What Is Terra Network? | LUNA Review | Notum
Apr 14, 20227 min read
Terra is a blockchain platform built using Cosmos SDK specialized in stablecoin creation. Each Terra stablecoin is convertible into the network's native token, $LUNA. Thanks to Terra a user creates stablecoins pegged to fiat currencies.
LUNA lets holders pay network fees, participate in governance, stake in the Tendermint Delegated Proof of Stake consensus mechanism, and peg stablecoins.
To peg a TerraUSD (UST) stablecoin, a USD value of LUNA is convertible at a 1:1 proportion with UST tokens. Let's have a look at an example if UST's price is $0.97, traders swap 1 UST for $1 of USD and make 3 cents. From one side, this mechanism boosts UST demand, and from another side, it also cuts its supply as the UST is burned. The stablecoin goes back to its peg.
Validators and delegators not only decrease stablecoin’s volatility but also stake LUNA for getting rewards.
You can purchase LUNA with SimpleSwap and then store it, stake, swap, trade, and participate in governance within Terra Network.
What does Terra do?
These coins primarily use the network's seigniorage mechanism. These coins mainly use the network's seigniorage mechanism. The network was launched by Do Kwon and Daniel Shin of Terraform Labs in 2018 and for a consensus mechanism, they decided to use Tendermint Delegated-Proof-of-Stake (DPoS). Terra provides smart contract opportunities for the creation of a vast range of various stablecoin types.
The project is especially popular within the Asian markets for e-commerce and has a wide userbase in South Korea. Can you imagine that you can pay for a taxi in Mongolia using a stablecoin Terra MNT pegged to the Mongolian tugrik? A token minted within the platform is Terra currency and exists together with the network's native LUNA token for governance and utility purposes. Terra and LUNA have a complementary relationship.
Terra has stablecoins pegged to the US Dollar, South Korean Won, British pound, Chinese yuan, and Euro. TerraUSD has already made it to the fourth-largest stablecoin by market cap.
What are Terra stablecoins?
Fiat-backed stablecoins and crypto-backed stablecoins use different methods to handle price parity within the Terra Network. Usually, collateralized stablecoins permit the holder to exchange their stablecoin for the same amount of fiat or crypto. It works with BUSD, which maintains verified US dollar reserves, and with DAI, which is supported by over-collateralized cryptocurrencies.
Terra's stablecoins use algorithmic methods to control their supply and handle the peg. Each stablecoin is backed up and swappable for the governance and utility token $LUNA. Terra acts as an opposite party for anyone looking to swap their stablecoins for LUNA and the other way around, which impacts the two tokens' supplies.
How does TerraUSD (UST) work?
The best way to illustrate is to bring an example. So, let’s say, you want to mint $50 of TerraUSD (UST), which is a peer to 50 UST at the peg. To mint the UST, you'll need to convert the same amount of LUNA tokens. Afterward, Terra will burn the LUNA tokens you supply. Thus, if the LUNA’s price is $25 for a coin, the algorithm would ask you to burn 2 LUNA to mint 50 UST. Beforehand, Terra only burned a portion of provided tokens, but with the introduction of the Columbus-5 update, 100% is burned.
There is another option to mint LUNA using Terra stablecoins. Minting $50 of LUNA would require burning 50 UST. Even if the UST market price isn't $1 per token, the minting conversion rate considers 1 UST as equal to $1. Such a mechanism gives UST its price stability.
How does it keep the price stable? Let’s have a look:
- The price of 1 UST falls to $0.97, 3 cents lower than its pegged value. Yet, for all trades between Terra stablecoins and LUNA, 1 UST is treated as it costs $1.
- A trader sees the price difference and wants to use an opportunity to make a benefit. So, they go to buy 100 UST for $97 and then convert it to $100 of LUNA within the Terra Station Market Module.
- A trader can keep their $100 of LUNA or convert it to fiat and cash to gain some profit. While $3 doesn't seem like a big sum, bigger profits still can be made. This difference between the price of minting the tokens and their actual value is called seigniorage.
But how does it stabilize the price at $1? Firstly, the boosted purchasing of UST by traders boosts UST's price. Secondly, Terra burns the UST during the exchange to LUNA, cutting back its supply and contributing to the rising UST price. Once 1 UST reaches $1, the arbitrage possibility finishes.
