CRYPTO CASE: SUMMARY OF ALL INFORMATION ABOUT TERRA AND THE CRISIS OF THE TERRA STABLECOIN AND LUNA TOKEN PROJECT
WHAT IS TERRA
Terra is a blockchain that allows users to create fiat-pegged stablecoins. These coins mainly use the “seigniorage” mechanism of the network. The Terra network was created in 2018 by Do Kwon and Daniel Shim from the Terraform lab, using the Tendermint Delegated-Proof-of-Stake (DPoS) consensus mechanism. Terra allows smart contracts to create different types of stablecoins.
The project has become famous in the field of e-commerce in the Asian market and has a large user base in Korea, where Terra's headcounter is located. For example, users of a taxi service in Mongolia can pay some drivers with the Terra MNT stablecoin pegged to the Mongolian tugrik. Tokens minted on the platform are called the Terra currency and exist alongside the network's native token, the utility and governance token LUNA. Terra and LUNA have a complementary relationship.
Terra already has stablecoins pegged to the US Dollar, Korean Won, Euro, and more. In a short time, the project gained popularity with stablecoins minted on the platform.
WHAT IS TERRA's STABLECOIN?
Stablecoins in the Terra network use a different method of maintaining price parity than fiat-collateralized stablecoins and crypto-backed stablecoins.
Often collateralized stablecoins allow the holder to exchange the stablecoin for a fiat currency or a cryptocurrency of equivalent value. This is precisely the case with BUSD, a stablecoin that uses US dollars as a reserve.
However, Terra stablecoins use an algorithm to control the supply. In fact, each stablecoin is secured and can be exchanged for utility and governance tokens of LUNA. Terra acts as a counterparty for anyone wanting to exchange stablecoins for LUNA and vice versa, which affects the supply of both tokens.
HOW DOES TERRAUSD (UST) WORK?
Let's say you need to mint $100 TerraUSD (UST), which equates to 100 pegged USTs. To mint UST, you will need to convert an equivalent amount of LUNA tokens. Then Terra will burn the tokens you provide. Therefore, if the price of LUNA is 50 USD/coin, the algorithm will ask you to burn 2 LUNA to mint 100 UST. Before that, Terra only burned a portion of the tokens offered, but when the Columbus-5 update came out, the number of tokens burned was 100%.
You can also mint LUNA with Terra tokens. To mint 100 USD worth of LUNA (2 LUNA), it will be necessary to burn 100 UST. Even if the market price of UST is not 1 USD/token, the conversion rate for minting still calculates 1 UST as 1 USD. This exchange mechanism keeps the price of TerraUST stable.
Let's take a look at an example to see exactly how the algorithm works for price stabilization:
1. The price of 1 UST fell to $0.98, 2 cents below its nominal anchor value. However, when converting between stablecoin Terra and LUNA, 1 UST is considered to be worth $1.
2. An arbitrageur sees this spread and recognizes an opportunity to profit. They proceed to buy 100 UST for 98 USD and then change it to 100 USD in LUNA on the Terra Station Market Module.
3. The arbitrageur can keep 100 USD in LUNA or convert to fiat and withdraw the profit earned. Although 2 USD doesn't sound like much, the profits are bigger when trading on a larger scale. The difference between the token minting price and the token's value is called seigniorage.
But how does this mechanism help stabilize the price at 1 USD? First, increased demand for USTs from arbitrageurs increases the price of USTs. Terra burns UST during the conversion to LUNA, reducing the supply and increasing the price of UST. Once 1 UST reaches a value of 1 USD, the arbitrage opportunity is gone.
The same process works in reverse when the UST price is above $1. Let's see another example.
1. When the price of 1 UST rises by $1.02, arbitrageurs have a way to make a profit.
2. Arbitrators buy 100 USD LUNA and convert it into UST 102 USD on Terra Station Market Module. Terra burns LUNA and mints UST in the process, increasing the supply.
3. The arbitrageurs can then sell the UST on the open market for a profit. This selling pressure on UST brought the price back to the closing level.
The LUNA token is integral to Terra's algorithmic stablecoins as it absorbs the volatility of stablecoin demand. With an elastic monetary policy, LUNA carefully controls Terra's currency supply. When compared to over-mortgage projects like MakerDAO, the Terra model is more scalable and affordable.
WHAT IS LUNA?
LUNA is Terra's cryptocurrency and has four different roles on the platform:
1. Payment method for transaction fees in the gas system (utility token).
2. A way to join the platform's administration system. By staking LUNA tokens, users can create and vote on change proposals related to the Terra protocol.
3. A mechanism to absorb fluctuations in demand for stablecoins minted on Terra to maintain anchor prices.
4. Tokens to stake according to the DPoS consensus mechanism behind validators that process transactions on the network.
LUNA has a maximum target supply of one billion tokens. If the network exceeds a billion LUNA, Terra will burn LUNA until the supply returns to equilibrium.
REWARDS STAKE FROM LUNA
LUNA token holders can stake tokens according to the consensus mechanism of the Terra ecosystem. By staking LUNA, users receive a direct reward from the swap fee on the Terra platform. Users pay these fees whenever they switch between LUNA and Terra stablecoin.
Before the Columbus-5 update came out, rewards were also taken from a seigniorage portion of each swap. In theory, the new system should provide a stake yield of around 7-9%. These rewards incentivize users and validators to join Tendermint DPoS. If you are used to mining on the Bitcoin network, the principle is similar.
How does Terra's Delegated Proof of Stake consensus mechanism work?
