What is Terra?

Terra is an open-source blockchain payment platform for algorithmic stablecoins, which are cryptocurrencies that track the price of currencies or other assets. The Terra blockchain enables users to spend, save, trade, or exchange Terra stablecoins instantly on it.

The Terra protocol creates stablecoins that consistently track the price of any fiat currency (a government-backed currency such as the U.S. dollar or euro). It consists of two main cryptocurrency tokens—Terra and Luna—which have the following features.

Key Takeaways

  • Terra refers to an open-source blockchain protocol that underpins algorithmic stablecoins and a growing network of financial applications.
  • Terra also refers to one of the two main cryptocurrency tokens under this protocol, the other one being Luna.
  • Terra stablecoins track the price of fiat curencies like the U.S. dollar and euro, while Luna is used for governance and mining.
  • The Terra protocol maintains the price of the Terra stablecoin by ensuring that supply and demand for it are always balanced. This is achieved by using Luna as the variable counterweight to the Terra stablecoin.

Terra: These are stablecoins that track the price of fiat currencies and are named after them. For instance, the base Terra stablecoin tracks the price of the IMF's Special Drawing Rights and is named TerraSDR or SDT. Other Terra stablecoin denominations include TerraUSD (UST), which tracks the U.S. dollar, and TerraKRW (KRT), which tracks the South Korean won. Users mint new Terra by burning Luna.

Luna: Used for governance and mining, Luna is the Terra protocol's staking token that absorbs the price volatility of Terra stablecoins. Users stake Luna to Terra blockchain miners (called "validators"), who record and verify transactions on the blockchain and receive rewards from transaction fees as compensation. As usage of Terra grows, Luna's worth increases as well.

How Terra Works

Since the primary value of stablecoins is derived from the stability of the price peg, thereby avoiding the volatility typical of cryptocurrencies, the Terra protocol maintains the price of the Terra stablecoin by ensuring that supply and demand for it are always balanced.

Luna is the variable counterweight to the Terra stablecoin and absorbs its volatility. To understand how Terra works, envision the entire Terra "economy" to consist of a Terra pool and a Luna pool. To maintain Terra's price, the Luna supply pool adds to or subtracts from Terra's supply; users burn Luna to mint Terra and burn Terra to mint Luna. This is achieved by the protocol's algorithmic market module, which incentivizes the minting or burning of Terra through arbitrage opportunities.

Expansion (of the Terra pool): When Terra is trading at a price that is high relative to its peg, the implication is that demand for the stablecoin is higher than supply; this means that supply of Terra should be increased to match demand. The protocol incentivizes users to mint Terra and burn Luna, which has the effect of lowering the Terra price (through expanded supply) and increasing the Luna price (by reducing its supply). Users continue this arbitrage process until Terra trades at its target peg price.

Contraction (of the Terra pool): The reverse situation occurs when Terra is trading at a price that is low relative to its peg, which implies that there is more supply for the stablecoin than demand. This would necessitate reducing supply of Terra until it matches demand. The protocol then incentivizes users to burn Terra and mint Luna, which has the effect of boosting the Terra price (through reduced supply) and lowering the Luna price (by increasing its supply). This arbitrage process is continued by users until Terra trades at its target price.

How big is Terra?

As of Nov. 14, 2001, Terra (LUNA) had a market capitalization of $22.6 billion, ranking it No. 12 among all cryptocurrencies by this measure. TerraUSD ranked fifth among stablecoins, with a market cap of $4.94 billion.

Example of Arbitrage

The Terra protocol's algorithmic market module enables atomic swaps between Terra and Luna, and between different Terra stablecoin denominations. Similar to a market maker, the market module ensures that there is a readily available and liquid market for the protocol's assets, with stable prices and fair exchange rates between them.

