Terra is a decentralized financial payment network based on algorithmic stablecoins. Terra is a smart contract blockchain that attempts to establish a decentralized environment for algorithmically controlled, seigniorage-based, fiat-pegged stablecoins.

Unpacking Terra

Terra is a blockchain technology and financial ecosystem centered on payments, driven by algorithmic and scalable stablecoins tied to real-world fiat currencies.

Terraform Labs created the protocol in January 2018. Daniel Shin and Do Kwon, serial entrepreneurs, launched Terraform Labs, a Korean blockchain company. Terra’s stablecoins, termed as “Terra currencies,” and its governance and utility token, LUNA, are two major ecosystem components. The balance of these two components is intended to be akin to how the Earth (Terra in Latin) and Moon (Luna in Latin) rely on one another for gravitational stability and rotation.

While the Terra ecosystem now supports numerous Terra currencies, including those pegged to the South Korean Won, Mongolian Tugrik, and the IMF’s SDR basket of currencies, Terra’s main product is TerraUSD, its native USD-pegged stablecoin (UST). UST, the fifth biggest stablecoin on the market, is one of the industry’s fastest-growing assets, having reached a market valuation of $2.5 billion within a year of its inception.

How Do Terra Stablecoins Function?

Unlike other decentralized algorithmic stablecoins such as MakerDAO’s DAI, Fei Protocol’s FEI, and Ampleforth’s AMPL, which rely on over-collateralization, fractional reserves, or rebasing to keep their pegs, Terra’s stablecoins rely on an elastic monetary policy to ensure price stability and growth.

Because of the elastic monetary policy, Terra stablecoins achieve price stability by altering their supply in response to real-time swings in demand. Seigniorage is important in this. Seigniorage is the discrepancy between the nominal worth of money and the cost of generating it in monetary terms.

Terra’s protocol, for example, employs a dual token approach to capture value and regulate the price of its stablecoins. Users must burn an equivalent dollar amount of LUNA tokens to create UST. To mint 1,000 UST, for example, with LUNA’s current market price of $38.87, they would have to burn 25.72 LUNA tokens. To create $1,000 worth of LUNA, the user would have to burn 1,000 UST.

Terra stablecoins, in essence, maintain price stability by leveraging market forces. When the value of one UST falls below $1, users and arbitrageurs can burn one UST to obtain $1 in LUNA. When the value of one UST exceeds $1, they can burn $1 of LUNA to obtain one UST, collecting “seigniorage” in the process. The LUNA token acts as a volatility absorber while also capturing rewards from seigniorage and transaction fees.

When demand for Terra currencies rises, the system mints them, earns LUNA in exchange, and then burns a portion of the LUNA earned, making supply scarcer. Furthermore, because LUNA is used for Terra transaction validation via staking, LUNA stakers earn transaction fees charged by the protocol.
Terra stablecoins maintain their peg without being over-collateralized thanks to this mechanism, making them significantly more capital-efficient and scalable than other algorithmic stablecoins on the market.

How Does the Protocol Function?

Terra is based on the Cosmos SDK and employs Tendermint’s Delegated-Proof-of-Stake (DPoS) consensus mechanism.
While the protocol currently relies on a set of 130 validators determined by who has the most stake delegated, the network will soon be expanded to 300 validators. Terra validators’ primary function is to verify, settle transactions, and secure the network by running full nodes to commit blocks to the chain. In a nutshell, validators in Proof-of-Stake blockchains are similar to miners in Proof-of-Work blockchains in that they secure the network and help it maintain consensus.

To become a miner or validator in Terra, users must either bond (lock their LUNA tokens for a minimum of 21 days) or have other users delegate their LUNA stakes. LUNA token holders can delegate their tokens to validators in order to become delegators.

Validators and delegators serve the same purpose and have the same benefits and responsibilities. This means that, while delegators earn a portion of the fees earned by validators, they also risk losing their funds if the validator to whom they’ve delegated their stake behaves badly. Validators (and, by extension, validators) risk losing their staked tokens if they attempt a double-spend attack or remain inactive for an extended period of time.

Terra’s DPoS consensus model, like other consensus processes, leverages the “carrot and stick” incentive structure. Validators and delegated get the incentive or “carrot” in Terra’s case through transaction fees and seigniorage. In the event of transgression, the “stick” is the danger of being “slashed” or losing the staked LUNA.

Governance, Decentralization, and the Future

Terra isn’t the most decentralized blockchain, with only a few hundred validators. Terra, like other DPoS-based blockchains like as Cardano, EOS, and TRON, optimizes for efficiency, scalability, and interoperability while making decentralization sacrifices.

While Terraform Labs continues to build and manage Terra, LUNA token holders can participate in governance through staking. Terra validators can submit protocol enhancement suggestions and vote on them with their staked LUNA.

Certain protocol changes, such as blockchain parameters, rewards distribution, transaction fees, and Terra’s treasury spending, can be applied automatically, whereas other more complex proposals are manually implemented by Terraform Labs’ core development team after they are voted in by the community.

While most other Layer 1 protocols today cater to crypto natives, Terra’s moat is that its adoption and growth plan looks outwards rather than inwardly. Terra is well-positioned to go outside the cryptosphere and establish a stable and straightforward ecosystem that fosters real-world adoption with interoperable and scalable stablecoins like UST, easy savings protocols like Anchor, and the synthetic stocks trading platform Mirror.

So far, this strategy has shown to be effective. Terra is now the world’s 11th biggest cryptocurrency, with a market valuation of $15.6 billion and a total value locked across protocols on the network of $8.6 billion. Terra is well positioned to continue rising in popularity with the impending release of the long-awaited Columbus 5 upgrade, which will bring a deflationary mechanism for LUNA comparable to Ethereum’s EIP-1559 update.

Natasha Dean

With an eye for detail and understanding of this exciting industry. My experience has given me an understanding of crypto trends and how to effectively break them down. I have a soft spot for NFTs and the Metaverse.