The Terra blockchain is built on top of the Cosmos SDK, thus using the Tendermint DPoS consensus mechanism. The consensus mechanism is part of the Cosmos suite of technologies and is an eco-friendly alternative to the Proof of Work mechanism.
As of October 2021, Terra used a pool of up to 130 validators to process transactions. The user (or delegator) stakes the token behind the validator. In turn, the validator secures the network by processing transactions similar to the job of a Bitcoin miner. Delegators will stake LUNA tokens behind a validator that they believe will efficiently and honestly process transactions on the network. Each validator can also set an arbitrary percentage of the reward they will give to their delegator.
Validators must also lock a set amount of LUNAs for at least 21 days. This process is called engagement. The delegator also undergoes a 21-day lockout period and risks losing staked funds if the validator is the bad guy.
For example, the validator can handle transactions that duplicate payments or contain false transactions. In this case, the validator may have the reward cut or even lose the original staked (committed) amount. “Terra Tax” on transactions and airdrops will be taken to award delegator and validator rewards. The reward the delegator receives depends on the amount staked by the delegator and the validator's commission rate.
WHAT IS TERRA STATION?
Terra Station is Terra's official cryptocurrency wallet and a dashboard that allows LUNA token holders to access funds, stake, and participate in governance. Terra Station has both a mobile app and a browser extension.
1. The Terra Station dashboard displays a range of on-chain data, including trading volume, stake profit, and the number of active accounts.
2. Terra Station's wallet is a non-custodial wallet, meaning only you can access your private keys. If you open a Terra Station wallet, be sure to keep the seed phrase in a safe and secure place. If you lose the phrase, there will be no way to get the money back.
3. The admin portal allows you to create a new proposal and move on to the voting stage by submitting 512 LUNA. Other users can deposit 512 LUNA on your behalf if you have no money. When a new proposal is created, other LUNA token holders can stake the token to vote.
4. The token stake section allows you to authorize, check rewards, commit LUNA as a validator and participate in every stage in the DPoS consensus mechanism.
WHAT IS ANCHOR PROTOCOL (ANC)?
In addition to managing Terra, Terraform Labs also develops and maintains Anchor Protocol, the leading blockchain application created by TVL. The project is managed by the community and provides a lending and lending platform for Terra users. With Anchor Protocol, you can earn interest, and borrow and lend cryptocurrency through over-collateralization. You can earn Anchor Protocol ANC tokens, in several ways:
You can stake ANC-UST Terraswap LP tokens for ANC rewards.
You can also stake ANC itself.
You can borrow stablecoins through the Anchor Protocol.
You can also use ANC as part of the Anchor Protocol governance mechanism to create and vote on proposals. You can buy ANC on Binance using the same method outlined for LUNA above.
LUNA LOSES 96% OF ITS VALUE
In the past few days, the UST and Terra's governance token LUNA have been under heavy selling pressure, causing the price to plummet. According to data from Coinmarketcap, LUNA is currently trading around the $5 mark, down more than 85% from 72 hours earlier. At the same time, since the peak of nearly 120 USD established on April 5, this digital currency has decreased by more than 96% in value.
There was a time when LUNA rose to a high position in the group of 10 largest cryptocurrencies in the world. Currently, the project governance token Terra has been knocked out of the top 30. The market capitalization of LUNA is more than $2.7 billion. Compared to the peak, more than 36 billion USD of the project's capitalization has evaporated in just a few days.
CAUSE OF THE CRASH
Terra's "collapse" stems from the fact that the ecosystem's algorithmic stablecoin UST lost the $1 mark for a long time. The incident started on 7/5 until now has not been resolved. After a sharp drop to $0.64/UST on the morning of May 10, Terra's stablecoin seemed to have stabilized at $0.9. However, the collapse of LUNA below 15 USD caused UST to drop in price.
The supply/demand relationship between LUNA and UST is the basic rule for stabilizing the price of UST at 1 USD. At the same time, because of the close correlation, every change in the price of one of the two digital currencies affects the rest of the system.
Terra's Anchor deposit protocol with an interest rate of 20%/year is the main driving force behind the recent cash flow into the project, raising the price of LUNA to a record high. However, currently, the amount of deposits on the platform is only about 4.6 billion USD, down more than 65% from the 14 billion USD mark a few days ago.
TerraUSD's loss of the $1 price mark negatively affected the entire project. Therefore, as soon as the stablecoin fell, hundreds of millions of dollars of cryptocurrencies were pumped into the market to reduce the supply of USTs, resisting the pressure. However, before the strong selling force, the number of assets injected could not provide enough support.
On Twitter, Do Kwon, co-founder of the Terra project, and his allies continuously reassured the community with the promise of injecting more money to save Terra and coming up with a solution soon. However, the market still reacted negatively, continuously selling off and pushing the price of LUNA down.
Before the negative developments from Terra, the cryptocurrency market is in the red. Bitcoin is currently trading at $30,400, down 4.2 percent from the previous 24 hours. Similarly, ETH fell to $2,290, losing 4% of its value. 10 of the 10 largest cryptocurrencies in the world (excluding stablecoins) all fell. Data from Alternative shows that the sentiment index of the entire crypto market is at a very low level, 12 points, in the extreme fear zone.
Before this downtrend, Terra was the second-largest decentralized financial platform in the world, after Ethereum. Currently, this ecosystem has fallen to 4th place, according to Defi Llama data. At the same time, other decentralized financial models were also affected by the collapse of LUNA. The prices of SOL, ADA, NEAR, and AVAX have been and continue to fall sharply.
On May 12, LUNA/USDT contracts were delisted from Binance after the value of the asset pair fell below 0.005 USDT. Previously, Huobi exchange also stopped transactions related to the LUNA key.