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Terra Classic over the last day (03.10.2023)
Terra is a blockchain protocol supporting decentralised Stablecoins pegged to fiat currencies.
It aims to disrupt both fiat payment systems and existing cryptocurrencies that lack stability and ease of use in the real world.
Its decentralised Stablecoins provide a foundation for building additional financial services with better savings rates, cheaper payment networks and more inclusive investment products. Taken collectively those parts can be described as the Terra Network.
The Terra Network can be broken down into five key components:
Though Terra’s unique selling point is providing a range of decentralised Stablecoins, it needs a blockchain to record transactions and balances. Terra’s blockchain wasn't built from scratch like Bitcoin or Ethereum. It uses an existing framework called Cosmos SDK; think of it as an off-the-shelf blockchain solution. The latest version is known as the Columbus 5 Mainnet.
Every blockchain uses a specific Consensus Mechanism, a method for agreeing on an accurate state of all transactions and recording them in blocks of data connected chronologically in a chain.
Terra’s Consensus Mechanism is called Tendermint and uses a Proof of Stake logic. Proof of Stake simply means that participants in the consensus process have to stake funds - ensuring they have skin in the game - to ensure accuracy and discourage spam.
On the Terra blockchain, the consensus mechanism involves two key roles. Validators and Delegators.
Validators pledge the native token LUNA to be able to propose blocks of new transactions, vote on their validity, and add each new block to the chain in exchange for staking rewards paid for from transaction fees. They do this by running a Node, a software that contains the consensus rules.
Delegators can pledge LUNA to a chosen Validator through the Terra Station wallet to passively earn some of the rewards but without having to participate in the validation process by running a Node actively.
Here’s how the Consensus Mechanism for Terra works in summary:
A type of Validator called a Proposer is chosen to submit a new block of transactions to the Terra blockchain.
Validators vote in two rounds on whether to accept the proposed block. This process protects the integrity of the chain. If a block is rejected, a new proposer is selected and the process starts again. Proposers are incentivised to fulfil their role through rewards.
If the block is accepted, it is signed and added to the end of the chain, and the process repeats.
The transaction fees from the block are distributed as staking rewards to Validators and as passive rewards to their Delegators.
Each validator stores a copy of the Terra blockchain with all historic transactions which they compare against the proposed block before voting. There are 130 independent Validators to ensure that the Consensus Mechanism is autonomous and maintains an accurate record of transactions and balances.
Terra’s mission is to offer decentralised Stablecoins that function like fiat money but with faster settlement, a transparent ledger and cheaper fees.
Terra’s most important Stablecoin is UST, which is pegged to the value of the real US dollar, and is currently ranked 7th by Coinmarketcap.com. To maintain that peg to the US dollar Terra has to balance supply and demand for UST constantly. If demand is high, then its price could rise above the 1:1 peg; if demand is too low, then the price could fall.
The Terra ecosystem includes Stablecoins pegged to other fiat currencies in a similar way:
Terra (UST) is what is known as an algorithmic Stablecoin because that constant rebalancing is managed automatically through its relationship with Luna, which is Terra’s native token. For Terra to remain stable Luna’s supply has to either expand or contract based on changes in demand.
If there is excess demand for TerraUSTA, its price might rise above the 1:1 peg, so holders of Luna are incentivised to burn Luna and mintUST. The supply of UST increases to meet demand stabilising its price at the peg. Luna’s supply falls, increasing its price.
If there is an excess supply of UST, its price might fall below the 1:1 peg, so holders are incentivised to burn UST and mint Luna, shrinking Terra’s supply until it returns to the required peg. Luna’s supply increases, and its price falls.
This whole balancing process is enabled by Terra’s Market Module, a trading feature within the Terra Station Wallet that encourages users to trade the imbalances between TerraUST, Luna and USD - known as arbitrage.
If TerraUST is trading above the $1 peg, there is excess demand. Users can sell Luna to buy $1 worth of UST, but because it is above the 1:1 peg, they’ll get more than a dollar in value. They can then realise that profit by selling the UST, which gets burned. That process continues until the relationship between Luna, TerraUST and USD rebalances.
