It is a Cosmos-based protocol that supports a suite of algorithmic stablecoins designed to maintain their rate with a cryptocurrency called LUNA. The Terra ecosystem was created in 2018 by startup Terraform Labs, and its creators are Do Kwon and Daniel Shin.
What are stablecoins?
Stablecoins are digital assets that are backed by traditional currencies such as the US dollar, pound sterling, shekel or ruble. They can serve as a store of value or unit of account, especially in cases where volatile cryptocurrencies are not suitable.
There are different types of stablecoin cryptocurrencies, with different strategies to keep their value stable. Some are centralized, while others are decentralized. Algorithmic stablecoin TerraUSD (UST) is produced by Terraform Labs, and aims to maintain the value of the U.S. dollar through an arbitrage network that buys and sells the volatile Terry cryptocurrency, LUNA. Terry is also a management token that provides holders with voting rights in the protocol.
Operation of Terry
To maintain the balance of its stablecoin, Terra mints and burns tokens while encouraging arbitrageurs. It requires payment of the current Luna rate before buying USTs.
The protocol takes cryptocurrencies and burns them, which reduces their supply and slightly raises the price of Luna. The reverse is also true: to mint Luna, you convert stablecoin USTs. Once these have been burned, the price of USTs rises slightly. According to White Paper, LUNA’s supply elasticity means that stablecoin can never lose its balance. However, its success depends on the continued interest of UST arbitrageurs.
Terry forecasts
The future of the Terra protocol depends primarily on the future of the underlying stablecoin market. One of the main topics of discussion is whether the centralized stablecoin USD will become so popular in the US financial system (perhaps even in the form of a digital currency issued by the central bank) that decentralized alternatives will cease to be competitive. On the other hand, will decentralized stablecoins be able to gain popularity due to the freedom afforded to them by the Terra protocol? There is also a risk that arbitrageurs may tire of the LUNA cryptocurrency, which could affect the prices of all stablecoin products in the protocol. All of these issues are under intense discussion in the cryptocurrency industry.
TerraUSD (UST) crash in 2022.
In May 2022, Terra’s native stablecoin, UST, lost its peg to the US dollar due to the broader crypto market crash. UST then fell to $0.30 essentially removing more than $11 billion from UST’s market capitalization. Luna Foundation Guard, through the deployment of massive reserves, recovered some of its losses, however, despite its efforts, the UST could not be pegged back to the dollar. Just as UST fell, so did LUNA.
The value of the indigenous asset fell by more than 95%, as the market lost confidence in its hike-and-burn mechanism to re-stabilize the UST. The decoupling of UST also brought the entire crypto sector to the attention of regulators.
At a May 10 hearing, US Treasury Secretary Janet Yellen cited the UST debacle as another reason for the need to regulate stablecoin in 2022.
