Relationship between Terra and Luna

  • 2 min read

If you’re new to the Terra ecosystem, at first glance it might seem confusing. The project is called Terra, but the token is called Luna. Why?

Well Terra Protocol is a blockchain that issues algorithmic stablecoins; Terra stablecoins. There are currently 18 Terra stablecoins, with TerraUSD (UST) being the most widely adopted at a market cap of about $2 billion. Another popular stablecoin is the TerraKRW (KRT), and that is due to the usage from CHAI; a payment app based in Korea. Other stablecoins include TerraEUR (EUT), TerraJPY (JPT), and TerraSGD (SGT).

So how is Terra able to keep its peg?

Since Terra stablecoins are algorithmic, they’re different from fiat-backed stablecoins such as USDT and USDC. Instead they’re able to keep their peg because of Luna. Luna acts as an asset that absorbs the short term volatility of Terra. This can be done so because at any moment in time, anyone can swap $1 worth of Luna for 1 UST. By doing this, the protocol creates incentives where users can profit risk free through arbitrage.

Let’s take a closer look (in this example we will be using UST):

If UST = $1.1, users will be incentivized to swap $1 worth of LUNA to receive 1 UST.

If UST = $0.9, users will be incentivized to swap 1 UST for $1 worth of LUNA.

Now this is able to be done because:

By minting 1 UST, $1 worth of Luna needs to be burned.

By burning 1 UST, $1 worth of Luna needs to be minted.

Luna’s Value Proposition

These set of incentives are what keep Terra to its peg. This also results in an elastic supply of Luna. As more UST is needed, more Luna will be burned and as less UST is needed, Luna will be minted.
This means that Luna is directly capturing the value of Terra through its elastic supply. As long as there is continual demand for Terra, the supply of Luna will continue to decrease, thereby Read More