“Terra Protocol has been in the limelight this year for its innovative platform for the creation of algorithmic stablecoins pegged to the fiat currencies such as USD, EUR etc. and also for the 100x gains that it provided to its investors in a single year. To accomplish this humungous feat, Terra introduced a protocol working model that is worthy of analysis and here we will try to comprehensively analyse the working of this protocol”.
The Terra Protocol and the Native Tokens
Terra is a decentralized and open-sourced blockchain protocol that is leading the creation of stablecoins. Terra Protocol is capable of creating stablecoins that consistently tracks the price of the fiat currency that they are pegged to. The Terra powered stablecoins can be traded, stored, spent or exchanged instantly on the Terra blockchain to create an ever growing ecosystem. Terra protocol has two main tokens:
- Terra: The Terra are the stablecoins that consistently tracks the price of the fiat currency they are pegged against. Each Terra token is named according to their fiat counterparts. For example, Terra token pegged to USD is known as TerraUSD (UST). Users can mint Terra by burning LUNA.
- LUNA: LUNA is the native token of Terra that is used for staking, governance, mining as well as an absorbent of volatility of the Terra token. The more Terra is used more LUNA is worth.
Terra Protocol: The Working
The creation of stablecoins is one of the major functions of Terra and a stablecoin is only useful for the users if it consistently maintain its price peg. Terra uses the basic market forces of supply and demand. The protocol balances the supply and demand of Terra thus providing stable prices to the stablecoins.
Expansion and Contraction
The Terra economy has two pools, one for Terra and the other for LUNA. Terra can be minted by burning LUNA and LUNA can be minted by burning Terra. The process of expansion and contraction keeps the price of the Terra Stablecoins stable. Expansion is when the price of Terra rises against its peg and there is a low supply of Terra and high demand, the protocol incentivize the validators to burn Luna to mint Terra thus stabilizing the price. Contraction on the other hand is done when the price of Terra becomes low against the price of its peg and there is high supply and low demand, the protocol incentivizes the validators to burn Terra and mint LUNA again stabilizing the price.
Terra uses a proof-of-stake consensus mechanism known as Tendermint. The Tendermint is a proof-of-stake consensus protocol that is Byzantine fault tolerant and uses Application Blockchain Interface (ABCI) to enable transaction processing in any language. Use of Proof-of-stake consensus makes it a highly scalable blockchain.
Disclaimer: The article is meant for the educational purpose only and in no way it should be considered as financial advice. Own research on the topic is advisable.
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