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Terra Protocol: a Highly Scalable, Stablecoin-Powered Platform Offering an Efficient Payment Solution to Merchants

In the past few years, stablecoins have gained quite some traction in the cryptocurrency space. While most cryptocurrencies are infamous for their high volatility, stablecoins feature value pegs to major fiat currencies or other financial assets. As a result, while they retain most of the benefits of crypto, stablecoins maintain a consistent price and avoid the often extreme price swings of digital assets. For that reason, stablecoins are increasingly adopted for digital payments, DeFi transactions, and cryptocurrency trading to replace fiat currencies.

However, conventional stablecoin solutions require either the managing organization or community members to lock the underlying asset as collateral for the coins to maintain their pegs. Doing so often comes with some problems, such as increased centralization (and counter-party risk) and limited transparency concerning an organization’s fiat reserves.

Terra, a next-generation, blockchain-based payment protocol, aims to solve the above issues by utilizing a unique monetary policy powered by its native platform token to issue and algorithmically stabilize various fiat-pegged stablecoins.

What Is Terra?

Terra is a highly scalable, payment-focused blockchain platform that operates an open financial infrastructure via programmable stablecoins. Interestingly, instead of keeping fiat reserves as collateral, Terra utilizes its native LUNA token to algorithmically stabilize a wide range of fiat-pegged stablecoins.

Since its launch in April 2019, Terra has focused primarily on connecting merchants and their customers in numerous industries with efficient, blockchain-based payments utilizing stablecoins.

With Asia as its main market, Terra has found quite some success during the two years it has been operating, featuring a vast number of partnerships with prominent businesses throughout the continent.

Furthermore, while Terra’s stablecoins are interoperable with other blockchains, its network supports smart contracts, allowing developers to launch decentralized applications (dApps) and decentralized finance (DeFi) solutions on top of the chain.

How Does Terra Work?

To understand how Terra works, let’s take a more in-depth look at each core component and functionality within the ecosystem.

Stablecoin Price Stability

Since Terra’s core value proposition is based on stablecoins pegged to various fiat currencies, the project must maintain long-term price stability for the cryptocurrencies it issues. Terra achieves that by utilizing an exciting and unique monetary system in which the native LUNA token is used to stabilize stablecoins. While neither stablecoins nor LUNA has maximum supply limits (their supply is dynamic), LUNA is required to back the issuance of a stable digital asset like TerraUSD (UST) to maintain its 1:1 peg with a fiat currency (USD, in this case).

In a process called seigniorage (the value of newly minted currency reduced by the cost of issuance), when the demand for TerraUSD increases, the system mints and sells UST to market participants and earns LUNA in exchange.

The system then burns a portion of the LUNA it earned and sends the rest to the Terra Treasury, the decentralized “central bank” of the protocol responsible for measuring the macroeconomic activity and adjusting monetary policy levers, to finance fiscal stimulus within the ecosystem. On the other hand, when the supply exceeds the demand for UST, the Terra protocol mints LUNA and uses it to buy back and burn the stablecoin.

In addition to the above process, Terra also relies on arbitrage (the practice of taking advantage of price differences between multiple markets) to maintain stablecoin price stability. When a stablecoin like UST trades above or below its 1:1 peg with the USD, the system automatically creates risk-free arbitrage opportunities to incentivize traders to participate in the price stability process.

Let’s see an example to better understand how Terra’s price stability mechanism works in practice.

Suppose Terra has achieved a significant milestone in the adoption of its stablecoin-based payment solution. As a result, the demand for UST surges rapidly. Based on the law of supply and demand, when the demand exceeds the supply, an asset’s price will appreciate. For that reason, UST’s price goes above its 1:1 peg to trade at $1.1 (instead of $1). To fix this issue, the protocol starts to mint UST and sells it to users for LUNA.

However, instead of trading the two tokens at the current market price, the system sells 1.1 UST for 1 UST worth of LUNA. Since the network’s pricing beats the open market’s, traders can get 10% more UST for every LUNA they sell to Terra. For that reason, many users take advantage of this arbitrage opportunity to make profits (and, therefore, provide price stability for UST). As a result of the whole process, the protocol will be able to drive down UST’s price to $1.

At the same time, since Terra burns a portion of the LUNA it bought back from users, it drives the cryptocurrency’s price up due to the reduction of its supply.

