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The Brilliant Algorithm Behind TerraUSD (UST) on the Terra (LUNA) Blockchain

Edit: Yup. Ignore this article. The Brilliant Algorithm turned out to be not so brilliant. 

Most cryptocurrency investors are familiar with stablecoins; incredibly useful crypto assets that are (usually) pegged to the US dollar. But the methods used to achieve the stability of these assets is often questionable and not necessarily decentralised. For example, USDC is a centralised crypto asset issued by Coinbase, and DAI, while appearing to be decentralised, has 61% of its collateral as USDC. USDT has severe transparency issues. So, is there a solution to all of this?

Well, dear reader, this is where the Terra ecosystem comes in. Terra aims to provide algorithmically designed stablecoins that are fully decentralised; and that they have. The native token of the Terra blockchain is the LUNA, and its US-peg coin is the TerraUSD / UST.

How it works

Let’s take a dive into an overview of how UST works. Take a look at the following diagram [source: Terra YouTube Channel]:

Let the total market value of all the UST be represented by the value of this pool. The height of the pool represents the value of one UST, and the width and length of the pool represent the total supply of UST. 

When more people want UST, the demand for it increases. This means the value of UST must rise above a dollar. The dimensions of the water tank remain the same but the height increases, representing this increase in value of each UST token.

But the whole point of UST is to be a stable $1, right? The way the algorithm works is by introducing more supply of UST to keep the water height at the fixed $1. The more demand of UST is adjusted for by increasing the length and width of the pool.



But where is this new UST coming from? On the Terra blockchain, people can buy and hold LUNA in a way that such that when the price of UST is increasing due to market demand, people can swap their LUNA for a bit more than a dollar for freshly minted UST. This new UST expands the length and width of the pool, increasing the total supply of UST, and keeping UST worth $1.

When this happens, LUNA becomes more scarce and as a result is now more valuable, and the price of UST remains a dollar. This way of keeping LUNA pegged to a dollar is fully decentralised and does not need a centralised collateral to be backed by.

What if people start selling UST?

Let’s imagine the opposite scenario: A lot of people selling UST and, as a result, the price of UST starting to drop. In this case, UST holders can simply swap their UST for LUNA for a profit. Once again, this method of swapping removes the total number of UST in circulation and mints back more LUNA. This reduces total length and width of the pool, keeping the water height at $1; i.e. keeping the price of UST $1.

What’s wrong with USDC? Everyone uses it!

USDC is centralised. USDC is a token that is issued by Coinbase; for each one USDC token, Coinbase has one US dollar stored. Coinbase can essentially freeze (and they have in the past!) any wallet address if required. This defeats the purpose of cryptocurrencies: decentralisation.

I am not saying USDC is bad. It’s a great asset for a stable currency but it isn’t decentralised. UST is simply a way forward to a decentralised future.

What about DAI?

DAI is certainly a better alternative to USDC in terms of decentralisation, but it uses other cryptocurrencies as collateral to maintain its peg, with 61% of it being USDC. If, for example, Coinbase got robbed (big time!) and there was nothing to back USDC, not only would USDC crash but also DAI. Do note that this happening is incredibly unlikely!

Unlike USDC, Coinbase cannot freeze DAI wallet addresses.

The future

It is still early days for the Terra blockchain and the utility it brings is simply incredible; and this really shows with the price of LUNA skyrocketing in recent times. Currently as of writing this article, LUNA is rank 9 on CoinMarketCap, which it has achieved in a relatively short period of time. In the world of cryptocurrencies, stablecoins will always be needed as a way of storing assets without fear of volatility, and Terra is perhaps the best decentralised contender there is.

What are your thoughts? Leave a comment below!



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