Terra Luna — algorithmic stablecoins blockchain
The two strategies in this and the following article will relate to the Terra Luna ecosystem, offering 20%-40% annual interest in stablecoins, with relatively low risks, so let's talk about it first. For those who want to skip the introduction can go down to the section "Anchor Protocol — 20% fixed APR."
Disclaimer: I share this information for your reference only and in no way means financial or investment advice. Be sure to do your own research (DYOR).
- Luna Management Token
- Launched in 2018
- Investors: Digital, Hashed, Coinbase, Binance Labs, Delphi Digital, Vlad Tenev-CEO & Co-founder of Robinhood
- Market cap — 5 billion (top 20-35)
- TVL (total money in the ecosystem): about 3.5 billion
Terra is a proof-of-stake blockchain specializing in stablecoins. Their mission is to create a stable that is "programmable, attractive to hold, and the easiest to spend."
Unlike most other networks, Terra focuses on average Joe, not only blockchain geeks, offering the products they need: lending/deposits on more profitable terms than regular products (banks), access to American stocks and ETFs without a broker, real-world settlements through a mobile app without hassle.
Due to this, many consider Terra to be a bridge to the non-crypto consumer.
Luna tokens, UST, and how they work
The main stablecoin in the Terra basket is UST (there are also EUT, KRT —Euro, and Korean won—). Unlike USDC, USDT, BUSD, which are backed by cash or its analogs on the accounts of issuing companies, the pegg stability to $1 in UST is fully guaranteed by arbitration initiatives.
How does it work?
If the market starts selling UST and its rate drops to, let's say, $0.98, arbitrage traders (in fact, bots with millionaire balances) come into play, buy UST on the exchange at a discount price of $0.98, and can immediately exchange it for $1 in Luna tokens on the Terra blockchain, fixing the dropdown without a deposit. Increased customer demand returns the rate to $1.
Vice versa, if the exchange rate rises to $1.02, it becomes economically profitable to sell UST tokens for Luna.
It's important to understand that when the demand increases and the protocol issues new UST, a certain number of Luna tokens go out of circulation, making its circulation on the market smaller, and therefore positively affecting the price. And vice versa, in downtrend periods for UST, new Luna tokens enter the market absorbing this UST volatility, decreasing in price.
Such an algorithmic design has its own advantages:
- Capital efficiency: no collateral needs to be blocked, meaning that the funds in the system are more efficient
- Tru-decentralization: The issue of UST is controlled by a protocol, which means neither the issuer nor the regulatory authority can block the funds, as in the cases with USDT, USDC.
Of course, there are also disadvantages:
- During periods of high volatility, the UST token may temporarily lose its peg to the dollar when the daily trading volume in the blockchain is not enough for a rapid recovery of the exchange rate by the bots. In the last fall in May, the price dropped 5 days to $0.9.
- Technically, if traders start getting rid of both UST and Luna at high speed, a so-called "death spiral" may occur, resulting in both tokens going down exponentially.
As for the first point: recently, changes were made through voting to prevent such a dropdown in the future. I will not go deep into technical details; let's just say the community reacted to the stress with appropriate patches.
On the second point. The main difference between Luna and similar algo-coins shines here. The Luna token is backed by a profitable product unrelated to crypto — the CHAI APP mobile application, which will be discussed later.
By adding tokens into staking, everyone can get a share of the profit that CHAI users bring. This, in exchange, protects the network from a death loop since the demand for a profitable asset will persist at any stage of the market.
A beautiful solution to the algo-stablecoin problem.
Stablecoins are familiar and convenient for poker players who use them for deposits to poker rooms and store a large/significant part of the bankroll in non-volatile assets. The same applies to a broader audience, crypto "casuals."
Terra has built an ecosystem of 3 protocols around UST (over 50 are currently under development):
- CHAI App — a Korean mobile application with 2.5 million users (5% of the Korean population) offering discounts in cafes/restaurants/Netflix and a more profitable merchant payment structure. It uses the Terra blockchain for all calculations and the algo-stable coin KRT linked to the Korean Won (KRW) rate. We are most likely not interested in this, but it's crucial for understanding Terra.
