TLDR
Terra is a decentralized payments network focused on the adoption of their native stablecoins
$LUNA, the native currency of Terra, is designed to accrue value as the network grows
$UST (Terra’s USD pegged stablecoin) is the 5th largest stablecoin by market cap and continues to expand
In this educational piece, we explain what Terra is, the role of the $LUNA token, and provide an overview of popular dApps in the Terra Ecosystem.
Disclaimer: NOT FINANCIAL NOR INVESTMENT ADVICE. Only you are responsible for any capital-related decisions you make, and only you are accountable for the results.
Centralized vs Decentralized Stablecoins
Before we discuss Terra, it’s important you understand the main differences between centralized and decentralized stablecoins. USDC (a stablecoin issued by Circle) and USDT, a stablecoin issued by Tether, are examples of centralized stablecoins. Centralized stablecoin issuers like Circle and Tether claim to have an equal amount of USD reserves in the bank for every stablecoin they issue. Centralized stablecoins raise several risks, such as censorship from the issuing entity as well as regulatory risk from the state in which the centralized entity resides. Decentralized stablecoins work differently.
Decentralized stablecoins, commonly reffered to as “algorithmic stablecoins” keep their peg through algorithmic incentives programmed into the blockchain economy. Decentralized stablecoins are generally more censorship resistant, as there are no reserve bank accounts that can be targeted by regulators and no centralized issuers that can freeze tokens. The flagship example of a decentralized stablecoin is MakerDAO’s DAI – although $UST recently surpassed it in market cap. DAI uses an over-collaterized minting mechanism in which users deposit ETH or other forms of collateral to mint DAI. This system is not scalable as it relies on borrowing demand to increase supply. MakerDAO also accepts centralized stablecoins as collateral to mint DAI, meaning DAI is a decentralized stablecoin partially backed by centralized stablecoins. Terra, on the other hand, aims to create a censorship resistant and scalable stablecoin completely independent from its centralized counterparts.
Who Created Terra?
The Terra protocol is developed by Terraform Labs, a Singapore based crypto firm founded in 2018 by UPenn and Stanford graduates Daniel Shin & Do Kwon. One of the first projects Terraform Labs incubated is an e-commerce platform called Chai, which utilizes the Terra blockchain to allow over 2,000 merchants in Korea to accept payments without unnecessary intermediaries taking a cut. Chai also offers its own digital wallet and debit card which has over 3M users. The Terra blockchain is actively being used for real life use cases in Korea. This differentiates Terra from other stablecoin creators that mostly have yet to display real life use cases for their stablecoins outside of DeFi.
What is Terra?
At its core, Terra is a payments focused financial ecosystem powered by the adoption of their decentralized algorithmic stablecoins. Terra is a layer one Proof-of-Stake blockchain built on top of the Cosmos SDK. Terra is powered by $LUNA, the chain’s native token. Terra creates stablecoins for numerous fiat currencies, the most popular being $UST, their USD pegged stablecoin. It has been one of the fastest growing stablecoins in crypto, and recently eclipsed as of Dec 24, 2021 sits at a $9.69B market cap. Terra’s TVL (Total Value Locked) has also increased, surpassing $16B. This is largely due to Terra’s rapidly growing DeFi ecosystem that you can see below. Earlier this year, Terraform Labs invested over 150M into the ecosystem with backers including Pantera capital and Arrington XRP.
(Source: TerraDaily)
Terra uses Cosmos’ Tendermint delegated proof of stake mechanism that allows maximum 100 validators to join the network. This makes the network less decentralized than other PoS chains that accept more validators. Terra validators receive rewards for securing the network, compute and transaction fees, seignorage rewards, and staking rewards. Similar to PoS networks like Solana, validators can stake LUNA tokens in order to be considered to produce or “mine” the next block. Terra can handle hundreds of transactions per second and confirms transactions in approximately six seconds. Terra is “chain agnostic” – the team does not care what chain $UST lives on. The focus is creating utility for Terra stablecoins across all blockchains in the crypto ecosystem. Since Terra is built on top of the Cosmos Software Development Kit, it can utilize Cosmos’ Interblockchain Communication (IBC) as well as other bridges like Wormhole to spread $UST to chains like Ethereum, Solana, and Avalanche. In order for Terra to achieve its goal of multichain domination, it must have a robust mechanism to ensure the stablecoins keep their peg.
How Does $UST Keep its Peg?
$UST, Terra’s native stablecoin pegged to the US dollar, has a peg mechanism different from popular counterparts such as DAI, USDC, and USDT. In order to mint one dollar worth of $UST, you need to burn the equivalent dollar amount of LUNA. If you want to mint 10 UST and the price of 1 LUNA = $10, then you need to burn 1 LUNA to mint 10 UST. This process also works in the reverse. You can burn Terra stablecoins to redeem the equivalent dollar value of LUNA. This creates a financial incentive for arbitrageurs to ensure Terra stablecoins keep their fiat peg. For example, when 1UST < 1USD, you can trade 1 UST for one dollar value of LUNA. This creates profit for the arbitrager and shrinks the circulating supply of UST, making the price go back up to its peg. When the price of $UST is high relative to its peg, users are incentivized to burn LUNA, mint $UST, and sell that $UST on the open market for USD to secure a profit and decrease the price of $UST, once again ensuring its peg.
