The Terra Triforce: Rise of the Lunatics

Blockchains and stablecoins share one critical weakness: they are useless without adoption.

 Most ecosystems take the approach of “build it and they will come.” That is to say; if the tech stack is good enough, projects will want to use them or at the very least port over from their main chain (e.g. Sushiswap launches on BSC, FTM, xDai, etc…). Other chains, like Polygon, take a different approach to adoption by offering highly dilutionary coins (MATIC) to attract high-yield thrill-seekers and thus bootstrap liquidity and chain usage. 

In all cases, a native stablecoin is the glue that holds the system together. Crypto users increasingly want the safety of a stable asset when on-ramping to a new chain rather than be exposed to the underlying volatility of the ecosystem’s native token. For example, no one wants to be required to hold AVAX, FTM, MATIC,, etc., to experiment with a new chain.  This is why USDC, USDT, and DAI are some of the first coins to be listed on a new chain. As centralized (USDC, USDT) and mostly centralized (DAI, which is exposed to USDC) entities, their exposure to regulatory risk cannot be understated; however, they are the most liquid and trusted* stablecoins and thus are the first to supply stability to new chains.

*Note: “Trust” in this case refers to a stablecoin’s ability to maintain their peg and be redeemed for their underlying pegged value, which frankly, these stables excel at, in part due to their centralization. Whether we should trust these external entities is a whole different conversation.

Enter Terra

While very much focusing on the quality of their blockchain, Terra took a unique approach to bootstrapping their ecosystem by doing three things:

  1. They created their own stablecoin, which uses a dual-token elastic supply mechanism: UST and Luna.
  2. They launched two homegrown projects, Mirror (synthetic stocks) and Anchor (makes UST yield-bearing), to create an immediate use-case and demand for their stablecoin.
  3. They created off-chain demand for UST by establishing a deep network of real-world usage from online and offline merchants in Korea (used by 5% of the population) and Mongolia (used by 3% of the population) with Chai and Memepay.

The Triforce of Terra

Each part plays a pivotal role in expanding the reach of UST and reinforcing the feedback loops that create deeper liquidity and value within the ecosystem. We will call these feedback loops “flywheels”, which is just another word for circular incentive structures that connect each part of the system and feed each other in an endless loop. Here’s an example of the Axie Infinity flywheel.

The rest of this paper will go over each section as follows:

  1. What is the Terra blockchain?
  2. Protocol flywheels: How do Luna and TerraStables work?
  3. On-chain flywheels: What is Anchor? What is Mirror?
  4. Off-chain flywheels: What are Chai and Memepay?
  5. Other complementary protocols
  6. What is the future of Terra? What is Columbus-5 and how does it change the rules of the game? 
  7. Conclusion and Opinion

What is the Terra Blockchain?

Pictured: timeline of the Terra ecosystem

Creation

Terra is a blockchain project that was launched in January 2018, with the mainnet launching in the following year in April 2019. Terra is the first project developed by the South Korean-based firm Terraform Labs, co-founded by Do Kwon and Daniel Shin.

Terra completed a seed round in 2018 for $32M, led by esteemed funds such as Polychain Capital, FBG Capital, Hashed, 1kx, Kenetic Capital, Arrington XRP Capital, and most unusually, four of the six leading exchanges at the time; Binance Labs, OKEx, Huobi Capital and Upbit’s investment arm. They raised another $25M fundraising round in the beginning of 2021, backed by Galaxy Digital, Pantera Capital, Coinbase Ventures, as well as returning investors Arrington XRP, Hashed, and Kenetic Capital. Most recently on July 16th, 2021, Terraform Labs completed a $150M raise from firms including Arrington XRP Capital, Pantera Capital, Galaxy Digital and BlockTower Capital. The $150M is earmarked for Terra’s “Ecosystem Fund”, which will be used to sponsor projects built on the Terra blockchain.

Intent

The development of the Terra blockchain is guided by a singular, driving goal: 

What can crypto do for people in the real world?

The crypto-space can often be myopically focused on its own developments on-chain. Partnerships, raises, launches, upgrades, mainnets, etc… By contrast, a huge portion of Terra’s success comes from off-chain sources such as merchant-focused apps like Chai (used by 5% of the population in Korea) and Memepay(used by 2% of the population in Mongolia). A key decision they made is to hide the inner workings of the blockchain and create user-friendly front-facing apps. In contrast to how payment apps typically focus heavily on the customer, Terra (through the Chai app) expanded extremely quickly into the Korean market by focusing specifically on merchant incentives, which we will dive into in a later section.

