Stablecoins are a huge part of the crypto ecosystem. With their total valuation exceeding $180 billion, they allow users to store and use their local currency on a blockchain. This is vital in facilitating trading on DEXes and yield farming.
Majority of stablecoins, including USDT and USDC depend on a central authority. A central body backs the stablecoins with a reserve of FIAT collateral. However, in a decentralized sphere such as crypto, there is a massive demand for decentralization.
It can also be a problem finding less well-known FIATs represented as stablecoin. Luna is a blockchain offering a solution to both of these problems with its stablecoin issuance protocol. Let’s dive into: What is Luna?
Terra is a proof-of-stake blockchain that allows users to create stablecoins pegged to FIAT currencies—using smart contract capability to incentivize arbitrageurs to keep a stablecoin pegged to its FIAT value. The blockchain was founded by Do Kwon and Daniel Shin of Terraform Labs.
Terra has already proved immensely popular in Asian markets, particularly South Korea. It is also proved successful in Mongolia where the Terra MNT token, pegged to the Mongolian turkic, is used by travelers to pay taxi drivers. On top of that, TerraUSD has already become the fourth biggest stablecoin on the blockchain, as of the first quarter of 2022.
What is Luna, Terra and UST?
Terra stablecoins use algorithmic methods to maintain the peg. This is all possible through Terra’s native LUNA token which is used in the creation of any stablecoin.
In order to mint $100 of terra USD you must first burn the equivalent value of LUNA. For example, for a $50-worth of Luna, you would have to burn two LUNA to mint the UST.
Any time you want to convert UST back to Luna, UST will always be worth $1 in the trade. This is where the arbitrageurs come in. If the price of UST falls to $0.96, an arbitraguer can buy it for that price and then convert it to $100 worth of Luna.
Once the UST is converted to Luna, it is burnt, decreasing the supply. In other words, this protocol creates buying pressure of any stablecoin in the system any time its value falls. This buying pressure will remain until the coin reaches its peg again.
Thus, the value of the coin remains. Terra can then use this method to issue any stablecoin. The LUNA token is also used to pay transaction fees, take part in the platform governance system, and delegate as part of the blockchain’s proof-of-stake consensus mechanism. LUNA has a maximum supply of 1 billion tokens. If this supply is ever exceeded, the Terra Foundation will burn any excess LUNA.
Terra uses a consensus mechanism known as delegated proof-of-stake. This involves users delegating their tokens to a specific validator. Users will select validators based on their belief that they will behave honestly. In turn the validator will run the nodes in the network and set a custom percentage of the rewards for their delegators.
Bitcoin As Collateral
Terra is also building up a huge reserve of Bitcoin to further collateralize its UST coin. So far, The Luna Foundation Guard (LFG), the non-profit tasked with building the reserve, has accumulated 35,768 BTC. This puts it ahead of Tesla in terms of the amount of BTC held. The goal of the foundation is to accumulate $10 billion worth of BTC and become its largest single holder.
As stable coins are becoming a bigger and bigger part of the crypto sphere. Their existence allows investors to avail of crypto’s profitable processes and borderless transfers without exposure to the volatility seen in many crypto currencies.
Terra’s ability to essentially offer any FIAT currency on the blockchain, together with the attention and security they have garnered from their massive Bitcoin purchases. Will make them a big player in the stablecoin sector for a long time to come.