UST "Collateralization"
Comparing circulating supplies
In the chart below I compare the circulating supply of LUNA and UST. As you can see post-launch as UST supply ramps up from 0 to 2 Billion, it has a negligible impact on the LUNA's supply. If LUNA was truly backing UST, then a lot of LUNA would have had to be taken out of circulation.
UST is not 'collatelarized' by LUNA
To say that UST is collatelarized by LUNA would be wrong because UST has no claim on a particular amount of Luna underlying. The price of Luna serves only to determine the quantity of Luna required at the margin to maintain the peg during arbitrage.
If Luna went to $0 this would be problematic. But Luna has exogenous income flows (e.g. from CHAI users in Korea) that provide it with intrinsic value above $0.
The following tweets from Do Kwon highlight this fact:
https://twitter.com/stablekwon/status/1396739010068840448
> $UST is not explicitly backed by $LUNA - the system allows swaps between the two assets to achieve stability.
> As long as $LUNA has non-zero market value, the system can offer arb incentives to bring prices to the peg.
A word on Stablecoins
What’s a StableCoin? It’s a cryptocurrency that’s trying to have as low volatility as possible when paired to a fiat currency. For example, a StableCoin paired with the US dollar should equal one dollar at all times.
Most of the current StableCoins out there use different methods to achieve their stability, while others share similar ways.
USDT, USDC, DAI and UST are the top stablecoins by marketcap. Here's how they achieve stability
How does USDT achieve its stability?
Tether USDT tries to achieve its one-to-one ratio to the US dollar by tying itself to a supposed reserve of actual dollars in their bank, but in reality, 3.87% of its reserve is actual cash dollars, with the rest representing secure loans, public bonds, precious metals, and other investments.
How does USD Coin USDC achieve its stability?
Unlike USDT, USDC’s supply is backed one-to-one with fiat dollars. Meaning if there’s 100 million USDC, there are actually 100 million fiat dollars behind it. That’s how it achieves its stability.
How does DAI achieve its stability?
DAI maintains its stability by locking in Ethereum in a smart contract as collateral, resulting in the issuance of DAI.
Considering Ethereum’s volatility, it was agreed that there needs to be an over-collateralization of ETH to issue out DAI, and that ratio would be 150%, where $1.5 worth of ETH needs to be locked in order to receive 1 DAI.
What’s interesting about DAI compared to the rest so far, is that it doesn’t have fiat as its reserve but use ETH instead, and that it’s a decentralized StableCoin where its issuance is tied to the mentioned smart contract.
How does UST achieve its stability?
UST is issued from a process known as seigniorage, where some of Terra’s native token/coin LUNA is taken out from a supply, then a percent of it is burned, and the other percent goes to a community pool to fund services and applications for the Terra network.
The more there is demand for UST, the more LUNA of appropriate amount and value is taken out of the supply to be burned, issuing UST into the market, and vice-versa.