slowly converting the majority of this into Bitcoin. As for new issuance,

Starting point is 00:07:05 the Terra team will refrain from having market participants burn 100% of their Luna when they seek UST. Instead, Terra may burn 60% of the Luna and use 40% to purchase Bitcoin. Here's an example. If I want $10 of UST stablecoin, instead of burning $10 of Luna, I may have $6 of Luna burnt and $4 would be used to purchase Bitcoin. This dual strategy begins to slowly add a Bitcoin backing to the UST stablecoin that is in circulation. The math shows that UST won't be 100% backed by Bitcoin initially. The idea is that over time, Bitcoin's price will continue to rise and will eventually

Starting point is 00:07:47 pull in line with the outstanding value of UST. There is a strong likelihood that the Bitcoin backing will actually exceed the UST value over a long enough timeline. So what are the ramifications of this decision by Terra? First, Terra is becoming a persistent buyer of Bitcoin. They are slowly purchasing $3 billion of Bitcoin from the Luna Foundation reserves today. This is being done via aggressive buying on price dips. Terra will then be a daily persistent buyer of Bitcoin based on the new issuance mechanism that I just described. You can think of Terra as new demand for Bitcoin that will be measured in tens of millions of dollars per day to start. Second, Terra is highlighting the opportunity for Bitcoin-backed assets. Terra's Do Kwon has

Starting point is 00:08:35 recently discussed at length his belief that Bitcoin is pristine collateral. It is the hardest most decentralized asset in the world. The move to back UST with Bitcoin creates a symbiotic relationship, which allows UST to have confidence that the asset is backed by the most superior collateral. Third, Bitcoin gets a credible layer two in Terra, one of the largest smart contract platforms in the world. There's a lot of conversation around what Bitcoin can and cannot do, but now it's becoming obvious that Bitcoin's role as pristine collateral opens a world of possibilities. Now, this evolution of Terra and Bitcoin's role as collateral doesn't come without risk. The team at Terra has identified the biggest risk being a successful bridge between Bitcoin

Starting point is 00:09:20 and their ecosystem. The security model for bridging Bitcoin to a large system with lots of users is still unproven. Many people will point to wrapped Bitcoin as a successful answer, but the process of wrapping Bitcoin in its current form eliminates the decentralized elements of Bitcoin. So this isn't a true bridge from Bitcoin to a decentralized ecosystem. Lastly, Terra is pioneering an idea of Bitcoin-backed currencies that Bitcoiners have long discussed. If you think of the U.S. dollar, there has been no underlying commodity backing the currency once we went off the gold standard. The gold bugs think we will return to the gold standard, but that seems hard to fathom. Some Bitcoiners believe we will use Bitcoin as the next global reserve currency,

Starting point is 00:10:01 including Bitcoin-denominated goods and services, Bitcoin as the only currency, and failure of all existing fiat currencies. While the Bitcoiners may or may not be right about hyper-Bitcoinization, it is easy to see a world where fiat currencies continue to exist, but they are simply backed by Bitcoin. This would be a replication of the gold standard, but using digital gold instead of the analog version. Regardless of how this situation unfolds, Terra's move to back UST with Bitcoin is worth paying attention to. There are lots of risks, but if they are successful in pulling this off, then they will be creating a playbook for other stablecoins and or central banks to follow.

Starting point is 00:10:39 Bitcoin is a decentralized digital currency that has successfully achieved the properties necessary to serve a superior collateral. As more people recognize this achievement, I would anticipate many other assets to adopt the Bitcoin standard. Bitcoin-backed assets are coming. It just may not be in the form that you previously thought. I hope each of you has a great day and I'll talk to everyone tomorrow. Thanks so much for listening to today's episode. I really hope you guys enjoyed this one.

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The Pomp Podcast - #877 The $10 Billion Bitcoin Bet On Stablecoins

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