Pictured above: User-friendly app design of the Chai App

Tech Specs


“Terra is an application-specific proof-of-stake blockchain using Tendermint consensus that’s built on the Cosmos SDK.”
Terraform Labs

Why Tendermint? Well, Bitcoin’s consensus mechanism requires very resource-intensive hardware and power consumption to quickly process transactions through PoW (Proof-of-Work), which over time has developed issues of scalability and speed. 

Tendermint aims to rectify this by building consensus through a large number of distributed nodes without resorting to PoW but instead using PoS (Proof-of-Stake). Their primary goal is to focus on speed, security, and blockchain scalability with a focus on cross-chain technology.

  Here is a brief overview of the features Terra Core, built on Tendermint, provides:

  1. Developers can write smart contracts in their programming language and development environment of choice.
  1. The Tendermint BFT (Byzantine Fault Tolerance) can still secure and replicate an application on many machines even if ⅓ of them fail arbitrarily or maliciously. However note that this is comparatively low tolerance when compared to Bitcoin, which fails at the 50% threshold.
  1. If a third of the validators are malicious, the blockchain will merely pause temporarily until consensus is met instead of forking the network.
  1. Blocks and transactions are shared across nodes.
  1. Can run on multiple chains as it is connected by the Cosmos IBC (Inter Blockchain Communication)

Keep in mind that some of the risks of DPoS (delegated proof-of-stake) inherently make Terra Core susceptible to some key risk factors:

  1. Node centralization.

    DPoS consensus mechanisms typically rely on a small number of delegates to secure the network and put the network’s interest first. This can create issues of centralization if there are too few delegators entrusted with securing the entire network, as 51% control of the delegates would be enough to control the entire network.


For Terra, there currently are only 130 validators, with a predetermined schedule increasing that amount to 300 over time. 

At the time of this snapshot, the top 10 validators own 42% of the voting power.

Pictured left: top validators’ voting power and % control from terra.stake.id 

As you may notice from the breakdown above, the top 4 validators also own a proportionally larger percentage of the voting power than the rest of the top 10. We can see that visually on the graph below.

Pictured: current validator ranking by voting power, data pulled from flipsidecrypto.com, using SQL code from 0XFRANK’s Terra dashboard

What are the measures being taken to battle this problem?

  1. Do Kwon has indicated that future airdrops would be targeted to validators who have fewer delegates (note: users who want to stake Luna but don’t or can’t run their own validator stake their Luna with validators and are called delegates, or delegators).
  1. The Terra Delegation Program was launched to encourage the decentralization of delegators to smaller validators. Some of the requirements included having less than 1.5mil in delegations, running a testnet validator, maintaining threshold uptime (≥99%) oracle votes (≤20% missed), governance participation (≥90% in last 10 polls), and a minimum of 3-month run-time. The total amount (50 million $LUNA) earmarked for this program from the Terra Foundation was redelegated and dispersed equally amongst the 43 remaining qualifying participants.

When we compare Terra to other blockchains, we can see that it has a relatively low validator account compared to other staking chains.

Pictured: number of validators per chain, data sourced from @shegenerates

Note: Cardano has >1200 validators who have never produced a block.


Note 2: Ethereum is an extremely decentralized network, but a validator is measured by 32 ETH deposits, not unique individuals. In fact, according to current data from nansen.ai, there are 202,000 validators as of 8/1/2021, with 40,500 unique depositors. From the breakdown of depositors pictured below, we can see that 8 entities control almost half of the staking power.

Pictured: 8/1/2021 breakdown of depositors in Eth2 staking. Data from nansen.ai, h/t to @larry0x 

As Terra continues to develop and expand, it remains to be seen if they reduce their dependence on large validators, but they are working to rectify this with airdrops for Luna stakers delegating to smaller validators and the successful launch of the Terra Validator Program, which re-delegates Luna to smaller validators who meet strict requirements of uptime and voting.

Protocol Flywheels: How do Luna and TerraStables work?

The Terra ecosystem operates under a two-token design:

1. Luna, the governance, staking, and validating token

2. UST, their native dollar-pegged stablecoin*

*Note: there are other TerraStables like TerraKRW, TerraMNT, TerraSDR, but UST is the largest by far so we will only discuss UST in depth.

Why two tokens and not just Luna and some other custodial stablecoin? Terra strongly believes in the crypto ethos of decentralization and censorship resistance, and more specifically believes that stablecoins are the pillar of the DeFi stack. 

By design, custodial stablecoins cannot serve these goals. As stable as Circle’s USDC and Bitfinex’s Tether are, they are forever at the mercy of how the government chooses to regulate stablecoins in the future. As recently as July 19th, Yellen demanded that regulators draw up a framework surrounding stablecoins as soon as possible. Custodial stables are also susceptible to censorship. Circle can freeze USDC at the request of law enforcement, which can create severe tail risk for individuals, businesses, funds, and ecosystems that heavily rely on USDC.

