The rise and fall of the Terra blockchain and family of related tokens is both one of the most convoluted and one of the most important stories happening in crypto right now.
Assembled here is a plaintext explanation of what Terraform Labs built, why it got so big, why it imploded, what it means for the markets, and what you need to know to keep yourself safe from similar projects in the future.
What exactly is Terra?
That’s a great question, and we will answer it. But first, let’s found a bank.
Our bank will do all the usual bank things, like take deposits, pay interest, enable payments and make loans. Obviously, we could restrict ourselves to only loaning out money we actually have, but that is tedious and unprofitable. So, like any bank, we will make more loans than we receive in deposits and keep only a fraction of our customers’ deposits available as cash to withdraw when they need it. The amount we will keep available as cash is 0%.
It will be fine! Since we are loaning out 100% of our reserves, we will be very profitable; and since we are very profitable, we will be able to pay very high interest rates. No one will want to withdraw! If we ever do need money, we can sell stock in our very profitable bank. When demand for our deposits grows, we can use the new money to do stock buybacks. Since everyone is confident in the value of our stock, they will know we can back up our deposits; and since everyone is confident in the demand for our deposits, they will value our stock. Nothing could go wrong.
Knifefight on Terra’s tragedy and the lessons learned.
Okay. One thing that could go slightly wrong is that this is all illegal for a variety of reasons, so we’ll need to run our bank on a blockchain and issue our deposits as stablecoins — but that’s fine. The difference between a bank deposit and a stablecoin is mostly regulatory optics.
That’s roughly the business model of the Terra ecosystem. Terra is a blockchain built by Terraform Labs that uses a stablecoin, TerraUSD (UST), and a reserve…