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What Is Terra?
First, we need to talk about what stablecoins are. A stablecoin is a token on a blockchain that is backed by a fiat currency and has the same value as this currency. 1 USDC, for example, is worth 1 USD. There is a demand for such tokenized dollars because you can use them on DeFi protocols like Aave or Uniswap, and you can earn up to 10% interest annually—which is far better than any savings account—by holding them in lending platforms like Celsius.
The price of a stablecoin is usually held stable by a centralized entity, like a bank, that guarantees that token holders can at any point redeem the tokens for the same amount of dollars. The problem here is that such companies can be very untransparent about their holdings, and they can be targeted by regulators and governments that are against cryptocurrencies. That’s why a decentralized method of issuing stablecoins is needed; Terra offers just that.
Terra doesn't only have stablecoins based on the US dollar; the blockchain can be used to create any kind of stablecoin. It already is very popular in Asia, especially in Korea, where many popular payment apps already partner with Terra.
Unlike its competitor, the Maker protocol, Terra is not only a DApp on Ethereum; it's also its own proof-of-stake blockchain that is able to connect with various blockchains. It is based on Cosmos and can therefor connect to theoretically every proof-of-stake blockchain as well as Ethereum, so that its stablecoins can be used on various protocols on those blockchains.
Stablecoins usually keep their value by being collateralized, but Terra uses a unique algorithmic approach to stabilize their minted stablecoins. To create UST, the USD-based stablecoin on Terra, you need to burn an equivalent dollar amount of LUNA tokens. If you want 10 UST, and the price of 1 LUNA is $1, then you would need to burn 10 LUNA.
You can also burn the stablecoins to receive the equivalent dollar amount of LUNA tokens. If you burn 10 UST, and the value of 1 LUNA is $0.50, then you would get 20 LUNA back. This creates an environment where you are incentivized to redeem stablecoins if their value drops, therefore making their value higher by a smaller amount.
Should the value of 1 UST crash down to $0.50, then you could make an instant 50% profit by burning it because you would get $1 worth of LUNA per UST. Should their value get higher than $1, people would have an incentive to burn LUNA and create stablecoins, which would make their supply higher and lower their value.
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Stablecoins are never completely stable in their price, and they fluctuate by a few percentage points here and there, but in Terra's case, each time they do, holders have an incentive to stabilize the coin again. The stablecoin and the LUNA token are constantly balancing each other, just like the earth and the moon do; that’s why the blockchain is called Terra, and its governance token is called LUNA.
Terra isn't limited to the creation of stablecoins, it also has the Anchor protocol that lets you earn a stable staking yield with many different proof of stake blockchains, and the Mirror protocol that makes it possible to create synthetic stocks that mirror the value of shares but can be traded on a blockchain and used in smart contracts.
The LUNA Cryptocurrency
The LUNA token is the native utility token of Terra. As mentioned, it is used to stablize the value of stablecoins minted on the Terra network. LUNA tokens are also used for staking since Terra is a proof-of-stake blockchain. Because Terra is not inflationary, stakers don't earn new LUNA tokens but instead earn only the network fees of the blockchain. Because Terra has rather low fees, stakers only get a return of about 1.4%.
Despite that, about 30% of the entire supply is being stacked and has an unlock period of 21 days, meaning that there is plenty of LUNA that couldn't instantly be sold if the price grows explosively, which is good for continued growth.
LUNA has a max supply of 1 billion tokens, but the token is deflationary. The more stablecoins are minted, the lower the supply of LUNA becomes, resulting in a higher value for LUNA tokens. However, should the demand for stablecoins fall, people could redeem them for LUNA, and their value would fall with the increased supply.
Right now, there is a growing demand for stablecoins, and since centralized versions are being targeted by regulators and are usually not very transparent with their holdings, there is a great demand for decentralized solutions.
Terra is already well-established and very popular, so it is likely that there will be a huge demand for LUNA to create stablecoins. The LUNA coin could grow a lot in value in the coming years due to its deflationary nature during high demand.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
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