Enter UST, an algorithmically pegged stablecoin. But before we dive into the mechanics of UST we need to first understand Luna, which plays a crucial role in both the Terra ecosystem and in maintaining the peg of UST itself.

Luna 

Luna is the Terra ecosystem’s governance, staking, and validating token. As a proof-of-stake blockchain, Terra Core needs validators to stake Luna to secure the system. An additional benefit that validators provide is absorbing volatility, which we will discuss in the UST section. As a reward for doing the protocol for this service and taking volatility risk, they receive staking APR% rewards from fees on gas, taxes, and seigniorage. 

Gas fees are applied to every transaction to stop transaction spamming.

Stability taxes are applied to every mint and burn transaction. There is a “Tobin tax” for spot-converting Terra – Terra swaps set at 0.35%. There is also a minimum spread tax, set at 0.5% for Terra – Luna swaps.

Seigniorage is the value of the currency minus the cost it takes to produce it eg. $1 dollar bill minus printing costs, or $1 TerraUST minus minting costs (zero). Currently, seigniorage profits are distributed weekly to the community pool that funds initiatives in the Terra ecosystem, and the rest goes to a reward pool for Luna stakers. The rewards for stakers are then released over a period of a year to encourage long-term dedication. 

Seigniorage is extremely important and occurs when Luna is burned. This happens when the demand for UST increases, e.g. people buy stablecoins on Terra. A portion of burned Luna goes to the Treasury to fund further initiatives, and the rest goes to stakers. This also has the effect of making mining/validator power more valuable and scarce, as it becomes more expensive to become a validator the more Luna is burned.

Stakers come in the form of validators, which we’ve discussed previously, and delegators. A delegator can be anyone who holds Luna (including you!) and wants to take part in securing Terra. To do so, they choose 1 of 130 validators to delegate their Luna to. In return they will receive a portion of the staking rewards from gas, taxes, and seigniorage, and also airdrops from certain protocols like Mirror (and many more protocols to come) on a weekly basis. Individuals who delegate and validate have to bond Luna, which can no longer be traded until it is unbonded. When it is unbonded, it will no longer accrue rewards and can’t be traded right away, instead, it is locked for 21 days. This ensures that large supply unlocks cannot be immediately dumped into circulation and destabilize the system, as well as encourage long-term thinking from delegators and validators who are securing the Terra network. A win-win for all sides!

UST

One can’t talk about Luna without also mentioning its homegrown stablecoins, of which the Terra Dollar, UST, is the largest. 

As mentioned previously, stablecoins are integral for chain adoption. As users onboard into a new system, they typically prefer a stable asset to eliminate exposure to what are typically volatile native assets like SOL (Solana), MATIC (Polygon), FTM (Fantom), Luna (Terra), and even ETH (Ethereum).

First, let’s briefly go over the types of stablecoins and what makes UST different.

There are primarily three kinds of stablecoins:

Custodial – USDC, Tether, GUSD, BUSD, TUSD

Over-collateralized Debt – Dai, sUSD, LUSD, alUSD
Algorithmic – Ampleforth (AMPL), Fei, Frax, TerraUSD (UST)

Custodial stablecoins are simply backed 1:1 by a centralized entity. For every 1 USDC, Circle holds the equivalent in dollars, and so on with every other coin on the list. The tokens themselves are essentially tokenized IOUs, which are redeemable at the point of origin. This makes it easy to hold a peg. For example, if the price of USDC dips down 5% to 0.95, you immediately have a guarantee of turning that 1 USDC worth 0.95 for its full value of $1, because it’s sitting in Circle’s reserves. This creates a high level of trust in the peg and allows efficient and tight arbitrage to occur around the $1 mark. The risk of course is censorship and trust in Circle to actually hold the equivalent in dollars to back the peg.

Pictured: Arbitrage behavior around USDC, a custodial stablecoin

Over-collateralized debt stablecoins are similar to custodial coins in that they are backed by a currency, but in the case of crypto are often overcollateralized by a highly volatile asset like Ethereum, Synthetix, and so on. For example, Dai is backed by Ethereum (and USDC more recently to create more stability), but to protect the stability of the peg, users who wish to mint Dai have to collateralize Eth in one and a half times the amount of Dai they wish to receive and lock it in a CDP (Collateralized Debt Position). This acts as a loan on their Eth so that they do not have to sell it, and in turn receive a percentage of the amount back in Dai, which is now backed by their Eth. In other words, you have to supply $150 worth of Eth for every $100 you receive. This is called a collateralization ratio and it is set by the MakerDao protocol at 150%. However because CDPs are a loan, if the underlying Eth value falls too fast, it can and will liquidate all of your Eth to pay it back. 

