Table of Contents

🤔 What is Terra?

Terra is a layer-1 blockchain platform with smart-contract functionality for algorithmic stablecoins and dApps that grow their ecosystem.

Terra blockchain is used to make stablecoins pegged to various currencies like USD, KRT, EUR etc. The blockchain also acts as:

  • Financial payment network to send value anywhere in the world
  • Smart contract platform to develop dApps that leverage functionality of stablecoins.

💡 What role does Terra and Luna token play ?

Terra ecosystem consists of two families of tokens:

  • Terra stablecoins: Terra blockchain allows users to mint various stablecoins like:
    • Terra USD (UST): Pegged to the value of U.S. Dollar.
    • Terra KRW (KRT): Pegged to the value of Korean Won.
    • Terra EUR (EUT): Pegged to the value of the Euro.
    • Terra AUD (AUT): Pegged to the value of Australian dollar
    • TerraSDR: Pegged to the value of IMF’s SDR
    • Terra KRW: Pegged to the value of KRT etc.
  • LUNA: It is used for:
    • Mint stablecoins:
      • To mint a stablecoin, an equivalent value of luna must be burned
      • Stablecoins can also be burned to mint an equivalent amount of luna.
    • Governance: LUNA holders propose and vote on future updates to the Terra ecosystem.
    • Staking: Blockchain validators verify and add new blocks to Terra blockchain. The validators need to stake LUNA tokens to take part in verifying/adding blocks. LUNA token acts as an incentive mechanism for keeping validators honest:
      • Validators are rewarded LUNA tokens for carrying out the task honestly.
      • Part of their staked LUNA tokens is slashed if they do not act honestly.
    • Delegation: Users can also stake their LUNA tokens with a validator to share part of rewards.
    • Transaction fee: Similar to Etherium, LUNA tokens are used to pay gas fees to record transactions on Terra blockchain.

In a nutshell, LUNA is responsible for the stability of Terra stablecoins, and vice versa. The protocol’s name is intended to be analogous to the symbiotic relationship between the earth and the moon, and the way in which the two celestial bodies confer gravitational stability upon one another.

📝 Origin of Terra network

  • 2018:
    • Entrepreneur Daniel Shin and computer scientist Do Kwon founded Terra forms labs, a company based in South Korea to work on developing Terra ecosystem.
    • The team raised $33 million in funding from venture capital.
  • 2019:
    • Terra blockchain along with Terra Station (wallet), Terra Finder (block explorer) went live in April 2019.
    • Terra whitepaper was also released in April 2019.
    • First stable coin KRT(pegged to Korean Won) was launched.
    • KRT stablecoin integrated with popular Korean mobile payment Chai.
  • 2020:
    • UST(pegged to US dollar) was launched in Sep 2020.
  • 2021: Columbus 5 upgrade was carried out to Terra blockchain.

👴🏻 Founders

Do Kwon

  • Education:
    • He studied computer science at Stanford University.
  • Career:
    • Do is the founder and former Chief Executive Officer of Anyfi, a wireless mesh network startup. Anyfi builds peer-to-peer connectivity solutions using mesh network technology to make last-mile telecommunications more scalable, accessible, and secure.
    • He has also worked as software engineer at Microsoft and Apple.
  • Terra:
    • He co-founded Terra forms lab, a company based in South Korea to work on Terra project.
    • He is the current CEO of Terra labs.

Daniel Shin

  • Education:
    • He did BSc. in Economics from The Wharton School in Philadelphia.
  • Career:
    • He founded Chai app, a peer-to-peer money transfer payment application in South Korea.
    • He was also the founding partner of Bass investment, an early-stage startup investment fund.
  • Terra:
    • He co-founded Terra forms lab, a company based in South Korea to work on Terra project.

😌 What problems does it solve ?