In the opposite case, suppose Terra experiences a decline in its user base or simply mints too much UST so that the stablecoin’s supply exceeds the demand. As a result, UST loses its peg to the USD again, which drives down the stablecoin’s price to $0.9. In this case, the protocol starts to mint LUNA to buy back and burn UST at a price of $1 for every UST token.

Since the $1 the system buys UST from users at is higher than the $0.9 market price, it creates an arbitrage opportunity again, in which TerraUSD sellers can generate risk-free profits. With arbitrage and the reduction of the UST supply, the stablecoin will eventually reclaim its 1:1 peg with the USD. However, since the LUNA’s supply increased due to the minting of new coins, the cryptocurrency’s price will likely depreciate as a result of the process.

Blockchain Architecture

Terra operates its own blockchain network that utilizes a consensus mechanism based on the Tendermint BFT protocol. With Terra’s algorithm, LUNA holders do not stake their coins directly. Instead, they delegate their digital assets to a validator who stakes them on their behalf to verify transactions and add new blocks to the chain.

For that reason, the project uses a consensus mechanism based on the Delegated Proof-of-Stake (DPoS) algorithm.

While everyone can become a delegator (those who select validators to stake coins on their behalf), Terra selects the top 100 validators by voting power (measured in locked up LUNA holdings) to validate blocks.

Coupled with a fast block time at around 6 seconds, the limited number of validators allows the Terra blockchain to achieve high scalability and throughput.

On the other hand, this also makes the network increasingly centralized, especially when compared to blockchains like Bitcoin or Ethereum, where all validators participate in the consensus process.

Furthermore, Terra used the Cosmos software development kit (SDK) to create its platform, which is primarily designed to build interoperable blockchain applications.

In addition to the SDK, Terra utilizes Cosmos’ CosmWasm smart contracting platform.

As a result, in addition to supporting smart contracts in the Terra network, CosmWasm allows developers to run them across multiple blockchains without further configuration.

Merchant Payments Solution

With its vast number of algorithmic, fiat-pegged stablecoins, Terra’s main focus is on facilitating efficient payments between merchants and consumers. Since Terra utilizes blockchain technology that features peer-to-peer (P2P) payments between users, a stablecoin transaction between a merchant and a customer doesn’t involve any intermediaries.

Terra takes advantage of this feature to offer merchants stablecoin-powered payment processing services with instant settlements for a fraction of the costs of traditional solutions (with up to 80% savings for businesses, according to the project). Interestingly, Terra utilizes a discount model to incentivize customers and merchants to choose its payment solution over its competitors.

As part of the model, whenever Terra issues a new stablecoin supply, it returns some of the money supply’s growth (funded from the Treasury as fiscal stimulus) to consumers in the form of discounts ranging between 5% and 10% of their order value. With a 10% discount, this means that buying a $500 phone at a merchant with Terra’s payment solution costs only $450 for a customer.

For that reason, Terra’s discount model is highly attractive for consumers (as it allows them to save money) and merchants (as it makes their offerings more competitive) alike. This, in addition to the cost-efficient payment processing fees, allowed Terra to score numerous partnerships with businesses in Asia. According to Terra, the project already had 15 partners with $25 billion gross merchandise value (GMV) and 45 million global users during its launch in early 2019.

In addition to the above, payment solutions built on top of Terra have gained quite some traction lately.

While the project states that the Mongolia-focused MemePay serves 3% of the nation’s population, the South Korean e-wallet app Chai features nearly 2.5 million users and a partnership with TMON, one of the leading local ecommerce platforms.

On-chain data serves as proof for Terra’s statements. According to CoinGecko, UST has become the fifth largest stablecoin in the crypto industry, with a nearly $40 million trading volume in the last 24 hours. At the same time, TerraKRW (KRT) is standing in the 19th place with a $52 million market cap and a $1.2 million 24-hour volume.

Anchor Protocol

The Anchor Protocol is a DeFi savings solution built on top of the Terra blockchain. What makes Anchor unique is that it utilizes bonded assets (bAssets) as collateral. Bonded assets are the tokenized representations of assets that have been staked on Proof-of-Stake (PoS) blockchains and their variants (e.g., DPoS).

On Anchor, users deposit bAssets to use them as collateral to borrow Terra-based stablecoins (e.g., UST). Since the borrowers’ collateral is already staked, the protocol adjusts the yields of lenders to a variable fraction of bAssets’ staking rewards. For that reason, Anchor can offer stable interest rates for both borrowers and lenders on the platform.

