Terra (LUNA) isn’t a stablecoin, but is the key to keeping Terra’s various stablecoins such as UST, pegged.
Terra is a protocol that allows the creation of algorithmic stablecoins.
The native cryptocurrency of the Terra network is called LUNA, acting as a utility and governance token to facilitate the entire network.
It supports Terra's suite of stablecoins, as well as all decentralised apps (dApps) such as the various payment processing systems.
This section of our Terra (LUNA) guide answers questions around whether Terra (LUNA) is a stablecoin itself and explores how it works.
Types of stablecoins
Before we talk about LUNA and the various stablecoins found on the Terra network, let’s first discuss the different types of stablecoins.
While the concept of stablecoins being cryptocurrencies that are pegged to the market value of an external market like the USD is fairly straightforward, did you know that not all stablecoins are created the same way?
There are actually two different types of stablecoins:
- Off-chain collateralised stablecoins: An example being Tether (USDT) which is (we hope) backed by actual USD reserves held in escrow.
- Algorithmic stablecoins: Such as the Terra stablecoins that use pooled LUNA tokens controlled by smart contracts, to maintain the pegged price.
Do you see how we used the words ’we hope’ when talking about off-chain collateralised stablecoins?
When it comes to the world of finance, a good rule of thumb to live by is to never have to hope or trust the word of a third party.
Human beings are inherently pieces of shit who will screw you over if they get a chance.
The fact that algorithmic stablecoins such as those found on the Terra network require the execution of a piece of code instead of hope or trust will always be the more favourable option.
Stablecoins on the Terra network
Before we jump into how the LUNA token is used to maintain a stablecoin’s peg, let’s first take a look at the various stablecoins found on the Terra network.
At the moment, stablecoins on the Terra network include:
- TerraUSD
- TerraEUR
- TerraCNY
- TerraJPY
- TerraGBP
- TerraKRW
As you can see, the Terra network allows for so much more than just a simple USD peg such as what you see with Tether.
Essentially this model of algorithmic stablecoins allows a peg to be maintained with any global currency, commodity or even things like stock prices.
All technically outside of the reach of a country’s regulator because no physical assets have to be bought or held for the peg to be maintained.
LUNA - The algorithmic stablecoin
But heading back to the LUNA token, no it’s not a stablecoin itself.
The LUNA token is actually the Terra network’s way of keeping the above listed algorithmically pegged stablecoins priced as they should.
This is achieved by incentivising trading between LUNA and stablecoins whenever supply/demand causes the price of the stablecoin to fluctuate away from the peg’s true fiat value.
Let’s run a quick example of how the LUNA token is used to maintain the peg of TerraUSD (UST) to $1.00 USD.
If the price of UST rises above the $1 level, then the algorithm would burn LUNA to mint more UST and therefore reduce the price.
If on the other hand, the price of UST goes below the $1 level, then the algorithm would instead swap UST back to LUNA and increase the price back to the peg.
To facilitate this process, LUNA investors can stake their tokens into a pool and are rewarded for absorbing the volatility within the various stablecoins.
The LUNA token actually has an elastic circulating supply that fluctuates according to the needs of the collateralisation mechanism described above.
With a max total supply of just under a whopping one billion LUNA coins, Terra is therefore able to manage its stablecoin monetary policy appropriately.
LUNA isn’t a stablecoin, but is the key to keeping Terra’s various stablecoins such as UST, pegged.
Best of probabilities to you.
Direct from the desk of Dane Williams.
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