The DeFi ecosystem that will disrupt Traditional Finance — Terra-Luna

Terra is a decentralized algorithmic fiat-pegged stable coin stablized by its native crypto asset Luna. I believe investing in Luna is similar to owning the equity of an early stage FinTech company where they pay dividends to the shareholders immediately after they have generated revenue.

Why are we here at this moment trading this ecosystem of magic internet money?

For crypto currencies to gain mass adoption, they must be able to perform tasks better than the existing traditional financial infrastructure. One major use case for cryptos are that they could be used for payments, which are faster and cheaper in certain scenarios (i.e. cross-border remittance). Knowing this, some companies (i.e. Expedia) started to accept payments in Bitcoin. While Bitcoin is the gold standard of the crypto world, the issue with this is that it is volatile with respect to fiat currencies, which brings us back to the Pizza moment back in 2010 where 10,000 Bitcoin was used to buy 2 Papa John’s pizzas.

Here comes the question — why would we pay / accept a volatile currency?

Stable coins are here to solve this problem. Price stability is required for both the customer and the merchant to properly transact and hence the stable coin is the most important product in crypto, uniquely serving the currency function of cryptocurrencies.

The $90 bn stable coins market are crowded, with popular ones such as USDT / USDC / BUSD that are fiat-backed (~72.5% of the stable coin market). In DeFi, the vision is to eliminate any single centralized parties within the ecosystem. However, fiat-backed stable coins have fiats stored in centralized banks, which would be a matter of time before it gets heavily regulated. This leads to the design of a decentralized stable coin.

Maker, which produces a decentralized crypto backed stable coin DAI (~3.8% of the stable coin market), seemingly solved the equation — until a black swan event hits in March 2020. The collapse removed over 50% in value from the collaterals in addition to network congestion and spike in gas prices, making DAI undercollateralized in a bear market, breaking the peg against USD, impacting vault owners, keeper and exchanges. Why does the peg fail? In short, users withdraw their collaterals in a bear market, reducing the supply of DAI in the market and resulted in a steep rise in DAI market prices. It is also very capital inefficient when DAI had to be overcollateralized in order to be stable.

Here’s where Terra comes into the picture. Instead of being collateralised by fiat / crypto, Terra is an algorithmic stable coin that differentiated itself from others by maintaining the peg through arbitrage incentives that adjusts supply to market demands, through minting and burning its underlying crypto asset Luna. This is like the current monetary system in Hong Kong, which HKMA buy and sell USD reserves to peg HKD against USD.

For example, if the demand of Terra increases, the peg will trade above 1. This creates an arbitrage opportunity for the traders to burn $1 worth of Luna to mint $1 TerraUSD (UST), so that they could sell UST at >$1 in the market, generating a risk-free profit. This increases the money supply for UST and will eventually stabilize the peg until no arbitrage opportunities exist. This design allows Terra to be one of the most stable coins in the crypto market.

Terra is pegged to different local currencies — i.e. KRT is pegged to KRW, UST to USD, AUT to AUD, HKT to HKD, GBT to GBP, EUR to EUT etc. This flexibility allows it to be adopted in any country with its local currency.

As more Luna will need to be burned to maintain the growing money supply of Terra, buying Luna is a simple bet on the growth of Terra stable coins.

Now that we have a stable coin — what’s next?

While a large portion of the crypto world has been focusing on solving the problems of the blockchain, Terraform Labs (TFL) has a different vision — it is outward looking and focusing on solving the problems in the non-crypto world. They have been building the finance building blocks to disrupt the Traditional Finance industry and bring real adoption from the masses. It has a grand mission — To innovate money, bring crypto and DeFi mainstream and make Terra the most attractive form of money.

It has proven itself from launching Chai for payments, Mirror for investments, Anchor for savings, along with 30+ upcoming DApps built on these 3 money legos such as SparFinance (Decentralized Fund Management) and Alice (Decentralized Neobank). All of these protocols are designed in a way that it is simple to use by minimising the complexities of the crypto world. Their aim is to make it so easy to use such that even the end users wouldn’t know that they are using cryptocurrencies / blockchain to conduct transactions.

With these minimum viable products (MVPs) in place, the opportunities for further growth are endless. There is a lack of universal access to financial services for a large share of the world’s population and inefficient cross-border retail payments, with 1.7 billion people globally who are unbanked or underserved with respect to financial services. DeFi solves this problem.

What about the current financial system — what are we trying to improve upon or replace?

Payments:

Chai, compared with traditional payment methods, is better (5–10% discounts offered), faster (6 seconds settlement compared to 1–2 weeks settlement for the merchant), and cheaper (0.6% transaction fee vs 2% from Visa / Master). This is proven in Korea where Chai has gained 2.5m users (5% of the population) since June 2019.

What differentiates Chai from other crypto protocols are the ability of it to bring non-crypto users onboard. Users do not need to understand crypto in order to use Chai — all they need to do is to deposit KRW and pay the merchant. When a payment is made, Chai will 1) Convert the KRW to KRT (Terra Stable coin that is 1–1 pegged to KRW), 2) Settle transaction through Terra blockchain sand transfer payment to the merchant’s wallet, and 3) Convert KRT back to KRW with minimal slippage for the merchant when they withdraw, all in 6 seconds at ~0.6% transaction fees. Meanwhile, customers would get 5–10% discounts from Terra’s seigniorage — the newly minted money from burning Luna (assuming the growth of Terra stable coins continued to rise). More recently, up to 50% discounts are offered by Korea Netflix if you pay by Chai.

