Terra is a decentralized financial payment network that rebuilds the traditional payment stack on the blockchain. It utilizes a basket of fiat-pegged stable coins, algorithmically stabilized by its reserve currency Luna, to facilitate programmable payments and open financial infrastructure development.
Luna is the reserve currency of the Terra platform. It has three core functions:
- Mine Terra transactions through staking.
- Ensure the price stability of Terra stable coins.
- Provide incentives for the platform’s blockchain validators.
The Terra protocol runs on a Proof of Stake (PoS) blockchain, whereby miners must stake their Luna in order to mine transactions. All else being equal, a validator who has staked more Luna has a higher chance of generating the next Terra block compared to another validator who has staked less. In essence, Luna represents a validator’s mining power.
However, in providing network security and validation, Luna holders and stakers are exposed to the price risks associated with the asset. This is because the Terra protocol readily exchanges Terra stablecoins for Luna at their determined exchange rate to maintain the peg. When demand is high and prices are above the peg, it will sell stablecoins for Luna. When demand is low and prices are below the peg, it does the opposite. In this way, validators absorb the short-term volatility of the network.
The Terra network achieves price stability by algorithmically adjusting its supply based on fluctuations in demand. Once it detects that a Terra stable coin has deviated from its peg, it will apply pressure to correct the deviation.
The protocol makes use of natural market forces to achieve this. For instance, if the price of 1 TerraUSD (UST) is above its $1 US dollar peg, the protocol must compensate by increasing the supply of UST. It mints some of the stablecoin and sells them on the open market. Arbitrageurs can then swap $1 US dollar worth of Luna in exchange for 1 TerraUSD and stand to profit. Minting and swapping occur until the supply of new UST is sufficient to bring back UST’s peg.
Likewise, should the price of 1 TerraUSD drop below its $1 US dollar target, the protocol will decrease the supply of the stable coin. It mints Luna and sells them on the open market. Profit seekers can then exchange 1 UST for $1 US dollar worth of Luna and pocket the difference. In both cases, the Terra protocol prints as much stable coin or Luna as necessary until the peg for each asset is satisfied.
The protocol thus serves as a market-maker for Terra/Luna swaps. So long as there is a certain level of demand within the Terra ecosystem, either driven by Luna’s value or Terra’s transactions, the exchange of value between both assets preserves stability and mitigates volatility.
Luna launched on the Binance Exchange in August 2020, at a price of $0.38. By January 2021, the price was still at only $0.65, but quickly gained momentum, reaching an all-time high in December that year, of just below $104. Luna has retraced with the rest of the market since then, and is currently trading just below $50. The $50 – $60 seems to be very tough resistance to get break at the moment, but once we can get through this area, and also break the descending resistance trendline, the first profit-taking area will be the 0.618 Fibonacci retracement at around $80.
The Terra Luna Ecosystem is very exciting, and with Luna’s deflationary use case, the price of Luna is set to increase over time.