Terra Proposes Token Burn and Increase in Pool Size to Stop UST Dilution

Terra, the protocol behind the UST algorithmic stablecoin that has lost its dollar peg and is putting pressure on the price of the LUNA token, plans to burn UST and increase the available pool of LUNA.

“The primary obstacle is expelling the bad debt from UST circulation at a clip fast enough for the system to restore the health of on-chain spreads,” said Terra in a tweet.

Algorithmic stablecoins like UST are supposed to be automatically pegged to the price of another currency, such as the U.S. dollar. As explained here, traders can swap LUNA for UST at $1 regardless of the market price because the algorithms in the back end will manage the supply of LUNA, creating enough scarcity to justify the $1.

A token burn refers to taking crypto out of circulation on the blockchain. It can be thought of as a deflationary event, because it would increase the value of the remaining blockchain. For token holders it would be a similar event to a share buyback.

In a proposal put forward to token holders, Terra said that it wants to burn the nearly 1 billion UST (roughly US$690 million) in the community pool while increasing the Base Pool of LUNA available to 100 million, which in turn increases minting capacity to over $1 billion. This will help expedite the outflows of UST from the system, thus pushing it back closer to its peg while pushing down the price of LUNA.

“Currently, the burning of UST is too slow to keep pace with the demand for excess UST to exit the system, which is hindered by the BasePool size,” reads the proposal. “Eliminating a significant chunk of the excess UST supply at once will alleviate much of the peg pressure on UST.”

Some comments on the proposal asked if this happened because of a bug in LUNA’s coding, or if it was also a product of a broader market downturn driven by the decline in bitcoin’s (BTC) price.

Validators of the network are able to vote for this proposal. According to a vote tracker, the Yes side has received 50.47% of the vote while the abstain side has 49.1%; 87.8% of eligible voters have already cast a ballot, and the pass threshold is 50%.