What is Terra (LUNA)?

3 mins read

Terra is a blockchain platform that supports decentralized finance (DeFi) applications (DApps) and the ability to tie the value of stablecoins to that of any kind of fiat. However, these aren’t typical stablecoins in that they’re backed by fiat, such as how the United States dollar backs USDC. Instead, Terra stablecoins are algorithmic.

An algorithmic stablecoin means that the digital asset derives its value from formulas and algorithms and not from the fiat it’s tied to. For stablecoins on the Terra network, much of this value is derived from arbitrage, or the act of buying an asset in one market and selling it in another, profiting off of the price difference between the two. While this method of derived value sounds complicated, it’s actually a useful idea. It allows users to invest in a digital version of a physical asset without actually holding said physical asset. 

Terra also powers another cryptocurrency, LUNA. LUNA is Terra’s staking and governance token. Those who stake LUNA become validators and earn rewards for validating transactions, as Terra is a proof-of-stake (PoS) network. That said, users can also burn Terra to mint a stablecoin tied to their local fiat and vice versa.

Incentivizing Arbitrage

Let’s use Terra’s USD-tied asset, TerraUSD (UST), as an example. Considering UST is a stablecoin tied to the US dollar, UST would, ideally, always be valued at one dollar. For typical stablecoins backed by the dollar, this would be the case. In UST’s case, however, since the price is algorithmically decided, it does shift in value.

For TerraUSD to remain at $1.00, the Terra network utilizes incentivized arbitrage. Say UST raises to $1.01. Validators must burn $1.00 worth of LUNA to mint UST at one cent higher than its base value. They can then sell that UST and continue doing so until the value drops back to $1.00, profiting from the difference. The process works in reverse, as well.

By incentivizing arbitrage and ensuring stablecoin prices remain at $1.00, Terra offers a reliable network in which developers can build blockchain-powered, stablecoin-centric financial DApps.

Terra’s Foundation

As mentioned, Terra is a PoS network built on the Cosmos blockchain. It utilizes Tendermint for consensus and requires validators to function. Validators propose blocks of transactions that others then vote upon. If a block receives a favorable majority vote, it is committed to the blockchain, and the proposer earns rewards. That said, only a select few can be a Terra validator.

At the start, all LUNA stakers are considered delegators. Delegators will then stake their LUNA toward a specific user they see fit to be a validator. As more users stake LUNA toward a validator, that validator is seen as valuable to the community, and they’re given more opportunities to propose blocks. Also, there can only be 130 ‘active’ network validators. Those 130 validators are decided based on the amount of LUNA staked toward them.

When a validator earns rewards, the delegators that have staked their LUNA toward them also earn a cut. As validators are how delegators earn additional LUNA, it is in the delegator's best interest to stake toward validators that prove their worth to the network. This incentivization helps ensure a safe and secure network for all.

Alternative Finance

Terra’s primary function is that of a DApp platform similar to Ethereum but without the exorbitant gas fees and dangerous volatility.

Instead, Terra DApps focus more on day-to-day financial use cases harnessing blockchain technology. CHAI, for example, is a popular Terra-powered payments app in South Korea. With CHAI, users can convert their fiat to Terra’s KRT stablecoin and use it to pay for goods and services at merchants that support it.

By supporting Terra payments, merchants save on fees typically associated with traditional payment providers. Merchants can then pass those savings on in discounts to their regular customers, offering a better value for all parties.

Other Terra DApps include lending and borrowing platforms, launchpads, yield management, and other types of financial innovation.

While Terra is still in its infancy compared to other DApp platforms like Binance Smart Chain and Ethereum, the stablecoin powered networks appear to aim for a smaller, more tight-knit ecosystem. According to CryptoSlate, around 160 Terra DApps will launch in 2022 — a far cry from Ethereum’s thousands of DApps.