Table of Contents
Table of Contents

Terra Definition

What Is Terra?

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

The Terra protocol creates stablecoins designed to consistently track the price of a fiat currency (a government-backed currency such as the U.S. dollar or euro). It consists of two cryptocurrency tokens—Terra and Luna.

Key Takeaways

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

Understanding Terra

Terra is a payment system that resides and is built upon a blockchain. It was developed by South Korea-based Terraform Labs, which was founded in 2018 by Do Kwon and Daniel Shin. Do Kwon was formerly employed by Microsoft and Apple and founded a startup, Anyfi, which offered decentralized wireless mesh networking solutions. Shin is the founder and CEO of Asian payment technology company Chai—a Terra partner—and was co-founder of Korean e-commerce firm TMON, also known as Ticket Monster.

The business rationale for developing Terra is outlined in a white paper from April 2019 that lists Do Kwon as one of its four co-authors. The paper proposes a cryptocurrency named Terra that is:

  • Price-stable and growth-driven
  • Based on the view that a price-stable cryptocurrency combines the best features of fiat currencies and Bitcoin (BTC).
  • 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.

In its quest to become a leading e-commerce stablecoin payment and decentralized finance (DeFi) service provider, Terra has a growing ecosystem in the crypto space with 114 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
  • 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

Terra and Luna

Because the primary value of stablecoins is derived from the stability of the price peg, theoretically bypassing the volatility typical of cryptocurrencies, the Terra protocol attempts to maintain the price of the Terra stablecoin by ensuring that the supply and demand for it are always balanced by employing arbitrage.

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, which are used to adjust the price via incentives for network participants.

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 International Monetary Fund'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, which 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 Terra usage grows, Luna's worth increases as well.

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 (by increasing the 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)

When Terra is trading at a price that is low relative to its peg, it implies that there is more supply for the stablecoin than demand. The network would need to reduce the supply of Terra until it matches the demand. The protocol then incentivizes users to burn Terra and mint Luna, which has the effect of boosting the Terra price (by reducing supply) and lowering the Luna price (by increasing its supply). This arbitrage process is continued by users until Terra trades at its target price.

On May 9, TerraUSD (UST) lost its peg to the dollar and, by May 11, had dipped as low as $0.30. The founders attempted to stabilize its price with cash infusions and by adjusting protocols to reduce supply.

Incentives

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 Arbitrage

The Terra protocol's algorithmic market module enables atomic swaps—cryptocurrency swaps between coins that run on different chains—between Terra and Luna, and between different Terra stablecoin denominations. Programmed to be 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 offers arbitrage opportunities to users through Terra Station, the official wallet for Terra.

The market module enables users to always trade $1 worth of Luna for 1 TerraUSD (UST), and vice versa, which incentivizes users to maintain the price of Terra. For example, if 1 UST is trading at USD 1.005 (i.e., above the $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 of Luna for 1 UST.

The swap will result in burning $1 of Luna and minting 1 UST. Because 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 $1 peg.

Conversely, if 1 UST is trading at USD 0.995 (i.e., just below the $1 peg), users can buy 1 UST for USD 0.995, and then use Terra Station's market swap feature to trade 1 UST for $1 of Luna. The swap will result in burning 1 UST and minting $1 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 $1 peg.

What Is Terra in Crypto?

Terra is one of two tokens used in the Terra blockchain as a payment method. It is pegged to different fiat currencies through algorithms.

Is UST a Stablecoin?

TerraUS (UST) is algorithmically pegged to the U.S. dollar, so it is considered a stablecoin because it's designed to maintain value. However, it lost its peg on May 9, 2022.

What Is Luna and UST?

Luna is the native token for the Terra blockchain, used for staking and adjusting Terra's price. TerraUS (UST) is the Terra token that is pegged to the U.S. dollar.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Terra. "About the Terra Protocol."

  2. LinkedIn. "Daniel Shin."

  3. CoinMarketCap. "Terra."

  4. Terra. "Terra Money: Stability and Adoption," Page 1.

  5. Terra. "Terra Money: Stability and Adoption,"

  6. Terra. "Terra - Luna Ecosystem."

  7. Terra. "Terra Money: Stability and Adoption," Pages 2-3.

  8. Twitter. "Do Kwon; May 9, 2022."

  9. CoinMarketCap. "TerraUSD to USD Chart."

  10. Terra. "Fees on Terra."

  11. Terra. "Proposal Details: Reduce the Terra Tax Rate to Zero."

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