The same happens in reverse if there isn’t enough demand and one UST is worth less than $1. This situation incentivises dollar holders to buy cheap UST, and then sell it for Luna to realise the profit, burning Terra.
The mechanics of UST have come into question as the wider crypto market suffered declines in April and May 2022. The Luna Foundation Guard, which manages the reserves of the Terra Network, began buying significant amounts of Bitcoin to act as more effective collateral.
The LFG Reserves of Bitcoin stand at over 83,000 making it one of the top ten holders of BTC, but that move has somewhat backfired, given Bitcoin has itself seen significant declines and leading to speculation that some BTC will have to be liquidated to support UST.
For the whole Terra ecosystem to come together, end-users need access to the best native digital wallet, which is called Terra Station.
The Terra Station Wallet ensures the Consensus Process works effectively by giving passive holders of Luna an easy way to delegate to Validators.
It helps maintain the stability of Terra by enabling the market operations between UST, USD and Luna in a simple Swap interface.
It supports the wider ecosystem by enabling users to make Luna/Terra transactions and on-ramp from fiat currencies.
For Terra to achieve its mission of creating a stable form of money with better utility than fiat currencies it brings together a unique set of services:
Anchor is a protocol built on the Terra blockchain that pays out a low-volatility yield on UST deposits. This has historically been set at around 20%, with no lock-in period, but under recent market conditions APY is trending down. We discuss the reason why below.
20% is a huge return compared to variable returns elsewhere within DEFI and the rates of return from a standard bank account (which are in real terms negative) so unsurprisingly, Anchor has attracted an enormous amount of locked value.
Prior to the change in APY Anchor had around $14bn in TVL ranking fourth in terms of all DEFI protocols according to DefiLlama, which is even more impressive because that is based on just funds originating from the Terra chain. The impact of declining APY saw that TVL drop by $2bn on May 7th, 2022.
The obvious question is how Anchor can achieve such a high and consistent return? According to its whitepaper this is how the magic happens:
The Lido Protocol plays a key part in Terra’s ecosystem solving the problem of staked assets becoming locked. Lido allows assets such as Ether and Luna to be staked, with an equivalent bonded asset (bAsset) generated which can then earn yield elsewhere, with rewards paid on a daily basis.
As Terra’s ambition is to allow its users to access real-world products with a decentralised Stablecoin it has created an investment platform called Mirror, which allows users the opportunity to invest in real-world assets, like shares.
Rather than buying shares in Apple or Amazon, Mirror users invest in synthetic versions of those stocks, known as mAssets. The protocol uses Smart Contracts to create Collateralised Debt Positions; users deposit Terra as collateral, and a Smart Contract mints an mAsset.
The protocol uses a native token MIR to incentivise liquidity in the system and encourage shorting assets to generate an efficient synthetic market.
Mirror’s innovative approach to creating synthetic versions of traditional securities has attracted the attention of the SEC which is currently investigating Terra Labs for offering unregistered securities through Mirror.
The final major piece in the Terra ecosystem puzzle is a payment network that lets Terra users spend their funds online and in-store, which requires Terra to bridge the decentralised and fiat payment rails. Rather than reinvent the wheel, in 2019 it partnered with Chai, an existing fiat payment gateway popular in Korea.
Chai already had existing relationships with Korea’s biggest banks, so the deal with Terra was win-win. Chai users got exposure to the blockchain, and Terra users could spend UST in the real economy.
Chai works with a traditional debit card and mobile App. Every time a user makes a purchase in the background, the user is buying a Korean pegged Stablecoin (KRT) using fiat funds, or from an existing pre-paid balance.
As we already know, the algorithm maintaining Stablecoin pegs must then burn an equivalent amount of Luna to maintain KRT’s peg to the real Korean won.
Given that both Terra UST and Luna both rank in the top ten cryptocurrencies by market capitalisation they are widely traded on centralised exchanges, with FTX generating the highest volume for UST and Binance the largest market for Luna according to Coinmarketcap.
Given how UST functions you can obviously follow the process described above to buy either through a supported wallet like Terra Station and use several DEXs, such as Osmosis, to buy TerraUST and Luna.
