Terra, the second biggest smart contracts platform after Ethereum, is a blockchain platform for algorithmic stablecoins that can fill the gap between fiat and digital currencies. These stablecoins are pegged to the traditional fiat. Thus, they provide a sense of security to those who are new to the blockchain industry.
Terra is dedicated to offering the next generation digital money with its stablecoins ecosystem and smart contract platform. Terra provides a secure platform for cross-border transactions with low fees. Terra has a user-friendly interface that is pretty much similar to a mainstream fintech platform.
Terra is commonly known as “Alipay on the blockchain” in the crypto community because many experts say that it has the potential to lead the eCommerce market in the future.
What Problem Does Terra Solve?
Although the crypto industry’s adoption rate is swiftly increasing, the majority of people are reluctant to use cryptocurrencies as a medium of exchange because of the volatility. Sometimes, the prices of cryptocurrencies fluctuate around 10-20% within a day. Terra offers a price-stable digital currency ecosystem to solve this problem.
Terra has designed internal algorithms to maintain the stability of algorithmic stablecoins within its ecosystem. Terra USD (UST) is the main stablecoin of this platform that is backed by smart-contract algorithms and Luna token. This unique feature differentiates between UST and USDT because Terra doesn’t make any misleading claims about its reserves.
Terra has established a treasury that is similar to a central bank. This treasury manages the fiscal governance and spending regime of the platform.
How Does Terra Work?
Terra isn’t just a stablecoins ecosystem but it’s also a smart contract platform. It means developers can build apps on Terra’s blockchain and other users can purchase products and services from these apps using their tokens.
If someone is willing to buy something from an app, they need to burn the LUNA tokens to mint the Terra stablecoin. They can then use these coins to purchases the items. A small amount of LUNA tokens that are burnt for the minting process are transferred to the community treasury. Thus, the minting process is made profitable for the network.
Furthermore, the users are required to pay a small transaction fee when they’re purchasing something using their stablecoins. This transaction fee is distributed among validators who participate in the transaction processing.
Terra Network processes transactions using the Proof-of-Stake consensus protocol. So, the validators need to freeze their LUNA tokens in a specified wallet to participate in this process. Depending on the amount of LUNA tokens the validators hold, they can also participate in the network consensus.
Understanding Terra Stablecoins
Terra’s stablecoins are a little bit similar to BUSD and DAI as they can be exchanged for an equivalent amount of fiat or other cryptocurrencies. However, Terra’s stablecoins are managed through algorithmic methods whereas the BUSD and DAI have to maintain US Dollars or Cryptocurrency reserves as collateral.
In Terra’s network, the stablecoins are backed by the utility token LUNA. The users can swap their stablecoins for LUNA whenever they want.
How Do Terra Stablecoins Work?
It’s already mentioned that the users need to mint their own TerraUSD coins by burning the equivalent amount of LUNA tokens. So, if LUNA’s price is $100 per coin and a user wants to mint 100 TerrraUSD coins, they’re required to burn 1 LUNA token. They can use the same process for minting LUNA tokens if they want to swap their TerraUSD for LUNA.
Thus, the price of TerraUSD remains stable because users are required to burn their UST tokens if they don’t need them anymore. The users need to pay 1 UST conversion fee for the minting process.
How the Value of Terra Stablecoins is Maintained?
Terra’s intended pegged value is $1. So, whenever the price drops below this level, arbitrageurs consider it an opportunity and they buy the UST from the exchange and then convert it to LUNA.
For example, if the price of UST drops to $0.98 per coin. The arbitrageur will buy 100 UST coins for $98 and they will convert it to LUNA because LUNA’s price is still $100 per coin. Thus, they can easily make a $2 profit from this simple trade. $2 may seem a bit small but when someone invests a huge amount, they can make massive profits in a safe way.
When a huge number of people start buying UST, the value of the coin gets back to $1 due to increased demand. Similarly, when the price of UST goes above $1, the arbitrageurs start converting their LUNA tokens into UST due to which the supply of the UST is increased and its value once again goes back to $1.
Thus, LUNA acts as collateral for Terra stablecoins while absorbing the volatility of the UST tokens.
Use Cases of LUNA Token
With a circulating supply of 372 million coins, LUNA is the seventh-largest cryptocurrency in terms of market cap. It has a maximum supply of 1 Billion coins. The Terra network will burn the LUNA tokens to maintain the level if the supply ever went beyond the maximum limit. LUNA plays four roles on the Terra network.
Gas Fee – When a user processes a transaction on the Terra network, they need to pay a partial amount of LUNA tokens as a gas fee.
Staking – LUNA token holders can stake their tokens to act as validators. The staked tokens are also used to maintain the volatility of stablecoins.
Governance – LUNA token holders have the right to vote or create proposals for the growth of the platform.
Collateral – LUNA acts as collateral for stablecoins by absorbing their volatility.
Terra is the second most popular smart contract platform after Ethereum. It has established an ecosystem of algorithmic stablecoins that have the potential to facilitate the eCommerce market on a large scale. We’ve shared detailed information about the Terra network and how Terra Stablecoins work. If you need more information about Terra LUNA, feel free to get in touch with us.