Terra has created two cryptocurrencies. One of them is the stablecoin UST, intentionally pegged to the US dollar.
There are other stablecoins that want to do this, but most are dollar-based. However, Luna, another Terra cryptocurrency, backs UST’s value, making things interesting.
How does the UST work?
When UST depreciates against the dollar, investors can make money by selling UST for dollars. However, selling UST will burn that token, reducing its supply and increasing the value of UST to match the dollar. If the value of UST gets too high, investors can make money by exchanging Luna tokens for UST. This exists in a one-to-one relationship.
However, exchanging Luna tokens for UST will create new UST tokens. The exchange will lead to an increase the UST supply and bring its value back to US dollars.
And not only this, it actually works. Other people have developed this before. There have been numerous competitions, but many of them crashed during the crypto network’s sell-off from May to June. Should the value of the collateral, or, in this example, the non-stablecoin, Luna, really decline, the price will fall. This could send them into a death spiral. If demand falls too quickly, the entire system collapses and nothing is worth anything.
What causes the death spiral?
This is because of the production of additional algorithmic stablecoins, and the utilization of financial incentives to assist individuals and promote demand for these stablecoins. As we discussed earlier in the game, this is not an official demand, Terra is not. The first and most important thing they did at Terra was to go to Korea and integrate it into their payment system. In reality, because this payment system uses Terra’s stablecoin, retailers who use it don’t have to pay credit card fees when their customers pay.
However, if they join the network, they will charge you with a tiny fee. This tiny fee is far less than a credit card fee. That is how the stablecoin gained popularity, as it is a much cheaper alternative to using Visa, Mastercard, or other credit cards in South Korea. There is a rough estimation that 5% of the Korean population has used it or roughly 2.5 million individuals. This is a logical need for the stablecoin, and it also generates demand for the Luna token, making it an intriguing option.
However, because they have already established this need, they are now beginning to develop network effects. On Terra, a genuine ecology is forming. There are exchanges where you may trade UST for other cryptocurrency tokens or vice versa. You may potentially get a 20% income on your stablecoin, which may sound like a scam, but it isn’t.
It won’t stay at 20%. This is because it isn’t viable in the sense that it is clearly dependent on credit supply and demand.