The success of Chai could be replicated in any other countries, especially those with hyperinflation, heavy reliance on the USD, strict capital controls, restrictions to invest and/or less developed banking infrastructures. To list a few examples, Indonesia, India, Vietnam, Thailand and Philippines are all markets with huge potential.

Savings:

Anchor protocol allows the user to deposit Terra stable coins to receive a fixed 18-20% APY savings yield on stable coin deposits without any lock-up period.

Anchor has 2 streams of users at heart:

1) Crypto native users: As a Proof of Stake (PoS) token holder, it provides crypto native users ability to use LUNA and other PoS tokens to borrow stablecoins up to 50% of their collateral’s value. Borrowing can generate additional yield as the borrower gets rewarded with ANC tokens to borrow. This is all possible because the borrower forgoes his staking yield from the collateral that are bonded to Anchor.

2) Mainstream users: On the other end, the lender (the mainstream users who may not even understand blockchain) receives a stable steady fixed rate yield which is powered by the borrowers’ collateral’s staking yield.

The mainstream user doesn’t take any risk on his invested capital since he is just depositing USD and receiving steady return on his capital (in USD) irrespective of whether the market is in an up cycle or down cycle. To expand this to the mainstream users, Anchor plans to integrate the 18-20% fixed savings on its native stable coin TerraUST to FinTech / Banks. It aims to be the Stripe for savings in which any institutions could integrate the Anchor SDK in under 7 lines of code.

This opportunity also extends to crypto native users on centralised exchanges such as Binance, which could offer their customers a 18–20% yield on their stable coins, by swapping USDT or other stable coins through Curve to TerraUST and deposit it into Anchor.

All of these increases the demand of Terra usage and will continue to bring non-crypto users on board, without the need of having them to understand crypto or blockchain. With interest rates from the TradFi at record low / negative territories, it will be a no-brainer for companies and non-crypto users to adopt the protocol for savings.

Investments:

Mirror is an AMM based investment protocol that allows users to trade synthetic assets (mAssets) on the Terra blockchain that track the value of real-world assets such as US equities. The mAssets can be minted by depositing TerraUSD as collateral with a minimal ratio of 150%, as opposed to Synthetix’s 750% collateralization ratio. The Price will be updated every 15 seconds by a decentralized price oracle operated by Band Protocol, as opposed to 3 mins in Synthetix. Furthermore, fees are 1000x-2000x cheaper than Synthetix. This comes with the typical benefits of trading with DeFi — Fractional asset ownership, 24/7 live access, global accessibility, permissionless access (i.e. KYC/AML/non-custodial), transparent fees and no counter party risk.

The underbanked or less privileged minorities from the less developed countries are usually blocked out of traditional ways to invest — due to the complex KYC / AML required from the centralized institutions. However, this protocol could help these users to gain access to the wide range of investment opportunities that are usually only available to the more affluent population.

This is proven by the rise of the unexpected users for Mirror — people from Thailand, China and Indonesia are using it to trade US Equities despite TFL had little to none marketing presence in those countries. With over $2.1 bn TVL in under 5 months since the launch on Dec 3 2020, it is the fastest growing protocol under the Terra Ecosystem.

Bottom Line:

All value from the above protocols accrues to Luna. As more use cases are being built from the Terra-Luna ecosystem, demand for the Terra stable coin will expand exponentially. This means more Luna are required to be burned in order to create the new money supply for Terra to sustain the 1–1 peg against the basket of the fiat currencies. This deflationary pressure for Luna would eventually push the price upwards. As the eco-system grows with a diverse use case for its stable coins, it will be more bear-market resistant and be less correlated to the general crypto market.

Luna is closing the gap between mainstream and decentralized finance. “Revenue” generated from this ecosystem (all transaction fees + seigniorage fees + swap fees + protocols airdrops) will go to the validators and the Luna stakers as staking rewards continuously. This is like owning the shares of an early stage Alipay where they pay dividends to the shareholders immediately after they generate revenue.

Mainstream adoption has constantly been a challenge for the crypto world and Terra has managed to find a product market fit from building a payment proof of concept in Korea with Chai and scaling its investment and savings protocol to the world through Mirror and Anchor. With these building blocks, Terra is in a good position to expand its DeFi ecosystem and start taking a slice from the Traditional Finance industry.

Team

Founded in January 2018 by two co-founders:

• Co-Founder and CEO of Terraform Labs — Do Kwon studied computer science at Stanford and was an NLP engineer at Microsoft. Also founded a startup called anyfi.io that worked on B2B mesh networking solutions for large enterprises.
• Co-Founder and CEO of Chai — Daniel Shin co-founded the South Korean e-commerce platform Ticket Monster (TMON) and start-up incubator Fast Track Asia.

Mission

To innovate money, bring crypto and DeFi mainstream and make Terra the most attractive form of money

Technology

Terra blockchain is a proof-of-stake blockchain built using the Tendermint consensus and Cosmos SDK allowing 6 seconds transaction speed and low transaction fees.

Tokenomics

Terra is the stable coin which is pegged to fiat currencies which are algorithmic stablized by its native crypto asset Luna. Whenever it deviates from the peg, it creates an arbitrage opportunity for the network participant to either mint or burn Luna to enforce the peg.