Terra’s crypto financial ecosystem and its LUNA token

Built by Daniel Shin and Do Kwon, graduates of Pennsylvania University and Stanford University, respectively, the Terra ecosystem might be one of the most resilient crypto projects on the market. What is it and how does it work?

What is a crypto financial ecosystem?

To grasp what an ecosystem is, let’s turn to nature. In the wild, there are trees, birds, insects, and other animals that, although independent, all rely on each other. A financial ecosystem works in a similar manner. It is a collection of people, organizations, processes, and systems that let us buy and sell, save, invest, and so on. To get even more specific, a crypto financial ecosystem is essentially the same thing, except it relies on blockchain technology.

 

The Terra ecosystem

Terra is a proof of stake blockchain project developed by Terraform Labs, that powers cryptocurrencies and applications. The focus of Terra is to propose mass payment processing backed by the creation of a stablecoin called UST.

In our traditional payment systems, companies like Mastercard and Visa run a business model where they take 2-3% fees on every transaction, paid by merchants. Terra’s goal is to cap fees at 1%, meaning they could even be much lower. It is not hard to see the argument for merchants here.

But what sets Terra apart from other blockchains such as Bitcoin or Ethereum? The main issue with these blockchains is their cryptocurrency’s volatility. The value of a Bitcoin or an Ethereum in dollars can greatly vary from week to week, or even from day to day. A fortune can be lost in a matter of days. This volatility inspired the idea of stablecoins.

Stablecoins are cryptocurrencies pegged to fiat currencies. This gives them much more stability compared to other cryptos. Although they won’t return double digits overnight like other obscure coins, they won’t fail you the other way around. Having your savings, or even part of them, in Bitcoin could give you headaches if you need money during a crypto sell-off. But what is the interest of investing in a value that does not fluctuate? The solution here is to make separate channels: one for payments with a somewhat stable and predictable value, and another for investing with larger fluctuations.

Terra built a solution that has its stablecoin pegged to fiat currencies with an algorithm to make sure they remain at a stable price. Terra has a few stablecoins for different cryptocurrencies, such as the UST for the US dollar, the KRT for the Korean won or the EUT for the euro.

In other terms, what Terra aims to offer is the same advantages of DeFi ecosystem with cryptocurrencies, but without the volatility and unpredictability it sometimes brings.

 

How does Terra’s stablecoin algorithm work?

The Terra ecosystem has two major assets at its core. The native network coin, called Luna, and the stablecoin, called UST, as mentioned earlier. The Luna coin is especially important as it is used to maintain the stable value of Terra at exactly $1.

When the value of UST is mismatched to the value of a real US dollar, Luna is used to incentivise people to perform actions that will adjust the price. UST will be either burned or created to control supply and thus, its value.

If a UST is over a dollar, the goal will be to increase UST supply to decrease its value. Users will trade these extra Terra tokens to people willing to trade their Luna tokens in exchange, for a profit. If UST is less than a dollar, users can trade their Terra coins for a dollar value of Luna, making yet another profit. In the same logic, this shrinks the number of circulating UST, causing its price to rise.

But where does this profit come from? Who’s paying for it? It looks like profit is coming from money flowing into the ecosystem. More people buying USTs are making the Luna coin grow in price and a small portion of these profit go to people helping make UST stable. However, the Luna coin will also fall in price if people start taking their money out of the ecosystem.

Why hold Luna? There are two reasons: First, if one is bullish on the Terra ecosystem and believes that more and more people will join it. This will make the price rise as mentioned earlier. The second reason is simply if you want to perform any action on the Terra network, as Luna is the native coin that allows transactions in the ecosystem.

 

What can you do with Terra?

As mentioned above, Terra is an ecosystem and the home of many cryptocurrency projects and wants to simplify transactions using stablecoins and using them to allow the use of financial tools in a way that is easy for people to understand and actually think in terms of dollars amounts.

Terra has two main protocols called Anchor and Mirror. The Mirror protocol allows the creation of mAssets, basically representations of other assets (e.g., One ETH = mETH). This is very similar to ETFs (Exchange-traded funds) on the stock exchange. In simple terms, this means that you can buy US stocks, commodities, or even Asian real estate, from anywhere in the world, without requiring permission. What’s more, you can do it fractionally (i.e. only buy a portion of the asset). There are critics to the use of such synthetic assets, but these nevertheless present an interesting investing opportunity.

The Anchor protocol uses the staking mechanism of Terra to create what one could basically see as savings accounts. Interesting saving accounts, as they are paying around 20% APY, much better than your traditional savings account, which is often under the percent. Of course, this incentivizes people to keep their money on the Terra ecosystem.

In summary, it seems that Mirror gets people to use Luna and UST, and Anchor keeps people on the ecosystem.

 

Conclusion and next steps

Terra is a broad ecosystem that has not yet shown its full potential. We also note that its foundations were built using the Cosmos blockchain. While the name does not ring a bell for many, readers should retain that it means that Terra was built with the idea of an integration of many blockchains, with a strong concern for interoperability right from the start. This only emphasizes Terra’s goal of building an entire ecosystem of DeFi products and services.

Right now, the system is targeting payment processing systems, specifically in a few Asian countries such as South Korea and Taiwan. Its success is showed in numbers, as it saves merchants on average 1.5% in transaction fees with a payment processor called CHAI – also led by Daniel Shin. Their goal is to keep coming with new services such as Anchor, to get users excited by the project and grow their user base. A project to keep an eye on, at the very least.

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