Defining Terra

Launched in 2019 by Terraform Labs, Terra is a blockchain payment platform that offers algorithmic stablecoins, and is powered by the native token LUNA. Working alongside 15 large Asian e-commerce platforms known as the Terra Alliance, Terra aims to provide a more efficient digital payment service. 

Co-founders Daniel Shin and Do Kwon introduced an ecosystem that prioritizes stability, thanks to an elastic monetary supply, as well as widespread adoption. Having seen significant gains in the last month (around $10 at the start of August 2021, to over $35 by the end of the month), LUNA is quickly becoming a crypto project to watch. 

Terra uses a Delegated Proof-of-Stake (DPoS) consensus model, built via the Cosmos Network’s Tendermint Consensus protocol. Terra’s basket of algorithmic stablecoins - stablecoins whose price is determined by an algorithm rather than a peg - are backed by LUNA tokens. LUNA is also used as a governance token, in validator staking to secure the network, and in rewards. 

The Terra ecosystem encourages dApp development, with two DeFi protocols available for use: Anchor Protocol (ANC) and Mirror Protocol (MIR).  

Let’s take a closer look!

How Terra Works

Terra is made up of a few key parts that all work together to make the protocol run. These include the Tendermint Consensus protocol, the price stability mechanism behind Terra’s stablecoins, and LUNA - the multifaceted native token. 

Consensus

Tendermint BFT is the Proof-of-Stake consensus protocol introduced by the Cosmos blockchain network. It is responsible for both the consensus (nodes coming to an agreement on the state of the network) and networking (communication) layers. Terra Core is built on top of this thanks to Cosmos SDK, which is essentially a framework for app development. 

Terra uses DPoS, meaning that LUNA token holders delegate their tokens to a validator. The top 130 validators (based on the amount of bonded LUNA) make up the validating set. A slashing mechanism - portion of validator funds slashed and temporary ban on said validator - is put in place in order to guarantee honest behavior. This is activated in three main cases: double signing (validators signing more than one block at the same height), downtime (validator inactivity for a prolonged period of time), and excessive number of missed oracle votes (validators failing to meet the minimum number of periodic votes on LUNA’s exchange rate). 

Rewards are paid both to validators (known as delegates), as well as the delegators. 

Stablecoins

Terra’s algo-stablecoins are essential to providing a rapid, inexpensive, and seamless cross-border payment service. The network maintains price stability by adjusting its supply based on demand through an embedded market maker. As a result, the more Terra stablecoins like TerraUSD (UST), TerraGBP (GBT), or TerraSDR (SDT) are needed, the more LUNA coins are generated to minimize volatility. How exactly does this work?

If a Terra stablecoin, say UST, is in high demand, more transactions will occur and the price will be pushed up. To counter this expansion, arbitrageurs can buy 1 newly minted UST (worth more than a dollar) for 1 UST of LUNA and make a profit by reselling it. This introduces more UST into the system (bringing the peg back to a dollar), while simultaneously reducing the amount of LUNA in circulation. 

A portion of LUNA returned to the system is burned, and the rest is stored by the Treasury for use in funding and development support. The value of LUNA recovered by the network, calculated as newly minted Terra minus cost of issuance (which is 0), reflects the profit gained. This is also known as seigniorage. 

Similarly, in a period of contraction, UST holders can exchange their (less valuable) UST for 1 UST worth of newly minted LUNA. 

Of course, this mechanism is reliant on a threshold amount of demand to maintain the peg. This means miners must be consistently incentivized to stake LUNA, despite price fluctuations. Terra achieves this by also implementing a demand stability mechanism, which calculates miner rewards by altering transaction fees (affects total rewards) and LUNA burn rate (affects supply of LUNA). As a result, mining rewards remain stable regardless of Terra’s market conditions. 

LUNA Token 

LUNA is absolutely integral to the functioning of the Terra ecosystem, with a role in staking, volatility absorption, governance, and long-term investment. 

As we’ve seen already, LUNA holders can stake their tokens in order to become validators, or delegate their LUNA. To incentivize LUNA holders to invest long-term in the network, staking rewards are granted first to validators, and then to delegators. Rewards are, unsurprisingly, proportional to the size of stake, and are comprised of gas fees, taxes, and seigniorage. As Terra’s flagship currency, TerraSDR (SDT) is the currency used for rewards and fees. 

Gas fees are essentially compute fees, and tax fees are a small percentage calculated on top and capped at 1 TerraSDR. Seigniorage rewards are distributed when validators take part in voting on LUNA’s exchange rate for oracles. 

LUNA is also used as a governance token. Similar to other protocols, this means that LUNA token holders can create and vote on proposals - ranging from software upgrades to how funds from the community pool are spent. 

Terra Ecosystem

As Terra aims at becoming a major blockchain payment platform, the health of its ecosystem is a primary objective. With a recent $150M raised by the protocol, from a number of investors keen to see Terra’s DeFi growth, there is an exciting roadmap ahead. Two existing and successful DeFi protocols on the platform are the Anchor and Mirror Protocols. 

Anchor Protocol

The Anchor Protocol is Terra’s savings protocol, configured for Terra stablecoin deposits. Users range from depositors and borrowers, to liquidators and ANC liquidity providers (LPs). 

Depositors (lenders) can earn low-volatility interest on their deposits, while borrowers supply liquid-staked PoS assets from other chains as collateral on loans. Liquidators are tasked with keeping an eye on high-risk loans, liquidating collateral as they deem necessary. ANC LPs supply liquidity to the ANC/UST Terraswap pair. ANC is also used for protocol governance. 

Mirror Protocol

Terra’s Mirror Protocol provides synthetic assets, known as mAssets (Mirrored Assets), that mirror real-world assets and their prices. This allows users to gain price exposure without having to deal with the actual assets. Minting an mAsset simply requires a user to lock over 150% of the asset’s value as collateral (in mAssets or Terra stablecoins). The protocol’s native token MIR is used in governance, staking, and rewards.  

Other notable mentions include CHAI, the South Korean payment app powered by the Terra blockchain with lower transaction fees. 

The Future With Terra

Terra prides itself on providing a scalable, stable, and transparent service that accelerates widespread crypto adoption both in Asia and across the globe. Having reached another ATH and ranking in 13th place by market cap in August 2021, things seem to be looking up for LUNA. 

The awaited major mainnet upgrade Columbus-5 promises simpler tokenomics and boosted integration. This includes the controversial burning of all seigniorage, which means LUNA could increase in value. Columbus-5 will also bring in the Cosmos Network’s Inter-Blockchain Communication Protocol (IBC), ultimately promoting blockchain interoperability.