Unlike Lehman Brothers, however, it appears there is still activity associated with Terra: the community refines revival plans, developers of Terra-based DApps start working on their transition to a new chain… Can it be that Terra is not over yet?

A stablecoin unlike any other

Terra is a blockchain specifically created to maintain a decentralized stablecoin called TerraUSD ($UST) – a cryptocurrency that kept its value pegged to the USD 1:1 via a set of algorithms and incentives.

It was different from the other stablecoins in several ways.

Being decentralized, it provided more transparency than centralized stablecoins like Tether or USDC that maintain the peg by keeping the collateral dollars and T-bills on their bank accounts (which cannot be directly verified by the public due to their off-chain nature).

Being algorithmic, it offered an innovative way of maintaining the peg. Unlike DAI, a decentralized stablecoin that over-collaterizes every dollar-pegged coin to counter sudden market movements, $UST relied on elastic supply mechanism embedded into the Terra blockchain itself:

  • when a $UST price fell, users could burn (destroy) it and mint (create) $LUNA; the burnt $UST reduce the overall supply, making UST scarcer and pushing its price up
  • when a $UST price rose, users could mint it and burn $LUNA, triggering the opposite process

The fees associated with minting/burning were sent into a pool, from which $LUNA staking rewards came. The swap fees spread, together with the whole system, were supposed to maintain the balance between $UST and $LUNA.

The story of a crash

The weak point of this mechanism was its confinement within Terra ecosystem: users needed to have constant confidence in $LUNA and a staking motivation. However, a hint of a bank run was enough to undermine this confidence, and the whole system went crumbling down.

It was triggered by Anchor, a DeFi lending-borrowing protocol that started reducing its yield for $UST deposits. Anchor was heavily involved with TerraUSD: $13 billion out of the total $17 billion of its Total Value Locked were in $UST, which itself represented over 70% of all $UST in circulation.

Many believe that it was Anchor’s 20% APR that fuelled Terra’s rise and the minting of billions of stablecoins. However, as the yield began to decrease, people started pulling their $UST out of the protocol and starting from May 5th the whole thing snowballed. Too many people were willing to change $UST (first – for $LUNA, then – for just any other coin), and then both $UST and $LUNA went into a death spiral, which progressively sent them to lower lows, causing massive losses for every investor involved.

Terra revival plan

After a week of heated discussions following the crash, Terra community agreed on a salvage plan. It consisted in creating a new blockchain without the stablecoin option and distributing this new chain’s currency across old $LUNA and $UST holders and old chain’s “essential developers”. The new blockchain is thus conceived as truly community-owned.

However, as Binance CEO CZ rightfully noted, “forking does not give the new fork any value”. So where does the new chain, deprived of its stablecoin originality, will draw the value from?

The answer may lie in the same “business model” as other PoS-based blockchains: the DApps developed on them bring users and stimulate the demand for the blockchain’s currency, needed to pay for the transactions.

Terra is known as a nice blockchain to build on, and it has pulled many talented developers into its orbit. These developers – and the projects they represent – must now decide whether to abandon Terra and adjust their DApps to other blockchains, or stay to see Terra 2.0. So far (and this in spite of Polygon’s and some other blockchains’ recruiting campaigns), some 20 protocols have announced their support of the revival plan and their intentions to continue developing on Terra.

It is yet to be seen if the community will be able to restore Terra to its previous glory, or market deception will definitely bury it together with the likes of Iron Finance. What is remarkable, however, is the community’s willingness to work on it.

Written by D.Center