Terra Overview

Terra, a blockchain built using the Cosmos SDK, was founded in 2018 by Daniel Shin and Do Kwon. It was built by TerraForm labs, a for profit company in South Korea. It has raised 100s of millions of dollars in VC funding. Terra can handle around 5,000 transactions per second.

The most popular stablecoin on Terra is UST, but it also hosts over a dozen algorithmic stablecoins pegged to other Fiat currencies.

These algorithmic stablecoins are not backed by assets. Instead they maintain their peg via a mint and burn mechanism between LUNA, (the native coin of the blockchain used for staking, governance and transaction fees. It’s the seventh largest cryptocurrency as of March 2022) and UST, an algorithmic stablecoin. As of writing, it is the largest algorithmic stablecoin by market cap. UST is a multi chain stablecoin but most of it is on Terra, with around half of it being locked in the Anchor Protocol alone.

UST peg maintenance mechanism

To maintain equilibrium, Terra mints and burns tokens while also incentivizing arbitrage, meaning you must mint UST by paying the market rate in LUNA. The protocol then burns LUNA, constricting the supply and slightly appreciating the value of LUNA. The same works in reverse: to mint LUNA, you'll convert UST. Those get burned and the price of UST goes up ever so slightly.

Arbitrageurs help maintain price equilibrium for UST by selling LUNA for UST when the price of UST is below $1 and buying LUNA when UST is worth more than $1. If, for example, UST slips to $0.95, traders can then buy a bunch at that price but sell it for $1 of LUNA. In doing so, UST supply is reduced and, therefore, the price theoretically should increase.

Community spirit is paramount to the success of UST as well. Interest from arbitrageurs is required for UST to continue to be successful (maintain its peg).

What is Anchor Protocol?

Anchor Protocol is a decentralized lending protocol on Terra. It was also built by Terraform labs and it was launched in Q1 2021. It is the largest Dapp on Terra by TVL (Over $15bn at the time of writing). Anchor has experienced incredible growth since its launch because it offers a stable annual interest rate of approximately 20% p.a (this promised interest rate is known as the ‘Anchor rate’.) on the UST stablecoin. This rate is fixed and can only be changed via a governance vote by holders of Anchor’s native token, ANC.

How it works

Borrowers on Anchor protocol deposit staked ETH (via deposits into LIDO and bridged over to Terra) and staked LUNA (via deposits in Anchor) to borrow UST. The staking rewards on these interest bearing tokens are forfeited by borrowers and earned by the Anchor protocol. The protocol also earns the fees levied on the borrowers however they are rewarded with ANC tokens.

Staking rewards on Terra are ~9% p.a. and ~5% on Ethereum’s Beacon chain. As of writing, $6.2bn deposited by borrowers. Around $3bn is borrowed against this collateral at ~13%. That equates to around $9.2bn of interest bearing assets on the protocol. For simplicity’s sake, if we take the interest on this amount to be ~10%. This equates to ~$920m.

~$920m is enough to pay ~20% interest on deposits of $4.6bn in UST. Any additional income is placed into the yield reserve which consists of UST and this is used to pay out to depositors when the Anchor protocol isn’t making enough fees to cover the Anchor rate.

Risk Observations

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