  • Crypto on and off-ramps: Crypto users have to sell their crypto assets to fiat using their centralized broker app to convert their crypto from one asset to another. Terra stablecoins and bridges on Terra blockchain will allow users to seamlessly transfer stable value from one blockchain to other.
  • International money transfer: Existing international payment solutions like Visa, Mastercard, Paypal etc can use Terra stablecoins in the backend to cheaply and quickly transfer value from one country to another.
  • Medium of exchange:
    • Volatile cryptocurrencies like Bitcoin cannot be used for day-to-day transactions. Intuitively, nobody wants to pay with a currency that has potential to double in value in a few days, or wants to be paid in a currency if its value can significantly decline before the transaction is settled.
    • The problems are aggravated when the transaction requires more time, e.g. for deferred payments such as mortgages or employment contracts, as volatility would severely disadvantage one side of the contract, making the usage of existing digital currencies in these settings prohibitively expensive.
    • Terra stablecoins solve this problem.
  • Proof-of-stake vs Proof-of-work: Terra blockchain uses a variation of proof-of-stake which has several advantages over proof-of-work:
    • It is much more energy-efficient.
    • Governments cannot ban miners, unlike proof-of-stake in which governments can trace miners depending on excessive energy usage and seize their hardware.
    • It has been observed that proof-of-stake systems get more decentralized over time(Initially Bill Gates had over 90% of the Microsoft shares, today he has less than 5% Microsoft shares.Whereas proof-of-work systems get more and more centralized around hardware, cheap electricity, favorable jurisdictions, etc with time.
  • Specialized blockchain:
    • Other blockchains like Etherium need to accommodate all use cases. Hence, it optimizes for the average use case. This results in developers having to make compromises on the design and efficiency of their application (for example, requiring use of the account model in a payments platform where a UTXO model may be preferred).
    • Terra blockchain is tailor-made to support Terra stablecoin and the ecosystem.
  • Trustless: Terra stablecoins are algorithmic stablecoins and are not backed by physical dollars in a bank account like USDT. Hence, there is no risk of a central company running away with assets or governments targeting reserves.
  • Transparent: Terra project’s code is open source for everyone to see how it works, unlike other stablecoin projects like Tether, whose reserves have never been audited.
  • Government resistance: All stablecoins are expected to face stiff resistance from governments because their projects are direct competition to CBDCs. Only the most antifragile and decentralized stablecoin projects are expected to survive such a government crackdown.
  • Broader scope: Most other projects like DAI, Tether etc only focus on creating stablecoins pegged to US dollars. Terra aims to create several stablecoins pegged to all the fiat currencies.

🤖How does it work ?

How is the stable peg maintained ?

It is important for Terra stablecoins to maintain their peg to play their role as reliable stablecoin.

The Terra protocol uses the basic market forces of supply and demand to maintain the price of Terra stablecoins. When the demand for Terra is high and the supply is limited, the price of Terra increases. When the demand for Terra is low and the supply is too large, the price of Terra decreases. The protocol ensures the supply and demand of Terra is always balanced, leading to a stable price.

Imagine the whole Terra economy as two pools: one for Terra and one for Luna. To maintain the price of Terra, the Luna supply pool adds to or subtracts from Terra’s supply. Users burn Luna to mint Terra and burn Terra to mint Luna, all incentivized by the protocol’s algorithmic market module:

  • Expansion:
    • When the price of Terra is high relative to its peg, supply is too small and demand is too high. The protocol incentivizes users to burn Luna and mint Terra. The new supply of Terra makes its pool larger, balancing supply with demand. Users mint more Terra from burned LUNA until Terra reaches its target price. The LUNA pool gets smaller in this process, increasing the price of LUNA.
    • For example, if 1 UST is trading at 1.01 USD, users can use the market swap feature of Terra Station to trade 1 USD of Luna for 1 UST. The market burns 1 USD of Luna and mints 1 UST. Users can then sell their 1 UST for 1.01 USD, profiting .01 USD through arbitrage, adding to the UST pool. This arbitrage continues until UST price falls back to match the price of USD, maintaining Terra’s peg.
  • Contraction:
    • When the price of Terra is too low relative to its peg, supply is too large and demand is too low. The protocol incentives users to burn Terra and mint Luna. The decrease in Terra’s supply causes scarcity, and the price of Terra increases. More Luna is minted from burned Terra until Terra reaches its target price. The Luna pool increases and lowers in price.
    • In other words, if the value of UST falls, the Terra network basically says, “No, for us, 1 UST is as good as 1 USD if you want to buy more LUNA.” This makes it economically attractive for people to essentially “turn in” their UST in exchange for LUNA; since they are effectively purchasing LUNA at a discount.
    • For example, if 1 UST is trading at .99 USD, users can buy 1 UST for .99 USD. Users then utilize Terra Station’s market swap function to trade 1 UST for 1 USD of Luna. The swap burns 1 UST and mints 1 USD of Luna. Users profit .01 UST from the swap. This arbitrage continues, and UST is burned to mint Luna until the price of UST rises back to 1 USD.

Consensus - delegated proof of stake

The Terra blockchain is a proof-of-stake blockchain, powered by the Cosmos SDK and secured by a system of verification called the Tendermint consensus.

Top 130 nodes with the maximum stake are called validators. They are responsible for securing the Terra blockchain and ensuring its accuracy. Following steps are involved in adding a new block to Terra blockchain:

  • A validator called a proposer is chosen to submit a new block of transactions(Validators with larger stakes get chosen more often to propose new blocks and earn proportionally more rewards).
  • Validators vote whether they accept or reject the proposed block. If a block is rejected, a new proposer is selected and the process starts again.
  • If accepted, the block is signed and added to the chain.
  • The transaction fees from the block are distributed as staking rewards to validators and delegators. Proposers get rewarded extra for their participation.
  • This process repeats, adding new blocks of transactions to the chain. Each validator has a copy of all transactions made on the network, which they compare against the proposed block of transactions before voting. Because multiple independent validators take place in consensus voting, it is infeasible for any false block to be accepted.