Furthermore, as borrowers’ annual percentage rate (APR) is very similar to what they earn as staking rewards after their bAssets, they can access extra capital on Anchor without sacrificing additional funds to pay interest to lenders. As with most DeFi protocols, loans on Anchor are overcollateralized, which means that the loan-to-value (LTV) ratio is lower than 100% (e.g., you can borrow only $60 of stablecoins against your collateral assets worth $100 with a 60% LTV).

In addition to the over-collateralization of loans, Anchor has a principal protection mechanism in place, which automatically liquidates some of the borrowers’ collateral when there is a risk of under-collateralization to protect lenders’ funds.

Mirror Protocol

Mirror Protocol is another DeFi solution in the Terra ecosystem. However, instead of focusing on lending and borrowing, Mirror enables the creation of Mirrored Assets (mAssets). mAssets are synthetic assets on top of Terra representing the tokenized version of real-world instruments, such as stocks, bonds, and other cryptocurrencies. mAssets on Mirror are minted by locking at least 150% of the real-world instrument’s value in either Terra stablecoins or other mAssets in a smart contract.

Suppose the collateral’s value falls below the required 150% ratio. In that case, unless the user deposits more funds into the smart contract or burns some of his mAssets, the protocol will automatically liquidate his collateral to guarantee the system’s solvency. At the same time, when a user burns all the mAssets he originally minted, the system will automatically return his collateral back to him.

Most importantly, while mAssets on Mirror track the real-world instruments’ prices in real-time via decentralized price oracles, they provide fractional ownership, open access, and censorship resistance to holders without actually holding the underlying assets. In addition to the minting and burning mechanisms, Mirror facilitates seamless mAsset trading via liquidity pools. In exchange for supplying the assets of a pair in a pool, liquidity providers (LPs) earn trading fees.

Furthermore, if they stake their LP tokens (cryptocurrencies representing their share of liquidity in a pool), users are rewarded in the native Mirror Token (MIR) of the platform that is minted by the protocol to incentivize behavior that secures the ecosystem.

Terra Bridge

It’s also important to mention Terra Bridge, a web app that allows assets in the project’s network to be moved between different blockchains. With a focus to provide interchain stablecoins, Terra already has a bridge between Ethereum and Solana.

What Is LUNA?

LUNA is Terra’s native governance token that features the following core functionalities:

  • Participating in governance decisions by voting on matters concerning the project
  • Staking the cryptocurrency to validate blocks and transactions
  • Providing price stability for algorithmic stablecoins issued on Terra by minting and burning LUNA

It’s important to mention that users staking LUNA receive three types of rewards in exchange for supporting the network:

  • Gas fees
  • Taxes, which represent a fee between 0.1% and 1% for every Terra-based asset
  • A portion of seigniorage rewards earned from minting new coins

LUNA has a dynamic supply, which means there is no hard cap for creating new coins. However, this is an essential feature that allows the protocol to maintain the price stability of stablecoins. Furthermore, since LUNA is burnt to mint stablecoins on Terra, the more the project’s adoption rises, the lower the supply of its native token gets.

For that reason, LUNA will likely face a long-term price appreciation if Terra and its partners can attract new users and maintain stable business growth.

Now, let’s see how LUNA has been doing in terms of price.

Except for some minor increases and decreases in its value, the cryptocurrency hasn’t experienced major price movements until this year. However, in 2021, LUNA surged from January 1’s $0.65 to as high as $21.98 by March 21 before dropping down to $4.1 on May 23 due to the sudden crypto market crash. That said, as the digital asset is currently trading at $6.24 as of May 31, it features an over 850% year-to-date (YTD) ROI in 2021.

Terra: the Stablecoin-Powered Payment Protocol Bridging Crypto and Finance

In its little more than two years of history, Terra has achieved great success in terms of its payment solution’s adoption. And this shouldn’t come as a surprise.

Terra utilizes a unique, elastic monetary policy that allows the project to operate an efficient, highly scalable payment protocol powered by a large variety of algorithmically stable, fiat-pegged stablecoins and its own native LUNA token.

In terms of stability, it’s important to mention that Terra’s fiat-backed digital assets are among the least volatile algorithmic stablecoins, featuring a good track record of maintaining their pegs.

In addition to all the above, Terra has an excellent potential to speed up its adoption as a payment solution among merchants due to its discount model, which the project’s partners can leverage to attract new customers.

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