Algorithmic stablecoins have a wide array of mechanisms to retain their peg ranging from bond purchases to partial collateralization to programmatic contraction and expansion or even a combination of all of these. The risk of these coins often involves a lack of incentive to maintain the peg, because once algorithmic stables veer off $1 and don’t immediately snap back, trust in the protocol’s ability to regain the peg is broken, and often the selling pressure from that disillusionment creates a death spiral to zero. 

So what makes Luna so dependent on UST and vice versa? Let’s introduce the minting and burning mechanisms involved between UST and Luna. 

UST is an algorithmically pegged stablecoin that uses a mint-and-burn mechanism with Luna and UST as its levers. This enables the protocol to expand and contract the supply to maintain the peg of UST. The peg is entirely maintained by arbitrageurs.

Let us consider two scenarios:

  1. The price of UST deviates from the peg by 5%, to $0.95. This requires the protocol to contract the supply of UST to maintain the $1 peg. To make this opportunity valuable to arbitrageurs, the protocol will let you mint $1 worth of Luna with your purchased UST even though the price of UST is $0.95. This allows the arbitrageur to immediately pocket $0.05 per UST dollar purchased. This grows the supply of Luna because arbitrageurs are minting extra Luna from the protocol, and contracts the supply of UST because they are turning it in to mint that Luna, which eventually restores the peg. 

Think of this mechanism as a free 5% discount on Luna when UST goes below $1.

  1. The price of UST deviates from the peg by 5%, to $1.05. This requires the protocol to expand the supply of UST to maintain the $1 peg. To make this opportunity valuable to arbitrageurs, the protocol will let you mint $1 worth of UST for Luna to turn in and burn even though the price of UST is $1.05. This allows the arbitrageur to immediately pocket the $0.05 difference when they turn around and sell that newly-minted UST back to the market. This grows the supply of UST because arbitrageurs are continually minting discounted UST from the protocol, and contracts the supply of Luna because they are turning it in to mint UST, and this constant pressure will eventually restore the peg.

Think of this mechanism as a free 5% discount on the price of UST when UST goes above $1.

Pictured: Arbitrage behavior around Luna and UST, a custodial stablecoin

If you recall our example in custodial stablecoins, this is in fact very similar to how you claim your USDC from Circle, except that instead of claiming a backed stable asset by turning in the tokenized version that has lost its peg, you are minting a volatile asset, Luna, against an unbacked asset, UST, and claiming the difference as an arbitrage. By arbitraging this difference you are helping UST to maintain its peg by burning the asset you are turning in and are rewarded by the free discount on the asset you receive.

Okay, back up! You might be thinking that it makes sense to arbitrage USDC because it is guaranteed and backed by Circle, and the US dollars you receive in exchange for USDC are actually stable. A US dollar is always worth a dollar (…psst, inflation! never mind…). This is definitely not true of the relationship between Luna and UST.

What could possibly compel anyone to arbitrage unbacked UST with highly volatile Luna, especially to the level where UST needs to maintain its peg? Surely it would inevitably spiral to oblivion because Luna would be sold to the ground and there would no longer be an incentive to buy the off-peg UST? UST is not backed by anything, so it should go to zero, and take Luna with it.

Well, UST is backed…sort of. Not by dollars or crypto, but by the growth of the Terra ecosystem itself. How does one profit from the growth of an ecosystem? Adoption! Earlier, we said that the most important thing for a stablecoin and a blockchain is to be used. So let’s recap what happens when UST is used and adopted.

We just covered that when the price UST goes above peg, or greater than $1, UST needs to be minted to drown the market in new Terra dollars and restore it to peg. To do so, you have to turn in your Lunas, which are burned. This reduces the supply of Luna, puts upward pressure on its price, and thus makes mining and staking that much more scarce. How does this relate to growth? Well, as UST is adopted and the protocol burns Luna, it continues to make Luna more valuable over time. Because Luna is used as a tool of arbitrage to keep the peg of UST, it needs to have value outside of it just being a token, otherwise, it would get sold to zero and nobody would voluntarily keep the UST peg. 

Burning Luna helps give it more value, but remember that the primary source of income for Luna is the usage of the network itself. Staking delegates and validators are paid in fees, taxes, and seigniorage, so this helps drive value back into Luna and make it essentially a call option on the growth of the Terra Ecosystem and therefore UST adoption.

UST is “backed” by the adoption of UST and usage of the network.

While adoption is very important, one might ask if UST is actually a “stable” coin or just a coin that tries to be stable.