The validators also double as oracles and provide prices of LUNA and Terra stablecoins. Average of price data provided by 130 validators is taken as the price for LUNA and respective Terra stablecoins.

Delegators

Delegators are users who want to receive rewards from consensus without running a full node. Delegators stake their Luna to a validator, adding to a validator’s weight, or total stake. In return, delegators receive a portion of transaction fees as staking rewards.

Slashing

Running a validator is a big responsibility. Validators must meet strict standards for participating in the consensus process to avoid getting slashed.

Slashing is the penalty for misbehaving validators. When a validator gets slashed, they lose a small portion of their stake and a small portion of their delegator’s stake(Delegators should monitor their validators closely, do their research, and understand the risks of staking Luna). Slashed validators also get jailed, or excluded, from consensus for a period of time.

Aaps

Many dApps have been deployed on Terra blockchain that complement and enhance the usability of Terra ecosystem:

    • Anchor Protocol:
      • It is a decentralized lending and borrowing dApp for Terra stablecoins and other crypto assets.
      • It offers interest as high as 20% on the deposited Terra stablecoins.
  • Mirror finance: It allows users to create and trade synthetic assets that track real-world price commodities like stocks and assets on blockchain like Synthetix.

🏛️ Governance model

Terra is governed by LUNA token holders. LUNA holders propose and vote on future updates to the Terra ecosystem.

One staked Luna equals one vote. If a user fails to specify a vote, their vote defaults to the validator they are staked to. Validators vote with their entire stake unless specified by delegators.

The following is a basic outline of the governance process:

  • A user submits a proposal and a two-week deposit period begins.
  • Users deposit Luna as collateral to back the proposal. This period ends once a minimum threshold of 50 Luna is deposited. Deposits are to protect against spam.
  • The one-week vote period begins. The voting options are:
    • Yes: In favor.
    • No: Not in favor.
    • No with veto: Not in favor, the deposit should be burned.
    • Abstain: Voter abstains.
  • The votes are tallied. Proposals pass if they meet three conditions:
    • Quorum is met: at least 40% of all staked Luna must vote.
    • The total number of No with veto votes is less than 33.4% of the total vote.
    • The number of Yes votes reaches a 50% majority.
  • Accepted proposals get put into effect.
  • Deposits get refunded or burned.

Once accepted, the changes described in a governance proposal are automatically put into effect by the proposal handler. Generic proposals are manually implemented.

😨Competitors

Tether has many competing stablecoin projects. They use different models to maintain peg to US dollar:

Governments issued CBDCs will also be in competition with Terra stablecoins.

🤑 How much money does the project have for future development ?

  • The project has raised around $48.5 million from seed and private sale of LUNA tokens.
  • Terraforms labs were allotted 10% of LUNA supply to fund future development.
  • 20% of the LUNA supply has also been reserved rewards for employees and contributors.
  • Every time a luna is burned a small fee is charged and put into a community treasury to fund future development

👍 Tailwinds

  • Growing ecosystem: Terra is an ecosystem of stablecoins and dApps deployed on Terra blockchain instead of a standalone US dollar stablecoin project deployed on Etherium. DApps on Terra blockchain complement each other and enhance usability of Terra stablecoins.
  • Sustainable model: Most crypto projects raise huge amounts of money once and do not have a continuous source of income. Terra treasury receives a continuous supply of funds. This will help the project to fund long-term development of the project.
  • Built on Cosmos SDK:
    • This makes Terra blockchain interoperable with all other blockchain built using Cosmos SDK.
    • It also makes the development process quicker, reliable and secure.
  • Network effects:
    • More and more people and businesses will want to use Terra ecosystem as the user base grows.
    • This positive feedback loop has potential to result in exponential growth in short period.

😨 Risks and challenges

Terra stablecoin peg can break

As UST market cap increases, Luna’s market cap should also go up as more Luna is burned = less Luna = price of Luna goes up. However, a flash crash on Luna (due to market conditions or otherwise) can lead to a scenario where Luna’s market cap is LOWER than UST in circulation, especially if UST market cap increases exponentially. At that point, the question is, what is backing the extra UST?

This is exactly what happened on 23 May 2021. 1.6 billion Luna backed 2 billion UST. The peg was restored after interventions, i.e. someone (hint: Terraform Labs) bought Luna to increase its price and market cap back above UST market cap.