The same process functions vice versa when the price of UST is above $1.
The LUNA token is build-in into Terra’s algorithmic stablecoins as it absorbs the stablecoin’s necessity of volatility. Thanks to elastic monetary policy, LUNA controls Terra’s currencies supply.
What is LUNA?
LUNA is Terra's native cryptocurrency that has four different roles in the Terra protocol:
- As a utility token to pay transaction fees in its gas system.
- An opportunity to become a part of the platform's governance system. Once staking your LUNA tokens, you can suggest changes and vote on proposals with changes within the Terra protocol.
- A way to absorb demand fluctuations for stablecoins minted on Terra to manage pegs of the price.
- As a token to stake in the DPoS consensus mechanism behind validators who make network transactions.
LUNA has a maximum target supply of 1 billion tokens. If the network exceeds one billion LUNA, Terra will burn LUNA until its supply returns to the equilibrium level.
LUNA token phases
There are some peculiarities when using LUNA and they are called "Phases":
- Unbonded: In this phase, you can easily trade your LUNA tokens within the Terra ecosystem.
- Bonded: This phrase means that the tokens are staked and therefore frozen, you won’t be able to use them.
- Unbonding: During this phase, you will have the LUNA tokens that you had in staking in "unlink" for 21 days period. During this period, your tokens will not get you a reward and you couldn’t use them either. After this phase passes, the tokens are in the Unbonded phase again.
Staking LUNA rewards
LUNA holders can stake their tokens in the Terra ecosystem's consensus mechanism. By doing that, users receive rewards gained directly from swap fees on the Terra protocol. Users pay these fees every time they swap between LUNA and a Terra stablecoin.
Before the Columbus-5 update, rewards were also taken from an amount of each swap's seigniorage. The new system can provide staking yields of around 7-9%. These rewards will work as a motivation for users and validators to take part in the Tendermint DPoS system. It’s similar to mining on the Bitcoin network.
How and where to buy LUNA and TerraUSD?
You can buy LUNA can on cryptocurrency exchanges like SimpleSwap, Binance, Gate.io, KuCoin, Huobi Global, and alike.
For strong, sending, receiving, and swapping your favorite tokens, use the simplest way — a SimpleHold wallet, that can be an extension within the browser of your choice and also a mobile app on both platforms — iOS and Android.
How does Terra's Delegated Proof of Stake consensus mechanism work?
The Terra Network was designed using the Cosmos SDK, that’s why Tendermint DPoS was an obvious choice. This consensus mechanism is part of the Cosmos technology, and it’s considered an environmentally-friendly alternative to the Proof of Work algorithm.
Users (also called delegators ) stake their tokens behind a validator. In turn, the validator protects the network by performing transactions similar to the work of a Bitcoin miner. A user stakes their LUNA tokens behind a validator they believe will most effectively and honestly make network transactions. Validators can also set a custom percentage of the rewards they will spread among their delegators.
Validators must also lock up a definite amount of LUNA for at least 21 days. This process is known as the bonding phase. Delegators also have this 21-day lockup period and have a risk of losing their stake if the validator is a fraudster.
For example, the validator may perform double-spent transactions or involve fake ones. So, the validator can have their rewards slashed or even lose their initial stake. With "Terra taxes," delegators and validators receive rewards on transactions and airdrops. Each delegator's part depends on the amount they stake and the validator's commission fee.
What is Anchor Protocol (ANC)?
Terraform Labs also manages Anchor Protocol, the blockchain’s leading application by TVL. The project is community-driven and offers lending and borrowing platforms for Terra users. Using it, you can earn interest, borrow, and lend crypto via over-collateralization. You can earn Anchor Protocol’s token, ANC, using the following ways:
- Stake ANC-UST LP tokens to receive ANC rewards.
- Stake ANC by itself.
- Borrow stablecoins via Anchor Protocol.
Terra Network is a trusty decentralized finance (DeFi) community and a genuinely decentralized stablecoin that doesn’t need any intermediary to stable the price.
The Terra ecosystem has more than 100 natively built projects such as non-fungible token (NFT) collections, decentralized finance (DeFi) platforms, and Web 3 applications.
The stablecoin is massively important worldwide because of regulation and wide adoption in payment systems, so there's always room for Terra to develop and improve.