Given that UST is an algorithmic Stablecoin generated from Luna and vice-versa, neither has a fixed cap. UST Has a value pegged to the US Dollar so its market cap, total supply, circulating supply and fully diluted market capitalisation are all the same figure - as of the time of writing, 18bn.
Though Luna is created and burned to balance UST, the stated intention is to ensure that no more than 1 billion are ever in circulation. If that ceiling is reached, Luna is burned.
385,245,974 Luna were minted as part of the pre-sale for the project in 2018 and distributed among Terraform Labs for development (10%), employees (20%), the Terra Alliance (20%), price stability reserves (20%), investors (26%) and genesis liquidity (4%).
Given the headline APY rate offered it should be no surprise that 57% of the $22bn total value locked in Terra currently sits with Anchor, followed by Lido Protocol (bonded assets), Astroport (DEX) and the Mirror Trading application.
Liquidity for UST and Luna is helped by the available bridges such as Terra Swap and Wormhole, as well as the IBC interoperability of Cosmos, which powers its blockchain.
Osmosis is a major DEX in the Cosmos ecosystem, which by April 2022, saw $450 million in liquidity of UST and LUNA showing health demand across IBC-capable networks.
Terra is a youthful company growing at a phenomenal rate in terms of market capitalisation and active users, but how much of that growth was fuelled by the bull market?
As wider market conditions have turned bearish, questions are being asked about the effectiveness of the UST peg and the sustainability of Anchor’s 20% yield. As the saying goes, you only know who’s been swimming naked when the tide goes out, and recent actions suggest Terra has been searching for a liferaft.
Terra’s CEO, Do Kwon, has been tweeting about purchasing Bitcoin to act as collateral for UST. While many Bitcoiners viewed this positively, others interpreted this as tacit acceptance that UST’s algorithmic stability wasn’t reliable.
The 20% returns of Terra’s flagship protocol, Anchor, are also being tested by the hard realities of a bear market. Sleuths on crypto Twitter have pointed out that much of that generous APR has been funded from Terra’s treasury, an untenable situation.
Those suggestions appear to have been borne out by reductions in that topline figure. The question is, how far will the rate have to fall, and what will users do? Is this simply a healthy sign that the Terra system is adjusting to reality or a house of cards about to collapse?
The recent South Korean election resulted in a victory for the right-leaning candidate who made crypto a key element of their manifesto, promising a friendly local regulatory environment that will be beneficial to the Terra ecosystem in the long term. Still, they may have to take some drastic steps to prove their model is sustainable through a bear market.
In just a few years, Terra has grown to become the second-largest blockchain in DeFi with a total value locked (TVL) of around $20.5 billion by April 4, 2022, supporting 600,000 daily on-chain transactions.
Unsurprisingly Terra’s market capitalisation has grown exponentially with UST and Luna both in the top 10 list of cryptocurrencies but it now faces significant challenges in order to underline its position as a serious challenger to Ethereum.
Terra has to ride out its first bear market without the algorithmic mechanism for retaining UST’s peg coming unstuck or have to slash the attractive Anchor APYs which have attracted so much TVL. That balancing act will become even harder if the ongoing SEC case against Terra Labs’s Mirror Protocol gains serious traction.
The Terra blockchain was created by Terra Labs in 2018; its founders are Do Kwon and Daniel Shin.
Terra launched at the end of July 2019.
Luna reached an all-time high of $119 in April 2022.
The current price of Terra is around $31 (April 10, 2022).
Yes, you can stake Luna by acting as a full Validator in the Terra blockchain, or simply Delegating your funds to a Validator.
Yes, Terra is a Proof of Stake blockchain running a Cosmos SDK and using the Tendermint consensus method.
Luna is not a Stablecoin but it plays a key part in maintaining the value of TerraUST, which is a Stablecoin pegged to the US Dollar.
As Terra is not a Proof Work blockchain you cannot mine Luna but you can earn block rewards by acting as a Validator and staking Luna.
Terra is secured by 130 Validators running the Tendermint consensus method under the Cosmos SDK.
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