Terra: The Algorithmic Stablecoin Leader

Summary

1. The price adjustment mechanism of the stablecoin Terra is closely related to the arbitrage powered by LUNA.
2. The users’ spontaneous arbitrage will adjust the UST supply and bring the UST price back to the 1$ anchor price.
3. Since the minting of UST on Terra will consume the corresponding value of LUNA, the increase in the total market cap of UST will undoubtedly reduce the supply of LUNA, causing LUNA to deflate.
4. When exchanging LUNA for stablecoins on Terra, users have to pay a certain amount of "seigniorage". A portion of the "seigniorage" will reward users with LUNA stakers, and the rest will go into the Terra treasury.
5. After LUNA skyrockets, whether Terra can gain a firm foothold in the current value or not depends on its long-term growth.

LUNA is arguably one of the most noteworthy crypto assets in recent times. In the past 10 days, the price of LUNA rose from about $50 to a maximum of $95, registering a nearly-doubled growth. And its market cap also reached $3.2 billion and ranked 7th among all digital assets, surpassing emerging public chains such as Solana, Cardano, and Avalanche. The growth of LUNA is inseparable from Terra, the leading algorithmic stablecoin project behind it.

What is Terra?

---

As a token native to Terra, LUNA is also the governance token and PoS staking token on Terra. Founded in 2018, Terra became the most significant Layer 1 public chain in the Cosmos ecosystem. It boasts that it is a decentralized algorithmic stablecoin project. Terra anchors the fiat currencies of various countries worldwide, such as USD, EUR, CNY, KRW, and JPY, and launches the corresponding stablecoins, of which the largest represents (UST) has a market cap of $13 billion, ranking 15th among all digital assets.It surpassed the well-known stablecoin DAI and ranked 4th among all types of stablecoins, second only to USDT, USDC, and BUSD.

Other than anchoring stablecoins with legal currencies of different countries, Terra has lots of differences from centralized stablecoins such as USDT. In theory, each issuance of USDT requires assets worth 1$ as support. However, because the running of TEDA has not been transparent enough for a long time, people often question whether USDT has 100% USD reserves. This is not the case with the various stablecoins issued by Terra. These stablecoins do not need the real assets behind them as value support. But they adjust supply and demand through algorithms, so that the value is always anchored to the corresponding type of fiat currency.


The price adjustment mechanism of the Terra stablecoin is closely related to the arbitrage behavior powered by LUNA. Users can exchange LUNA worth 1$ for 1 UST at any time on Terra, or exchange 1 UST for LUNA worth 1$ at any time. When the UST price is >1$, users tend to exchange more LUNA for UST, thus increasing the supply of UST in the market and subsequently reducing the UST price; when the UST price is <1$, users tend to exchange more UST for LUNA, thereby reducing the supply of UST in the market and subsequently increasing the price of UST. Whether the UST price is high or low, the user's spontaneous arbitrage behavior will adjust the UST supply and bring the UST price back to the 1$ anchor price. As a result, the operation mechanism of the stablecoin Terra is, to some extent, similar to that of the central bank in the real world.

LUNA Value Analysis

---

Since minting UST on Terra will consume the corresponding value of LUNA, the increase in the total market cap of UST will undoubtedly reduce the supply of LUNA, causing LUNA to deflate. Recently, geopolitical tensions have led to turmoil in the crypto market, resulting in a surge in demand for stablecoins. In the previous month, USDT experienced a positive premium constantly, and the total supply of UST also grew from $11.3 billion to $13 billion, which partly explains the spurt in LUNA prices.

Except for participating in Terra's on-chain governance by voting, LUNA holders can also earn rewards while maintaining the network by staking LUNA. The staking reward mainly comes from the handling fee when interacting with the Terra smart contract. When users exchange LUNA for stablecoins on Terra, they need to pay a certain amount of "seigniorage". A portion of the "seigniorage" will reward users with LUNA stakers, and the rest will go into the Terra treasury.

Terra can utilize treasury funds through governance voting to incentivize other projects in the Terra ecosystem, a process similar to the government fiscal policy in the real world.

What’s Terra Ecology?

Terra's strong growth is also closely related to its relatively quality ecosystem. Besides the algorithmic stablecoins, DApp, the decentralized lending protocol Anchor with the highest pledged amount on Terra, aims to provide users with higher and more stable deposit returns. There are also superb projects such as Mirror, a synthetic asset protocol in the ecosystem. Terra is also cooperating with the payment program Chai in South Korea offline. More than 3% of Koreans use Chai to make payments.


Algorithmic stablecoin is one of the most important projects in the crypto space in 2022. In the token economy, Terra has a relatively novel mechanism design that simulates the central bank in the real world. The mechanism can maintain stable currency exchange rates through monetary and fiscal policies, and promote DApps in the ecosystem. After the growth of DApp has increased the demand for UST, the value of LUNA has been raised again.

After LUNA skyrocketed, it remains a question whether Terra is able to gain a foothold at the current value. Perhaps only the long-term development of the ecology can support LUNA in the long run. Therefore, let us wait and see how far the Terra ecology can grow.



Author: Gate.io Observer: Ashley H. ; Translator: Cedar W.
* This article represents only the views of the observers and does not constitute any investment suggestions.
*Gate.io reserves all rights to this article. Reposting of the article will be permitted provided Gate.io is referenced. In all other cases, legal action will be taken due to copyright infringement.