Imagine a scenario where price of LUNA falls from $100 to 5$, in such a case if a lot of users lose their trust in the project and start selling UST, then:

  • They will burn UST tokens to mint a lot of LUNA tokens(because price of LUNA had fallen).
  • This will increase the supply of LUNA tokens. Thereby dropping LUNA price even further.
  • There will be no buyers for LUNA as its price keeps crashing, lack of buyers will drop the price of LUNA even further.
  • Soon LUNA tokens will be worthless, resulting in stablecoins losing their peg.

Unsustainable yield of anchor protocol

Anchor protocol offers yield up to 20% for depositing Terra stablecoins. The 20% yield is an arbitrary number and not set by market forces of supply and demand.

As a result, almost 50% of the Terra stablecoins have been deposited in Anchor to earn this unbelievable 20% yield.

But as the value of deposited stablecoins grow it will not be possible for the anchor protocol to pay 20% interest to everyone.

Even worse, there are protocols like Abracadabra that use huge leverage to earn even higher returns on Anchor.

These leverage users are just milking the protocol for insane yield till it lasts. This is draining Anchor’s funds used to pay interest even faster.

Moreover, these leverage strategies will be liquidated in case stablecoins fall by just 2%. These liquidation events will dump UST in the market, which will reduce the price of UST even further, liquidating even more leveraged positions, breaking the peg.

In second scenario, it is possible that Anchor protocol is not able to pay such high-interest rate. This will reduce the demand of UST as fewer and fewer users will find it attractive to deposit and earn reduced interest on Anchor. If the interest rate falls quickly many users would want to burn their UST for LUNA

When Anchor was in trouble to pay the 20% interest, Terraform Labs topped it off with $70 mil. At one point they will not be able to “control” the market from finding an equilibrium. Particularly if the ecosystem grows beyond their means of controlling divergences. That is when the crash takes place.

Centralization

There are only 130 unknown nodes backing Terra blockchain. Moreover, each node has to store complete history of the blockchain eliminating normal users to use their computers to run node software.

CBDC & Government crackdown

Many countries are planning to launch their own CBDCs. They will never allow other projects to compete with their currencies.

Role of fiat currencues in the long run

Ask any Bitcoiner and they will say that fiat currencies are doomed to fail eventually. It is only a matter of time before fiat currencies become worthless. There will not be much use of stablecoins pegged to the value of these worthless currencies.

💰 Tokenomics

LUNA token had initial supply of 1 billion which were distributed as follows:

  • 30% to terraforms labs and employees
  • 20% to terra alliance
  • 26% to investors
  • 4% to exchanges
  • 20% stability reserves for market volatility

Token Inflation

  • LUNA can become deflationary as they are burned to mint stablecoins.
  • The reverse can also happen, LUNA can turn inflationary if a lot of users burn their UST to mint more LUNA.

Demand pressure

Token’s price increases due to demand pressure.

Demand pressure on LUNA will come from:

  • Governance: Users will acquire LUNA tokens to take part in the governance process.
  • Mint stablecoins: Users will acquire and burn LUNA tokens to mint stablecoins.
  • Transaction fees: Users will acquire and pay LUNA tokens to include their transactions in the Terra blockchain.
  • Staking & Delegators: They will acquire LUNA tokens to take part in the process of block validation.
  • Speculators: They will acquire LUNA tokens for future price appreciation.

Supply pressure

Supply pressure on a token decreases its price.

Supply pressure on LUNA will come from:

  • Early investors: They have made a huge profit on their initial investment, some of them will sell to realize their gains.
  • Some users will burn their UST tokens to mint LUNA tokens.

Market cap

Marketcap for stablecoins for all the currencies that can also facilitate cheap and quick international transactions will definitely be in trillions. Marketcap of LUNA tokens backing the marketcap of these stablecoins will also be comparable.

🧐 Indicators to watch out for

  • Total value locked is growing:
  • Terra Youtube channel is growing:
  • Twitter following is growing:

👋Final remarks

Terra stablecoins are being integrated into several apps and being used in the real world.

However real-world usage is minimal as compared to the value of stablecoins earning high yield on Anchor protocol.

The game theory of Terra is basically a bait-and-switch maneuver. It goes like this:

  • People come to Terra with their capital for the Anchor deposit rate. While these people are in the Terra ecosystem they start investing in other projects.
  • Eventually, the Terra ecosystem becomes vibrant and robust because of all the people and capital present, which were originally attracted by Anchor.
  • Once the ecosystem reaches that critical mass where there are enough people and capital embedded in it to be self-sustaining – only at that point can the Anchor deposit rate be reduced.
  • So basically, people are hooked into using Terra ecosystem because of the extraordinary Anchor deposit rate, then once they get used to the ecosystem Anchor lowers the rate to a more sustainable level.

However, it is easier said than done.

I will wait to see how the project grows once the high-interest rate of anchor protocol dries up.

😊 Do further research