- Anchor Protocol — the first credit (lending) platform using PoS network assets as collateral (those that can be staked through a validator and get rewards). Offers a 20% fixed rate per annum to depositors.
- Mirror Finance — allows you to buy, sell, and short "synthetic" American stocks and indices: Tesla, Facebook, Galaxy Digital, S&P500, gold, silver, without a broker, and KYC. All this with additional farm rewards up to 40% APR.
Terra is distinguished by a top end-user experience — clean protocol interfaces, 6-second blocks (hence transactions), a friendly wallet. Against the backdrop of the marginal, confusing designs of most DeFi apps on Air, Terra's UX feels like a hot tub after the war.
I'll finish the presentation of Terra with this. Finally, let's move on to the topic of farming and Anchor protocol.
Anchor Protocol — 20% fixed APR
Anchor Protocol is a DeFi bank where you can lend and borrow funds, in this case, UST. At the time of writing, the second most capitalized protocol in the Terra blockchain. Lenders are offered the actual "leverage," a loan, and extra rewards with the local ANC token for receiving it (yes, in cryptos, this is still possible thanks to generous promos).
For depositors — a flat rate of 20% on a deposit in UST. At the same time, the funds remain completely liquid; they can be withdrawn at any time, transferred to the exchange, withdrawn to fiat, or exchanged for another stable.
The first question that is usually asked after learning the basics of Anchor is: "where does the 20% come from?" (in other words, "why it isn't a Ponzi?")
The protocol generates 20% from:
- Interest paid by UST borrowers on the same protocol (13-21% APR).
- Proof-of-stake assets, such as Luna and ETH, generate rewards, which borrowers block as collateral (5%) and go to Anchor.
- Terra allocated a fund of $70kk to subsidize the "cash gap" until the protocol came out on the positive side.
Economy of Anchor
Let's take a look at the current Anchor metrics. The data is current as of 05.08.2021 and may fluctuate wildly.
- Total deposit: $850kk — this is how many deposits are now receiving 20% per annum.
$850kk x 20% = $170kk — this is how much profit Anchor should generate annually to maintain 20% for depositors.
- Total Borrow: $416,000,000 — the current debt generates 21.31% APR, which is $87kk of profit to Anchor.
- Total Collateral: $1,100,000,000 — the total collateral estimate generates about 5% = $55kk of profit per year in the background.
170kk - (87kk+55kk) = 28kk — this amount of missing money per year is subsidized from the Yield Reserva of Terra.
- Yield Reserve: $68kk — this is how much money remains in the fund now. At current rates, this is about 2 years of farming if the protocol doesn't get positive during this time.
Assessing the risks
As with everything in the crypto world, there are several risks associated with Anchor. Let's analyze and evaluate them.
Smart contract risk. Risk of the protocol being hacked or an economic attack.
How do I assess such risks here?
- Has the project been audited? How many times? By whom?
There are audit firms in the crypto world. Their task is to check the code of smart contracts and applications in search of vulnerabilities. And although audits are far from perfect, such a process from a trusted team adds credibility points.
Anchor was audited by the Cryptonics team.
- What's the TVL? There is some correlation between the amount of blocked funds in the protocol and its security. Recently, it has become more blurry since billion-dollar and small projects are being hacked. Nevertheless, let's check it. Anchor's current TVL is 1.9 billion, which is TOP20 in the capitalization of all DeFi protocols.
- How old is it? The longer the protocol is online, the higher the probability of having already been hacked and failed. Anchor has been operating since March 2021. By the standards of an ultra-fast industry, a confident teenager.
- Who is behind the protocol? IMHO is the most important and underestimated factor by many. If the team is public, backed by significant funds, then almost always, the lost fund is compensated from the project's treasury. The founder and team leader of Terra is Do Kwon. The company is listed in Singapore. Its backers are listed above.
Risk of rug pull (liquidity removed). This is when the team sells all tokens on the open market, and simply steals funds, and rides off into the sunset. In the case of Terra, I don't consider this a real risk for the reasons described above.