It is in fact very stable a large percentage of the time, but that doesn’t matter if it can lose its peg for even a day. By definition, a stablecoin must retain its peg, and algorithmic coins, in particular, can exhibit extremely reflexive behavior. Once the trust in the protocol is broken, a death spiral can happen in mere hours.

So what happened with UST in the days between 5/19 and 5/23? If you are familiar with UST, you’ll know that UST did in fact lose its peg for two consecutive days as pictured below.

While it was only 2 days actually off-peg, and in general UST has only been below $0.95 on 2.1% of recorded days it has been trading, it is worrisome. This also occurred when the rest of the market was “halvening” in value, with drawdowns of 50%-80% across the board. But none of that is reassuring when a stablecoin that is supposed to be a safe haven in the face of a black swan event fails to be the very thing it calls itself.

How did UST lose the peg?

UST did lose its peg, but not because the underlying mechanics broke under stress as most people assumed, but because oracle feeds stopped providing price data on Luna. One of the responsibilities of a validator is as an oracle service. Validators supply accurate price data through on-chain transactions through a public node. 

What happened is that Anchor Protocol, Terra’s lending and borrowing platform, was undergoing enormous stress due to crypto-wide volatility. Users submitted 2.58 million requests in 30 minutes and Anchor’s nodes became overloaded. Luna’s sell-off triggered over 4000 liquidations, and the result was the network became overwhelmed and transactions were no longer being accepted by the nodes, which are the very same nodes validators were using to supply price data on Luna. 

The oracle feeds going down caused the Terra protocol to automatically freeze the Luna <> UST swap market and thus arbitrageurs were unable to complete their essential task of bringing UST back to $1.

Sentiment + Tweet Vol

Here is a brief overview of the sentiment and tweet volumes of Luna and UST against their competitors:

Pictured: Tweet volume of competing ecosystems since 7/4

Tweet volume for Luna has recently overtaken its competing ecosystems at just over 2000 tweets/day. 

Pictured: 30d avg of daily sentiment of competing ecosystems since 4/1

The 30-day average of daily sentiment for Luna has climbed above 50 and is in the lead against its competitors for the first time as of 4/1.

Pictured: Tweet volume of top 5 stablecoins since 7/4

In the last month since the treasury talks on stablecoin regulation, tweets for UST rank second out of the top five stablecoins.

On-chain flywheels: What is Anchor? What is Mirror?

We have established that in order for Terra to grow it needs greater adoption for UST, which in turn strengthens its peg by making Luna more valuable. Luna also becomes more valuable by greater network usage. This is the protocol flywheel in full effect. UST powers Luna which powers UST and so on.

However, stablecoin adoption is one of the most difficult areas to succeed at. A good protocol design isn’t enough to keep a stablecoin pegged. A stablecoin requires a huge network effect to be successful, which means adoption in as many apps and blockchains as possible. This requires strong partnerships and integrations with apps to facilitate usage. 

Terra adopted a unique approach to bootstrapping UST demand and network growth. Instead of waiting around for projects to build on Terra and drive adoption organically, Terraform Labs chose to bootstrap the ecosystem by launching two native apps, Anchor and Mirror.

Anchor and Mirror are the on-chain flywheels funded and launched by Terraform labs to bootstrap demand for UST.

Anchor Protocol

Anchor is a fixed APY savings product and is arguably the single most important protocol in the Terra ecosystem. It offers 20% fixed (not variable!) APY on cash deposits, which are some of the highest rates for stablecoins around. Compare this to the average interest rate of 0.03% (!) in the United States of dollars held in your bank account. This fixed-rate offering is the single largest driver of UST adoption as it’s used as both an advertising tool and lynchpin for its off-chain offerings.

People typically scoff at 20% APY for stables and assume it functions like a ponzi, i.e. new depositors pay out old ones. But where do these yields come from?

Anchor functions just like a bank. When you deposit money in a bank you’re actually loaning out your money to someone else, the bank captures the borrow interest rate, and pays out the meager lending rates back to you. A legacy bank is essentially a borrowing and lending platform that pockets the gains instead of giving them back to you.

Anchor derives its yield from yield-generating assets. As of this writing, Luna and Eth are two of the collaterals accepted for deposit. With these assets, you may borrow up to 50% of your collateral to mint UST, which you can then use in any way you choose. You can sell it for another asset, bridge it to another chain to farm with, and even deposit it back in Anchor for a 20% yield. For example, you can deposit $1000 worth of Luna, mint $500 UST, bridge it to Solana using the Wormhole, and deposit UST in the Mercurial platform to farm yields at 27.74%.*

*Note: rates are as of this writing and are variable

What Anchor does is use your yield generating deposits, and instead of pocketing the yield or giving the yield back to you, it actually pays that yield forward to depositors of UST. This is how UST depositors get their 20% fixed rate APY. 