The market module enables users to always trade 1 USD worth of Luna for 1 TerraUSD (UST), and vice versa, which incentivizes users to maintain the price of Terra as follows:

  • If 1 UST is trading at USD 1.005 (i.e., above the USD 1 peg), users can use the market swap feature of Terra Station—which is Terra's native platform for wallet, swap, governance and staking functions—to trade 1 USD of Luna for 1 UST. The swap will result in burning 1 USD of Luna and minting 1 UST. Since 1 UST is currently trading at USD 1.005, users can sell the 1 UST resulting from the swap for USD 1.005, pocketing the difference of USD 0.005. As multiple users engage in this arbitrage activity, the UST pool continues to expand, generating downward pressure on the UST price until it reaches the USD 1 peg.
  • Consider the reverse situation in which 1 UST is trading at USD 0.995 (i.e., just below the USD 1 peg). In this case, users can buy 1 UST for USD 0.995, and then use Terra Station's market swap feature to trade 1 UST for 1 USD of Luna. The swap will result in burning 1 UST and minting 1 USD of Luna, generating a profit of USD 0.005 for the user. As this arbitrage activity continues, the UST pool continues to shrink, generating upward pressure on the UST price until it reaches the USD 1 peg.

Terra Rewards: The Terra protocol incentivizes validators (Terra blockchain miners) and delegators (users who want to receive rewards without running a full node) with staking rewards that come from two sources.

  • Gas fees: Computational fees added to transactions to cover the cost of processing them, and to avoid spamming; validators can set their own minimum gas fees.
  • Stability fees: Fees added on to each transaction to provide market stability. There are two types: Tobin Tax, which refers to a percentage fee added to any swap between Terra stablecoins; and spread fees, which is a percentage fee added to any swap between Terra and Luna, the minimum spread fee being 0.5%.

Terra's Development

Terra has been developed by South Korea-based Terraform Labs, which was founded in 2018 by Do Kwon and Daniel Shin. Current CEO Kwon was formerly employed by Microsoft; Shin is founder and CEO of Asian payment technology company Chai—which is a Terra partner—and was previously founder of Korean e-commerce firm TMON.

The business rationale for developing Terra is outlined in a white paper from April 2019 that lists Do Kwon as one of the four co-authors. The paper proposes a cryptocurrency named Terra that is both price-stable and growth-driven, based on the view that a price-stable cryptocurrency combines the best features of fiat currencies and Bitcoin (BTC), while a successful new digital currency needs to maximize adoption to become useful as a medium of exchange. The paper notes that there is demand for a decentralized, price-stable money protocol in both fiat and blockchain economies, and such a protocol could be the best use case for cryptocurrencies.

Terra-Luna Ecosystem

In its quest to become a leading ecommerce stablecoin payment and decentralized finance (DeFi) service provider, Terra has a growing ecosystem in the crypto space with more than 100 projects across DeFi, Web 3.0, and non-fungible tokens (NFTs). These projects include:

  • Anchor Protocol: A fixed yield platform with borrowing yields and frictionless access
  • Andromeda Protocol: Next-generation NFT protocol
  • Chai: A payments app with over 2 million users in South Korea
  • LoTerra: A decentralized lottery platform built on the Terra blockchain
  • Mirror Protocol: Allows for the creation of fungible assets or "synthetics" that track real-world asset prices
  • Talis Protocol: A platform where artists can sell their creations and offer services
  • Vega Protocol: A platform for minting and trading derivatives

What is the Terra Ecosystem Fund?

The Terra Ecosystem Fund will be used to develop applications and protocols on the Terra network. The Fund is supported by $150 million of capital commitments, pledged by major crypto investors in 2021.

Is Terra a blockchain or cryptocurrency?

It's both. Terra refers to an open-source blockchain protocol, as well as to the stablecoins—a class of cryptocurrency—generated under this protocol.

Why did the SEC file a subpoena enforcement action against Terraform Labs and its CEO?

On Nov. 12, 2021, the Securities and Exchange Commission announced that it had filed an action against Terraform Labs and its co-founder and CEO Do Kwon, seeking an order directing them to comply with subpoenas for documents and testimony related to the Mirror Protocol. Terraform Labs launched the Mirror Protocol in 2020, through which users may create and trade digital assets referred to as mAssets that mirror the price of U.S. securities. The SEC is investigating whether Terraform Labs and Kwon violated U.S. federal securities laws by not registering the offer or sales of securities, selling security-based swaps outside of a national security exchange, and acting as an unregistered broker or dealer.

Article Sources

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