Risk of UST (or similar) losing the peg the dollar - depeg. Despite all the proactive measures and the demand for the Luna token, the design of the algostablecoin is more vulnerable to "downswings" and sometimes to the death spiral of the entire economy. And although in the case of Terra, the likelihood of this is lower every year compared to a new project, it's important to always consider it.
Obviously, with such many DeFi farms (Anchor with 20% is still a super tight call, there are farms with 50%-1000%+ APY), demand for risk mitigation was born.
Insurance companies have emerged on the market to cover different types of problems related to DeFi and CeFi investments. In the last post, I talked about how to take insurance against the default of centralized exchanges. Now I will explain how these insurers actually work.
Let's start with a spoiler — now there are pretty profitable insurances on the market both from the bug/hack smart contract and the peg loss to the UST dollar. But first, it's essential to understand how they work.
So, insurance companies are not in the centralized sense of the word but insurance DAOs (Decentralized Autonomous Organizations). For this example, we will use one of the largest insurers: Nexus Mutual.
As in other decentralized applications, the insurance protocol is managed by its users. There are three types of participants (actually more, but only these are important to us now).
- Stakers — deposit and block their funds in the insurance pools of individual protocols, for example, Anchor, providing funds for compensation in case of hacking. They earn money on "premiums" paid by insurance buyers. They are essentially investing in the security of an independent application.
- Insurance buyers — choose the amount of insurance, pay the "premium," and get insured.
- DAO (Claim Assessment) — evaluates claims for compensation from buyers after hacking and decides on the validity of the insured event.
Next, we have two scenarios from the point of view of the insurance buyer. First, during the insurance period, the protocol worked as it should. The premium we pay goes as profit to those who have invested their funds in the Anchor insurance pool.
Second, Anchor was hacked. We fill out the claim — an application for compensation on the Nexus website. If the case meets the insurance conditions, the local DAO makes a positive decision on our case, and we receive full compensation.
The next logical question is — what happens if the DAO simply colludes, and in the event of a big hack, it won't approve the application? There are two answers to this question:
- Long-term financial incentives for NMS token holders (Nexus Token). If an unfair decision is made on the case, it's almost guaranteed to cause an outflow of funds from Nexus, which will affect its prize. And those who evaluate applications are always holders with a stake of tokens and are directly interested in its success.
- Suppose, nevertheless, someone tries to abuse the system. In that case, DAO participants can open arbitration on it, and if the actions are recognized as fraudulent, they can burn their tokens.
Have there been any exploit attempts? Yes, the tokens of the participants were burned. Since 2019, all reasonable applications in Nexus have been satisfied.
Overall, the top insurance protocols have so far fulfilled their tasks for buyers. This does not guarantee that this will always be the case; moreover, there is a non-zero risk that the insurer itself gets hacked. Therefore, it's more correct to treat this as a reduction of risks rather than avoiding them.
Let's say there is a 1 in 1000 probability of a bug in the Anchor protocol that can be detected. And the same 1 in 1000 chance that the bug is in Nexus. Then, having insurance, the probability of losing funds for us will be instead:
- 1 in 1000 (no insurance)
- 1 in 1000 x 1 in 1000 = 1 in 1,000,000 (insured)
(Since two protocols must break at once)
We will analyze step-by-step how to use Anchor from opening a Terra wallet and take insurance under the program "Restful sleep and 15% per annum."
Opening an account in the Terra wallet
First, we need to create an account in the Terra ecosystem in a wallet called Terra Wallet. It's available as a stand-alone Windows application and as a browser extension.
To exclusively farm on UST, you can go with a browser extension. Luna staking, participation in protocol management, exchanges, and other features, are available in the full desktop version.
- Download the Chrome extension. Click on install
- Launch it, a window will open in a new tab in which we select "Create new Wallet."
- On the account creation screen, enter your wallet name, choose a password. Important! Write down the password and the Seed Phrase (our phrase for restoring the wallet in case of password loss) on a piece of paper, or at worst, save it encrypted in a password manager. Click Next.