Anchor has baked in additional incentives in order to generate a constant flow of Luna and Eth depositors into the protocol. 

Borrowers get paid.

Current APR % paid to UST borrowers as of 8/3/21 

Yes, paid. Anchor has a governance token, ANC, which is used in a liquidity mining program to pay borrowers APR% over time. These rates are constantly fluctuating based on borrowing demand, and have been as high as 400% in the early stages of the protocol. The ANC token itself can be used for both single-sided staking and the ANC-UST LP pool to generate additional yield.

Here’s what this flywheel looks like in the graph below:

Risks

A key risk in the Anchor Protocol is when the deposited collateral cannot yield enough APR to pay UST lenders. For example, if the yield of staked Luna is only 8% and you multiply it by 2 because the collateralization ratio of Anchor is 200%, that only creates 16% worth of yield. This is 4% shy of the 20% promised to UST lenders.

In order to make up the difference, Anchor Protocol has a treasury that is used to pay the difference. In the good times, any extra Luna yield over 20% is used to top up the treasury. However, when the Luna yield market is depressed (typically during violent crypto crashes and bear markets), the treasury is constantly being drained to pay UST depositors. As crypto traders and investors flee to stablecoins like UST and seek safe yield, more and more users deposit UST and this drains the treasury faster. ANC borrower rewards go up to compensate (>200% in the May crash), but this often can’t attract enough capital to rectify the imbalance.

Users became increasingly worried after 5/20 that the yield reserve would run dry, and so TerraForm Labs injected $70mil from its Stability Reserve fund to continue paying the fixed APY. Additional levers like increased LTV to 65%, diversification of yield sources, and additional depositing assets such as SOL, ATOM, and DOT are measures being adopted to alleviate the drain on yield reserves. According to the proposal, this injection of funds is expected to support a 20% APY of $500 million worth of deposits for 1.5 years.

As the owner of over 22% of the supply of UST, Anchor is expected to be heavily supported by TerraForm Labs until they are a self-sustaining system. This is essential for long-term growth as it is not just on-chain protocols that rely on Anchor’s yield, but off-chain projects like Chai and Memepay.


Pictured: TVL share of major Terra protocols as of 8/3/21

Anchor is the glue that holds everything together, and thus may be too big to fail.

Mirror Finance

Mirror Finance is the other largest owner of TVL in the Terra ecosystem. Launched in December of 2020, Mirror is a protocol that creates synthetic assets called mAssets (mirrored assets) which “mirror” the price of their off-chain counterpart. Eg. mTSLA will track the price of Tesla. The currently listed assets on Mirror are mQQQ, mAAPL, mBABA, mTSLA, mNFLX, mUSO, mAMZN, mVIXY, mGOOGL, mTWTR, mMSFT, mSLV, and mIAU. Users can mint mAssets, swap, provide liquidity and enter “Long” and “Short” farms.

The protocol also has its own native token called Mirror Token (MIR). This is used to reward users who provide liquidity to pools, and it can also be staked to earn governance votes as well as earn a percentage of the protocols’ CDP withdrawal fees.

Just like Dai, users commit their UST, aUST (yielding UST from depositing on Anchor), or mAssets to enter into a Collateralized Debt Position (CDP). This allows users to mint mAssets. Minters have to maintain their CDP collateral ratio and can adjust as needed.

Long and Short farms are new as of Mirror V2. Just like they sound, they take up directional positions on the asset in question but let you earn APR in MIR for doing so. 

A short farm borrows the mAsset for you and sells it on the market for UST, and you must repay that amount in UST back (to purchase and return the borrowed mAsset) when you are done.* 

A song farm is basically just an LP pool where you must provide the mAsset and equivalent in UST to earn MIR rewards and pool rewards. 

*Hot tip: you can buy the equivalent amount of mAsset in spot holdings through the swap interface to make your Short Farm delta neutral. This can be done in addition to earning 20% APY from Anchor because Mirror lets you use aUST as collateral! This way if the mAsset you shorted goes up you hold the equivalent in the underlying which allows you to repay your short.

Pictured: the short farm interface on Mirror protocol for mAMC

mAssets on Mirror trade 24/7, meaning you can trade synthetic stocks on the platform outside of market hours. This can often offer interesting trade opportunities when the oracle price and market price diverge.

Part of the unexpected and organic growth in Mirror comes from Thailand, which is its biggest market.

