Terra is a blockchain protocol that aims to provide an ecosystem for algorithmically governed, seigniorage-share-style stablecoins in a decentralized manner.
The Terra protocol has two native cryptocurrencies playing an equally important role in its ecosystem: TerraSDR and Luna.
TerraSDR represents a stablecoin pegged to the IMF’s international reserve asset SDR, serving as the unit of account in which transaction fees, miner rewards, and stimulus grants are denominated. On the other hand, Luna represents a governance token serving as a volatility absorption tool that also captures rewards through transaction volume and seigniorage.
What is Terra?
What makes Terra different from other blockchain networks and stablecoin protocols is that it looks outwards instead of inward in its growth and adoption approach. Rather than primarily focusing on being interoperable with other DeFi protocols (even though it does that too), Terra seeks to create stable, scalable products that drive immediate real-world adoption. These include e-commerce crypto payment solutions such as CHAI, MemePay, and PayWithTerra, high-yield saving solutions such as Anchor, and so on.
The true testaments to Terra’s success are the swift adoption and growth of Terra’s native token Luna and the most used stablecoin in its ecosystem, TerraUSD (UST). Currently the 21st largest crypto asset on the market, the Luna token is one of the fastest-growing cryptocurrencies in the industry, growing from roughly $250 million to just above $6.7 billion year-to-date. The TerraUSD, on the other hand, is increasingly becoming one of the most adopted stablecoins on the market, reaching a market capitalization of roughly $1.4 billion in less than five months since its launch.
The Terra Alliance
The Terra protocol was developed in January 2018 by Terraform Labs, a Korean blockchain enterprise founded by Daniel Shin and Do Kwon. The company was incubated by a conglomerate known as the Terra Alliance, a collective of 15 Korean and Southeast Asian e-commerce companies that processes $25 billion in transactions annually.
Aside from Terra Alliance’s support, Terraform Labs also received $32 million in backing from prominent venture capital firms such as Coinbase Ventures, Polychain Capital, and Pantera Capital.
Before founding Terra, Shin and Kwon both founded extremely successful companies outside the blockchain industry. For instance, Shin founded TMON, an e-commerce enterprise known as South Korea’s Alibaba and CHAI, a Softbank-backed Korean payment app with more than 2.7 million users. Do Kwon, on the other hand, acquired his computer science degree from Stanford and made the Forbes 30 under 30 list in 2019. Prior to co-founding Terra, Kwon worked at Microsoft and founded Any-Fi, a startup specializing in peer-to-peer telecommunications solutions such as meshed Wi-Fi networks.
The intention behind Terra is to create a back-end protocol for various applications developed by Terraform Labs and the Terra Alliance that would have immediate real-world applications.
How Does Terra Work?
The Terra blockchain is built using the Cosmos SDK and the Tendermint Delegated-Proof-of-Stake (DPoS) consensus mechanism.
The protocol relies on a set of 100 validators who verify, settle transactions, and secure the system by running full nodes to commit blocks to the blockchain. Their primary role is to help the decentralized network reach and maintain consensus on the blockchain by broadcasting votes containing cryptographic signatures signed by each validator’s private key.
In order to participate in broadcasting, validators must either bond (lock for a minimum of 21 days) their own Luna tokens or have Luna tokens delegated/”staked” to them by other token holders. Luna holders that decide to participate in staking are called delegators and share the same benefits and responsibilities as the validators.
This means that while the delegators get to participate in securing the network and earn a portion of the revenue generated by the validators, if that validator misbehaves (double-signs transactions or remains inactive for a prolonged period) and gets slashed, the delegators will also get slashed.
Like all blockchain consensus algorithms, Terra’s DPoS mechanism relies on the “carrot and the stick” incentive structure. The “carrot” or the reward represents the income that validators earn in the form of fees generated by the protocol, while the “stick” is the threat of slashing or losing the bonded Luna tokens if misconduct is detected.
In general, the Terra protocol has two primary ways of rewarding the validators and their delegators:
- Transaction fees: To prevent spamming, all transactions require a small fee paid out to stakers. These default to 0.1% of the transaction value and are capped at 1%, making Terra a superior settlement layer compared to traditional payment processors such as credit cards, which charge significantly higher transaction fees.
- Scarcity incentives: To further incentivize adoption, the protocol charges a small fee on all swap transactions between Luna and other Terra stablecoins. The swap fees are then burned, creating scarcity in Luna, which indirectly rewards all Luna token holders.
In the spirit of decentralization, Terra validators can also participate in the protocol’s governance by voting on various protocol improvement proposals made by the community. Their voting power is proportional to their total staked amount, including delegations.
It is important to note here that Terra’s blockchain design sacrifices overall decentralization for speed and scalability. That is to say, Terra is considerably less decentralized than other proof-of-work-based blockchains, but it makes it up by delivering orders of magnitude higher transaction throughput.
How do Terra Stablecoins Work?
Another thing that further differentiates Terra from other crypto protocols is the unique way it can mint stablecoins that are pegged to various fiat currencies like the Korean Won or the US Dollar in a decentralized and, more importantly, scalable manner.
Unlike some decentralized algorithmic stablecoins like MakerDAO’s DAI, the TerraKRW (KRT) and TerraUSD (UST) stablecoins are not necessarily over-collateralized. Instead, Terra stablecoins achieve price stability by adjusting their supply according to real-time fluctuations in demand.