- Enter a few verification words. Click Next. We see this screen:
- The wallet has been created. Copy our new Terra address by clicking on the button as shown by the arrow and save it; no need to encrypt it.
- Now we need to buy some UST to put them in Anchor. There are several ways; I will describe the easiest one through the Kucoin exchange (top 5 in the Coinmarketcap rating at the time of writing).
If you don't have a Kucoin account, open it. Carefully save the password and set 2FA. For a minimum KYC, you will need to indicate your name, country, passport ID.
- Go to Main Account -> Deposit -> Choose USDT / USDC depending on what we will buy UST for.
- Copy the address and transfer the required number of coins from another exchange or personal wallet to Kucoin. The coins will be added to the Main Account of the exchange; for trading, they will need to be transferred from Main Account -> Trading Account.
- Next, go to the trading terminal of the UST/USDT or UST/USDC pair.
- Select the Market tab, enter the required number of USDT/USDC, and click Sell.
Now we have UST.
We return to the main menu Assets -> Main Account, and there, we transfer the UST back from the trading account to the main one.
Finally, in the same account, we find the withdraw button opposite our UST in the list of assets. In the pop-up window, indicate the entire amount, enter the main and trading passwords, specify our wallet address on Terra, created above.
The transaction costs 4 UST. You don't need to specify a Memo. Now UST is on our account!
Now to go to the Anchor App.
We find the deposit button, enter the amount, but we must leave 5-10 UST on the wallet for subsequent transactions. In the Terra network, UST is used as ETH over the air to pay rewards to validators.
Ready! On the bottom right, you can see your expected interest for the deposited amount per day/week/month/year. Then, you can study the site. It is as intuitive as possible in the crypto world for an inexperienced user.
You can withdraw UST in precisely the same way. Withdrawl from Anchor, then, if necessary, cash out from the Terra wallet to the exchange and then wherever you want.
Yield can float between 19.5% - 20% — this is normal.
At this stage, there are two ways to go. Study the following sources for research on Terra and Anchor, get acquainted with the project, its applications, tokenomics, roadmap, community, and decide about insurance. This is for those who are interested in Terra and want to go deeper.
Or just take two insurances against bug/hack of the smart contract + UST stability without spending extra. You will get about 15% with deductions from insurers.
Let's start with the second option.
Insurance from Nexus Mutual + Unslashed Finance.
I will not describe all the steps for buying insurance. In any case, this option is for crypt regs, so I'll just leave the links to sites and auxiliary guides for studying. Insurance against the failure of a smart contract from the already mentioned Nexus.
It currently costs 2.6% per annum. You can pay in the Ether network for any period from 1 day.
You can insure against losing the peg to the UST dollar here. Everything is plus or minus as with Nexus, but payment is only in ETH, so it may be necessary to add our Ethers when its exchange rate fluctuates.
It currently costs 1.9%.
Total: insurance will take away from us about 4.5%, leaving us with 15% net APR and healthy sleep.
For those who are interested in exploring Terra more deeply, I attach below the sources for digging.
I would like to add that studying the work of protocols and their fundamentals is an extraordinarily fascinating and addictive activity.
Crypto is not only about speculation but also new management models, open interaction of ideas, teams, and capital. In general, the topic is for free-spirited people.
I hope this post will be helpful; I will be glad to receive feedback on our social networks.
If you like the format, in the next part, I will try to tell you in detail and understandably about the second large Terra protocol — Mirror Finance.
Links to sources:
- Luna token on CoinGecko https://www.coingecko.com/en/coins/terra-luna
- UST token https://www.coingecko.com/en/coins/terra-usd
- Terra's Twitter https://twitter.com/terra_money
- Do Kwon Twitter (Terra founder) https://twitter.com/stablekwon
- Terra website https://www.terra.money/
- Documents (all the mechanics of the network are described here) https://docs.terra.money/
- A video explaining the principle of issuing stablecoins in conjunction with the Luna token https://www.youtube.com/watch?v=KqpGMoYZMhY
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