Defi projects: Terra
What is the fuss about?
- Founded in 2018, Terra is a blockchain protocol supported by a number of algorithmic stablecoins. The most popular is called TerraUSD, or UST.
- The stablecoins maintain their peg's through a coin called LUNA.
- LUNA is a speculative cryptocurrency. Terra keeps the prices of its stablecoins in check by changing the supply of Luna.
- This supports a Defi ecosystem, which hosts apps like CHAI which is used by 25 million Koreans as a payment system.
Since writing this project has collapsed, we haven't altered this article however, as discussed in the chapters below, there was a danger that this had ponzi scheme economics. To read more about the collapse visit the news section here.
Well, Terra is a blockchain project that enables the issuing of stablecoins, and the building of a Defi ecosystem that allows users to earn yield on stablecoins, spend crypto in the real world as well as many other banking needs.
Unlike other stablecoins like USDC and USDT, Terra stablecoins are not backed by US dollars, Korean won, or any other fiat currency. Instead, Terra issues algorithmic stablecoins that are collatorised by their own crypto. These stablecoins hold a pegged value using a circular dual-token system that creates arbitrage opportunities via seigniorage.
Seigniorage = New minted currency - Cost of acquiring collateral
Seigniorage refers to the value of newly issued currency minus the cost of issuance, which for a stablecoin is the cost of acquiring external collateral such as fiat. Though this may sound too good to be true, it is also a universal feature of every fiat monetary system.
"At Terra we see seigniorage as fuel with the potential to make stable-coin applications fundamentally superior to fiat-based counterparts. If we can find a way to bootstrap steady demand for Terra and capture healthy seigniorage, Terra could finance fiscal spending of its own and subsidize its dApps."- Do Kwon, Founder of Terra
According to Kwon, this would lead to examples like:
- For a payments app, users can get a discount on the goods purchased compared to goods purchased via Visa
- For a credit app, seigniorage can be used to make interest rates more competitive
- Insurance apps on Terra can charge lower premiums
- Non-financial businesses can see a valuable source of revenue in seigniorage
This is really interesting, as users would be getting discounts on real world goods on an ongoing basis, not just as introductory offers. As the discounts are implemented, it would lead to more demand for the Terra coin, and therefore more seignorage for the ecosystem. It's a self enforcing loop.
The wealth is generated by minting new coins when there is too much demand, so what happens when demand falls? Well, essentially the wealth is clawed back from the capital gains of the holders of the LUNA coin, as to keep the dollar peg steady, Terra mints more Luna which creates more supply and therefore reduces price. This means that as long as there are speculators looking to buy Luna and arbitrators in the market, the stable coin will remain pegged. There is demand also created in the utility of the token, so the bigger the ecosystem grows, the more natural demand there is for the native coins through use cases which further supports price.
At the time writing, price is 84.58 - we have seen incredible growth in the last 8 months.
Much like Scallop, Terra believes that mass adoption through utility is a key use case for blockchain technology. Using unique economic mechanisms, Terra has created a more efficient ecosystem to traditional finance, and when there is efficiency, you eventually see demand.