LUNA joins the big kids’ playground: but will its tokenomics hold up?

With Binance's announcement of 21% APY interest on UST staking, there is little doubt that the Terra ecosystem is entering the mainstream of stablecoins. As I write this post the value of the LUNA token is rising steadily as new UST coins are being minted. However, some valid concerns have been raised as to whether the Terra ecosystem really is on terra firma.

The biggest concern revolves around the interplay of the LUNA value storing token and the stablecoin assets. For those who are unfamiliar with the process, as new stablecoins are minted, LUNA is burned, and the converse is also true. Importantly, this means that there must be available market soakage to absorb burning of stablecoins through the sale of newly minted LUNA. This poses a problem, as in times of extreme uncertainty, a sell off of both LUNA and stablecoin could occur simultaneously, which may result in de-pegging of the stablecoin, with disastrous consequences. To combat this, Terra have invested in Bitcoin as a backup reserve. This certainly helps to alleviate an immediate risk, but also relies on what is also a highly speculative asset (sorry, Bitcoin purists), again raising questions over the consistency of its available liquidity.

The other significant issue surrounds the sustainability of Anchor Protocol, the lending platform through which stablecoins earn interest. Offering almost 20% APY returns, it is difficult not to raise an eyebrow when considering its sustainability. Governance of the protocol has recently agreed to reduce this APY in incremental steps to help preserve the available liquidity pool. However, presuming Binance are also making use of this protocol, the value of borrowers to lenders is likely to increase, placing further strain on its sustainability.

So will Terra continue to advance as a major stablecoin ecosystem? Binance seems to think it will, and their decision to support it should not be taken lightly. Regardless of personal opinions of Binance, we must appreciate that a company of this size will not knowingly risk liquidation of its customers through a novel stablecoin – such an event which could wipe out trust in the company overnight, causing its rapid decline. Unlike USDT, Terra has not yet been adopted by all of Binance's competitors, leaving it exposed as an early major adopter.

I am interested to hear your opinions about the Terra system. It is certainly an interesting experiment. If it goes wrong now, there will be serious consequences for the entire crypto economy.