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Terra’s 25-Fold Jump Shows Bet on Algorithmic Stablecoins

There’s no shortage these days of blockchain-based projects to build or develop a digital version of U.S. dollars: private efforts including tether, USDC, diem, dai and the Federal Reserve’s research into whether to issue a central bank digital currency. But one project, Terra, appears to be outperforming the rest – at least based on the issuer’s governance token price so far in 2021.

Terra is a three-year-old project from the South Korean developer Terraform Labs, built to support a basket of decentralized stablecoins. Demand has surged in cryptocurrency markets for Terra’s LUNA token, which works as part of an automatic balancing system that helps to keep prices for the stablecoins, well, stable.

The LUNA price has climbed a flabbergasting 25-fold this year, outpacing the already-impressive sevenfold gain for larger rival MakerDAO’s maker tokens. LUNA’s market capitalization has jumped to about $6 billion from $300 million in less than five months, overtaking MKR at $4.7 billion.

Cryptocurrency analysts see value in Terra’s two current major use cases: Mirror protocol, which allows users to create tokens that track the price of real-world assets like stocks, and Anchor protocol, a lending and saving platform. Both protocols make use of Terra’s own stablecoins such as TerraUSD (UST), which is pegged to U.S. dollars, and TerraKRW (KRT), which is pegged to the Korean won.

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LUNA serves as a governance token and is used as part of an algorithmic balancing system that helps the stablecoins maintain their pegs. For example, when TerraUSD trades above $1, users can send $1 worth of LUNA to the system and receive 1 UST in return – a trade that helps to bring the stablecoin’s price back in line.

The combination of Anchor and Mirror creates “a flywheel that effectively retains and grows monetary inflows,” Messari analyst Phang Jun Yu wrote May 6 in a report.

“When the market is bullish, users will turn to equities and start using Mirror,” he wrote. “When the market is bearish and people are wary of investments, they turn their assets back into cash and deposit it into Anchor.”

The market capitalization of Terra $LUNA since January. Source: CoinGecko

Stablecoins – whether centrally managed versions like tether and USD coin, or decentralized versions like dai that are managed by blockchain-based protocols – have proven popular assets in digital-asset markets, as alternatives to major cryptocurrencies like bitcoin and ether, whose prices can be volatile.

An emerging subcategory is “algorithmic stablecoins” like Ampleforth (AMPL) and Fei Protocol (FEI), which use software-coded procedures embedded into the protocol to maintain the currency peg. While some of these projects have encountered mixed success with keeping the peg at an on-target reading of 1-to-1, proponents say they have advantages.

“The advantage you get with algorithmic stablecoins is that nobody can take that away from you and it retains all the censorship-resistant properties of bitcoin,” Terraform CEO Do Kwon told CoinDesk in an interview.

Of course, it’s important to note that prices for newer cryptocurrencies like Terra can be extremely volatile, and these decentralized blockchain-based protocols have short track records and can be prone to glitches and snafus. Fei’s recent difficulty keeping its stablecoin at a 1-to-1 peg might be seen as a cautionary tale.

Kwon said that some algorithmic stablecoin projects are struggling because they failed to recognize the importance of mainstream adoption and limited their projects’ use cases – such as staking the stablecoins to earn rewards.

“These protocols don’t natively print stablecoins to incentivize the users to hold, which would be like a recursive incentive,” Kwon said.

Since the UST dollar stablecoin was first minted in December, the amount outstanding has climbed above $2 billion, according to CoinGecko. While that’s still a fraction of tether’s $58.5 billion, it’s not too far behind the $4.6 billion for two-year-old dai.

Kwon said the rapid value growth of UST is backed by the success of protocols like Mirror and Anchor.

At least 50 different protocols have announced plans to support the Terra-backed stablecoins, including an options protocol on top of Mirror.

Facebook-backed crypto project Diem to launch U.S. stablecoin in major shift

Representations of virtual currency are displayed in front of the Libra logo in this illustration picture, June 21, 2019. REUTERS/Dado Ruvic/Illustration//File Photo

Digital currency group Diem Association, formerly known as Facebook Inc (FB.O)’s Libra project, plans to launch a U.S. dollar stablecoin as it scales back its global ambitions to focus on the United States, the group said on Wednesday.

The association, which comprises 26 financial firms and non-profits, said it was relocating its main operations from Switzerland to the United States and withdrawing its payment system license application with the Swiss financial regulator.

Diem Networks U.S., a unit of the Deim Association, will run a blockchain-based payment system that allows real-time transfer of Diem stablecoins and will register as a money services business with the U.S. Department of the Treasury’s Financial Crimes Enforcement Network, the group said.

Stablecoins are digital currencies pegged to a fiat currency. California-based Silvergate Bank will issue the Diem USD stablecoin and manage the Diem USD reserve. Diem said it would launch a pilot of the stablecoin, but it did not say when.

“We are committed to a payment system that is safe for consumers and businesses, makes payments faster and cheaper,” the association said.

In a statement, the Swiss Financial Market Supervisory Authority confirmed Diem’s decision to withdraw its application for a payment license.

“Diem is planning to launch the payment system from the USA in a first phase because initially the project will focus on the USA as its target market,” it said.

Facebook first unveiled plans for Libra in June 2019, part of an effort to expand beyond social networking into e-commerce and global payments. It said Libra, alongside partners like payment firms and credit card companies, would create a digital token backed by a wide mixture of currencies and short-term government debt.

The social media giant said it hoped Libra would power transactions between consumers and businesses around the globe, and offer more people access to financial services.

But the project immediately ran into fierce opposition from policymakers globally, who worried it could erode their control over the money system, enable crime, and harm users' privacy.

In April 2020, Libra and its partners abandoned plans to hold a basket of currencies and sovereign debt in favor of stablecoins backed by major currencies and sought the Swiss regulator’s approval.

In December, Libra rebranded as Diem in a renewed effort to gain regulatory approval, with its scope scaled back further to a single dollar-backed digital coin.

Currently, Facebook’s digial wallet Novi is one of Diem’s 26 members and a minority investor.

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