To mint a UST, users need to burn an equivalent dollar amount of Luna tokens. For example, if you want to mint 150 UST, and Luna’s current market price is $5, you would have to burn 30 Luna tokens. Vice versa, if you burn 50 UST, and Luna’s current market price is $10, you will get 5 Luna tokens.
Terra is effectively leveraging market forces to achieve price stability for its stablecoins. When UST’s price deviates above $1, arbitrageurs can step in to collect risk-free profits by purchasing the UST that is currently worth more than $1 for $1 worth of Luna and then immediately selling that UST for a profit. Therefore, Terra stablecoins rarely deviate much from their peg.
With this mechanism at work, Terra stablecoins achieve price stability without being over-collateralized, making them much more capital efficient and scalable compared to other algorithmic stablecoins on the market.
That being said, Terra’s stabilizing protocol still has its vulnerabilities because the system depends on a certain threshold of demand within the Terra ecosystem, either through Luna’s price or Terra’s transaction volume.
Terra stablecoins derive their price-stability from mining demand because the miners are the ones who absorb the short-term volatility of price changes in Luna. Since value enters the Terra ecosystem through exchanges between fiat and Luna, the system’s stability depends on the demand for various Terra products and stablecoins. As Terra’s adoption rate rises, Luna’s value is maintained, which guarantees stable mining rewards for stakers and further stabilizes the entire system. To achieve this, Terra is already boosting mass adoption through CHAI and other successful products built by the Terra Alliance members.
How does Terra Governance Work?
While Terra is primarily a centrally governed system, developed and maintained by Terraform Labs, Luna token holders can still openly participate in certain aspects of the protocol’s governance.
For example, Luna token holders can submit protocol improvement proposals alongside a deposit of Luna tokens for the broader Terra community to consider. Some proposals can even be automatically applied as changes to the protocol when voted for approval. These include changing the blockchain’s parameters, updating the monetary policy or the reward weight, changing the tax/fees rate, and spending from Terra’s community pool fund.
More elaborate proposals requiring manual implementation are done through text proposals, which anyone from the community can submit by depositing Luna tokens.
What is the Anchor Protocol?
As mentioned before, Terra is a high-performance, Turing-complete blockchain protocol that supports all kinds of fast and scalable decentralized applications. One of these dApps is Anchor — a savings protocol built on Terra that offers a stable 20% APR on stablecoin deposits.
While the protocol’s precise mechanics are quite complicated, using Anchor to earn a stable 20% APR on Terra stablecoins is simple. Anchor generates a stable yield for its depositors by lending out their deposits to borrowers who have put up “liquid-staked PoS assets” as collateral.
These liquid-staked assets are also called bonded assets(bAssets) and act as fungible and transferable tokens representing ownership of staked (bonded) PoS assets. Unlike stablecoins or other volatile cryptocurrencies often used as collateral in other yield-generating protocols, bAssets generate cash flows from staking rewards, which is effectively where the high yield for lenders comes from.
For example, currently, the only whitelisted bAsset for use as collateral is bLUNA — a token representing staked Luna, which at the time of writing yields around 11% APR. When someone wants to borrow $1000, that person has to deposit $2000 worth of bLUNA. At 11% APR, $2000 worth of bLUNA collateral earns the protocol $220 to pay out to lenders.
This way, instead of earning 11% on $1000, which would make 110$, lenders earn 11% on $2000, which makes 220$, earning a 22% annual interest rate.
However, since Anchor targets a stable 20% APR, the protocol stores the excess 2% of rewards in a UST denominated “yield reserve,” used to compensate lenders when the lending APR falls below the 20% target due to low borrowing demand.
What is the Mirror Protocol?
The Mirror protocol is another flagship product built on the Tera blockchain. Mirror is a DeFi protocol powered by smart contracts that enables the creation of synthetic assets called Mirrored Assets (mAssets), which mimic the price behavior of real-world assets such as stocks or bonds.
The idea is to allow anyone anywhere to trade and own stocks in a decentralized manner. Users can mint new tokens for mAssets by creating a collateralized debt position (CDP) using either TerraUSD (UST) or other mAsset tokens as collateral. This process is very similar to how MakerDAO borrowers mint new DAI. For example, users can mint $500 worth of Apple stock using 1000 UST as collateral. This newly minted synthetic representing a fractional share of AAPL will mirror the real stock’s price movements using the BAND blockchain oracle. The mAssets are tradeable on Terraswap and can be bought and sold by anyone, just like any other cryptocurrency on Terra.
Important to understand here is that the CDP is effectively a short position against the price movement of the mirrored asset — i.e. if the price of the mAsset rises, minters of mAsset will be pressured to deposit more collateral to maintain the same collateral ratio (the minimum collateral ratio is 100%).
Tokenizing stocks has numerous benefits. Once the stocks have been transformed into fungible and transferable assets on the blockchain, they can be used as collateral to borrow money or provide liquidity. What’s more, liquidity providers on Mirror can earn fees based on the ratio of their stake in the specific pool. For example, if you provide 10% of the liquidity in the mAAPLE/UST pool, you will receive 10% of the fees generated from trading in that pool.
While most crypto projects are either trying to cater to existing crypto users or onboard new ones, Terra is doing something entirely different. It is trying to bring crypto to existing real-world products and services people are already using, without the need to know how crypto protocols work.
Judging by what Terra has already achieved in the two short years since its launch, it seems there is clearly a product-market fit for their stablecoin and DeFi solutions.