The success of Mirror is due to its interoperability in the DeFi system. mAssets are easily moved and redeemable, eg. You can trade them on Ethereum’s Uniswap or Binance Chain’s Pancakeswap. Contrast this to Synthetix where synthetic assets are backed by an extremely high 600% collateralization ratio (which eats into an investor’s capital efficiency) and can only be used in a closed-circuit system like the Kwenta exchange.

Demand for synthetic assets drives demand back to UST, and just like Anchor, bootstraps the Terra ecosystem and provides value for Luna and UST.

Off-chain flywheels: What is Chai and Memepay?

The problem with having everything on-chain, and especially with UST being paired against a volatile currency like Luna, is it becomes susceptible to the ebbs and flows of the overall market. If the market takes a nose-dive, so do yields, and investors’ appetite for borrowing diminishes, which puts the 20% APY flywheel from Anchor in jeopardy. Investors then sell Luna to protect their portfolio’s value which weakens the lever that keeps the UST peg and you can quickly see how the flywheel reverses and goes the other way and has the potential to create a death spiral. 

To remedy this, TerraForm Labs needed to create demand for its stablecoins from somewhere other than the blockchain and crypto-centric world. 


Chai and Memepay are the off-chain flywheels that supply organic demand for Terra’s homegrown stablecoins like TerraUSD and TerraKRW.

Chai

Funded by TerraForm Labs and launched on June 13, 2019, Chai App is Terra’s premier payment network built on the Terra blockchain. Chai app has one singular purpose: be the go-to payment app for merchants in Korea. While most payment apps target the customer, Chai made significant efforts to prioritize merchants. 

The reason they did this is that in Asia there is a lot of friction surrounding settlement times for merchants. Transactions fees can be as high as 2.7% per transaction and settlement times can take days for the merchant to receive the money in their account. This doesn’t work when working capital is tight and needs to be used the same or the next day. Cab drivers will often refuse cards and only accept cash because they need to use it right away.

Chai alleviates this by streamlining settlement time using the Terra blockchain (which is near-instant) and cutting fees to 1.3%. Merchants are able to easily integrate Chai into their POS terminal with a Stripe-like SDK checkout service. There are currently over 1700 merchants in Korea that have integrated Chai.

Pictured: Chai App continues to add to their total users at a steady pace, averaging just over 50,000 users per day with 2.47M total users. Data sourced from https://www.chaiscan.com/

Chai App continues to add to their total users at a steady pace, averaging just over 50,000 users per day with 2.47M total users, and processes more than $2 billion in yearly transaction volume. For context, the total number of users on the Chai app equates to about 5% of the Korean population. 

For the end-user, Chai also offers features called “boosts”, which are essentially different kinds of promotions that merchants pay to be featured on the app. A customer can easily find deals at the vendors they’re interested in and click in to use them. As of May 10, 2021, Korean users no longer need a bank account to top up their $KRT deposits after Chai integrated the Terra Station Mobile network.*

Note: watch a video of a user converting $UST to $KRT here 

Pictured: “Choose up to 80% discount every day” – Chai card offering “boosts” to card users.

To bring back our flywheel, here’s what happens when a Chai card user in Korea buys a stablecoin.

  1. $1 worth of KRT (Terra’s stablecoin pegged to the Korean Won) is purchased
  2. $1 of Luna is burned
  3. Luna’s supply contracts and this creates upward price pressure
  4. Higher Luna prices create greater worth and stability to the token, which creates stronger backing for the UST peg

Memepay

A similar app launched in Mongolia in 2019 called MemePay. It functions as both a remittance and payment app like Venmo, for usage online and offline. The app uses MNT (Terra’s stable pegged to the Mongolian Tugrik). Usage of the app is a lot smaller than Chai, with only 3% of the Mongolian population using it, which comes out to roughly 90,000 users.

Pictured: screencap from a youtube video on memePay. A customer pays a cab driver.

Other Notable Apps

  1. Alice app + card will utilize Anchor’s yield to pay out a portion of that dividend to users in a front-facing, user-friendly way.


  2. Orion Money: from their litepaper — 

“Orion Money’s vision is to become a cross-chain stablecoin bank providing seamless and frictionless stablecoin saving, lending, and spending. Within the Orion Money stablecoin bank, we have three main products planned — Orion Saver, Orion Yield and Insurance, and Orion Pay.”


Today you can deposit a large number of stablecoins on the Ethereum network to access Anchor’s yields.

Pictured: interest rates for stablecoin deposits on Orion Money
  1. Pylon Protocol: is a suite of savings and payment DeFi products that build on top of Anchor Protocol to provide services for users. From their documents, “Pylon introduces a new paradigm of incentive alignment between payers and payees, consumers and creators, patrons and artists, investors and entrepreneurs, borrowers and lenders, and many more relationships.”