(Source: Dirt Roads on Substack)
Role of LUNA Token
LUNA is the native staking token that, as explained above, is primarily designed to absorb the volatility of the Terra stablecoins ensuring they keep price parity with the fiat currency they are pegged to. Like many PoS networks, LUNA is also used for governance and staking. Those who stake LUNA can participate in governing the protocol, mine new blocks, and earn off of network fees. The demand for LUNA increases as the demand for Terra stablecoins increases. If you are asking yourself, “why would I hold $LUNA when the main focus of the network is $UST?” – you should then ask yourself the follow up question: “Do I believe $UST will grow in demand throughout the DeFi ecosystem?” If so, then the subsequent conclusion is that LUNA will accrue value.
Terra’s economic activity is incentivized by a series of applications that use Terra stablecoins as the underlying currency. Below we discuss in brief the roles of a few of these applications and how they promote the expansion and utility of $UST.
Terra DeFi Ecosystem Overview
Anchor ⚓️
Anchor Protocol, like it’s name states, is the application the entire ecosystem bottoms out to. It is likely the most important application in the ecosystem. Anchor offers the best stablecoin yield in DeFi at 19.5%. In order to use Anchor as your neobank savings account, one must deposit Terra stablecoins. Anchor does not accept any other stablecoins. This incentivizes users to purchase and hold Terra stablecoins, thus increasing the demand for $UST. Users can also use Anchor for LUNA staking as well as traditional borrow lending. For a more in depth explanation of what Anchor is and how it generates its impressive yield, read our in depth report on Anchor here.
Mirror 🪞
Mirror Protocol is a synthetics protocol that allows anyone globally to permissionlessly get price exposure to stocks and other real world assets while remaining inside the Terra ecosystem. Mirror does this by creating “mAssets” which mirror assets such as US stocks and precious metals. Mirror adds DeFi economics to tokenized real world assets by allowing you to add mAssets to liquidity pools. You can mint mAssets by creating collateralized debt positions using $UST as collateral. This expands the use cases of $UST, enhancing the stickiness of the stablecoin, and keeping users inside the Terra ecosystem.
TerraSwap 🔄
TerraSwap is Terra’s native AMM, and the first DEX on Terra. You can swap from the many emerging CW20 (Terra) tokens and provide liquidity in liquidity pools to earn interest. It is similar in function to Sushi or Uniswap.
Stader Labs ❎
Stader is a nascent, community driven liquid staking solution that has quickly surpassed ~500M TVL. Stader allows you to stake your LUNA and receive a liquid staking token called “LUNAx” in return. This way, you can earn staking yield on your LUNA, while keeping the freedom to utilize “LUNAx” in DeFi strategies as you please. Stader is a new protocol and we do not reccomend you stake with them until you have done the proper research on the protocol and understand the complexities of liquid staking.
Mars Protocol 🪐
Mars Protocol is an upcoming dApp incubated by the highly competent and respected Delphi Labs. Mars plans to be a non custodial open source borrow lending protocol. Like a bank, Mars aims to attract depositors and lenders. Unlike banks, Mars aims to lend the money responsibly, generating yield for both the dApp and its users. Mars will be fully automated with an on chain transparent system that is governed by the $MARS community. Decisions are made by the “Martian Council” – users who stake $MARS.
Orion Money 💸
Orion Money is an Ethereum based protocol that takes advantage of Anchor’s 19.5% interest rate by collecting ERC20 based stablecoins such as wrapped UST, DAI, USDT, USDC, FRAX, BUSD and exchanging them for $UST. After the stables are exchanged to $UST, Orion deposits them in Anchor to earn yield for users not native to Terra. When users want to withdraw their deposits, Orion automatically withdraws the $UST from Anchor and swaps it back into the native asset the user deposited. The current fixed yield rate on Orion is 13.5-16.5% which makes sense given it is a couple percentage points shaved off the Anchor rate that is the source of their yield.
Conclusion
Terra is a burgeoning ecosystem that has one clear goal: make $UST the most adopted stablecoin in all of crypto. Thus far, they have done a phenomenal job of making that dream a reality. Terra has a series of decentralized applications that create utility for $UST, incentivizing users to make the switch from their current stablecoin of choice. $UST has expanded to numerous blockchains such as Ethereum, Avalanche, and Solana. We at Cryptonary definitely think Terra is an important blockchain to keep an eye on. We look forward to updating you on further developments within this up and coming ecosystem.
Until next time, thanks for reading!
Appendix:
Proof of Stake: a cryptocurrency consensus mechanism used for procesing transactions and creating new blocks in a blockchain – owners of the native staking currency validate block transactions based on the amount they have staked
Cosmos SDK: framework that allows developers to easily build complex, secure application-agnostic state machines