What Is Terra? The Algorithmic Stablecoin Protocol Explained
In brief Terra is a blockchain protocol underpinned by a suite of decentralized stablecoins. The most popular is called TerraUSD, or UST.
The stablecoins maintain their pegs through a coin called LUNA.
LUNA is a volatile cryptocurrency. The elasticity of its supply keeps the prices of its stablecoins in check.
Peek behind the hood of the leading stablecoins—cryptocurrencies pegged to the price of another asset, most commonly the U.S. dollar—and things don’t look so stable at all. Take Tether: an opaque governance structure, a New York Attorney General lawsuit and undisclosed commercial paper holdings might give investors pause.
Decentralized stablecoins try to avoid these governance issues by maintaining their pegs through algorithms instead of through vast reserves of cash and debt.
TerraUSD, produced by Terraform Labs, is one such stablecoin. (It has others pegged to different world currencies.) It maintains its peg to the U.S. dollar through a network of arbitrageurs, who buy and sell Terra’s volatile cryptocurrency, LUNA (also, confusingly, known as Terra), which is the seventh-largest cryptocurrency as of March 2022. LUNA is also a governance token, and grants holders voting power over the protocol.
Who created Terra?
The Terra ecosystem was created by a startup called Terraform Labs in 2018, founded by Do Kwon and Daniel Shin.
How does Terra work?
To maintain its stablecoins' equilibrium, Terra mints and burns tokens while also incentivizing arbitrage. Here's what that means:
Before you can buy UST, you'll have to mint some. To do so, you'll pay the going rate in LUNA. The protocol takes those LUNA and burns them, which constricts their supply and makes the price of LUNA go up just a bit. The same works in reverse: to mint LUNA, you'll convert UST stablecoins. Those get burned and the price of UST goes up ever so slightly.
Why might you want to do this? In addition to using the assets for some service or utility, there's a potential arbitrage opportunity. Arbitrageurs—traders who profit from small price discrepancies—help to keep the price of UST in check by selling LUNA for UST when the price of UST is below $1 and buying LUNA when UST is worth more than $1. If, for example, UST slips to $0.95, traders can then buy a bunch at that price but sell it for $1 of LUNA. In doing so, UST supply is reduced and, therefore, the price heads back up.
This same mechanism powers Terra’s other stablecoins, including a stablecoin pegged to the South Korean won and another pegged to a basket of leading world currencies maintained by the International Monetary Fund (called Special Drawing Rights).
Terra’s whitepaper claims that the elasticity of LUNA’s supply means that the stablecoins will never fall out of kilter. Still, their success depends on arbitrageurs' continued interest in UST. If arbitrageurs decide that UST is doomed to fail, or move their money to another project, some analysts fear that they might not arbitrage UST back to its peg of $1. Like a lot of crypto projects beholden to free markets, the community spirit is paramount.
What else is special about Terra?
The coins are built on the Cosmos ecosystem, a blockchain framework shared by Cosmos Hub, Cronos and Thorchain. Unlike Ethereum, where all tokens are secured by proof-of-work mining from the main Ethereum chain, Cosmos protocols can be backed by independent, app-specific miners.
Since Cosmos, and by extension Terra, is a smart-contract blockchain protocol, you can use Terra coins within any of the applications built on the protocol. You can use Terra coins across blockchains through Terraform Labs’ Mirror Protocol, which provides stocks that mirror the price of major U.S. firms.
At the end of September 2021, Terra launched an upgrade called Columbus-5. This added functionality for the Inter Blockchain Communication (IBC) protocol, which allowed Terra to become interoperable with other blockchains. Standouts include an insurance protocol called Ozone, and support for UST from cross-blockchain bridge Wormhole V2.
Did you know? UST overtook DAI in 2021 to become the largest decentralized stablecoin by market capitalization. As of March 2022, UST had a market cap of $13.4 billion and DAI $9.6 billion. However, both lag far behind centralized stablecoins like USDT ($80 billion) and USDC ($53 billion).
Who's building on Terra?
Anchor: a lending protocol on Terra that has $11.5 billion in total value locked (TVL)
Lido: a staking protocol that lets you spend staked assets
Astroport: an automated market maker for Terra tokens
Where to buy Terra (LUNA)?
You can buy Terra on many centralized exchanges. The largest markets for LUNA are on Binance, KuCoin, Huobi, and Bybit.
The future of Terra
The future of Terra’s protocol is really a discussion about the future of the stablecoins that underpin it. Will centralized U.S. dollar stablecoins become so ingrained within the U.S. financial system (perhaps through a central bank digital currency) that decentralized alternatives fall out of fashion?