    Currently live is a fair project launchpad called Pylon Gateway that allows crowdfunding with yields. Users deposit UST into a pool to receive a share of the token’s distribution. The project’s tokens are distributed proportionally to the investor’s stake in the pool. The Pylon protocol’s token “MINE” mimics Luna’s mint/burn role in the UST mechanism by absorbing the value of the project’s launched token on Pylon. Up to 10% of the yields generated by project launches will be used for MINE buybacks.
  1. Loop Finance – First AMM Dex on Terra
  2. Mars Protocol – Terra’s lending and borrowing protocol will issue both collateralized and uncollateralized debt to users. Users can earn protocol fees by staking MARS (akin to Sushi).

As of today, according to @Josephliow somewhere around 50% of all upcoming Terra projects plan to use Anchor’s yield in some manner. 


For a large (but not exhaustive!) list of existing and upcoming projects on Terra, see this post from @FlynnToTheMoon.

What is the future of Terra? What is Columbus-5 and how does it change the rules of the game? 

The Terra ecosystem is growing at an incredible pace. Pictured below are from Anchor Protocol showing the increase in deposits and borrowed UST over time, followed by the value of the Luna collateral locked in the protocol.

TerraUSD (UST) has broken into the top 5 market cap of stablecoins, but the gap is still enormous to reach the big leagues. Nevertheless, it’s an impressive feat to be just under Dai when so many coins have failed, and even more so with it being the only algorithmic coin in the top 9. Do Kwon has indicated his goal for UST is $10bil by end of the year or 5x growth from today.

New chains typically fail at attracting usage, and new stablecoins fail even harder. A huge network effect is required to stabilize a peg and projects need an inventive to move somewhere new. Terra uses protocol, on-chain, and off-chain feedback loops to grow their ecosystem.
Pictured: marketcap rankings of stablecoins from Coingecko

What’s next for Terra? The next biggest update on the horizon is Columbus-5. It makes a few key differences to a lot of the mechanics we just discussed, so let’s highlight some of the important changes in the proposal.

  1. Seigniorage distribution. Currently, the protocol directs all seigniorage to the community fund (which is used for funding projects in the Terra ecosystem), but because UST has grown so fast over the year the pool is currently overfunded. Col-5 will burn all seigniorage.
  2. Swap fees. Currently, all swap fees are burned. In Col-5, swap fees will be distributed to stakers. This should have the effect of increasing rewards for Luna stakers as the ecosystem continues to grow. Remember that this has the benefit of increasing the stability of the UST peg (backed by growth!).
  3. Some technical changes like cosmos-SDK upgrades and Oracle performance optimizations
  4. Terra will include Cosmos’ IBC modules which enable Terra Core to “talk” to all tendermint-based chains. This introduces a new world for Terra to interact with.
  5. Instead of burning the overfunded community pool, the funds will go toward funding Ozone, an insurance protocol to insure the Terra DeFi ecosystem. This will begin with creating insurance for the Anchor Protocol first.

Conclusion and Opinion

Do Kwon has a massive vision for Terra, and they are well-capitalized to fulfill their goals. The three flywheels of the protocol, on-chain, and off-chain level serve to drive demand directly to UST, which makes Luna more valuable by the burning mechanisms involved and thus reflexively strengthens the UST peg. Terra’s vision of cross-chain expansion and partnerships creates additional demand for UST and Terra products and this continues to strengthen the network. 

With Anchor as the lynchpin to the ecosystem, I do believe it may be too big to fail. I have some doubts on the efficacy of ANC liquidity mining to encourage borrowing in perpetuity, but by the time ANC ceases to be useful, it may be that no one needs incentives to borrow from Anchor, and the training wheels come off.

The peg of UST around those ill-fated days in May is concerning, but that it was a technical issue with transaction overloads from Anchor stuffing up the node used for reading oracle prices and not a more fundamental and grievous flaw in the UST peg stabilization mechanics is more comforting to me than not. Shortly after the market turmoil, Anchor did introduce some changes to decrease the amount of liquidating transactions that would clog the network and “squeeze” out oracle votes, and Columbus-5 will offer increased mempool prioritization which should nip this problem in the bud and prevent days like that from happening again. Since then, the peg has not exceeded a 5% deviation.

Increased rewards for stakers in Columbus-5 along with continued UST expansion may be the “zhupercycle” catalyst Luna needs to flywheel itself into an extended growth period.

The following charts from @The_Babylonians show a pathway to reach Dai, and I think it’s not out of the realm of possibility that this occurs within the year, and more. Users hungry for fixed yield in an ecosystem that represents all the ethos of decentralized finance and crypto is a very compelling argument.

Disclosure: I do not currently hold any investments in Luna or the Terra ecosystem.