FishMarketAcademy

Jul 25, 2021

7 min read

Bigger than ETH EIP 1559? Terra’s Next Big Update — Columbus 5 Explained.

Ethereum long awaited EIP 1559, aka London hard fork, is slated for deployment on August 4, which is approaching quickly.

A quick explanation — EIP 1559 is a highly anticipated proposal that has been discussed for months, and under the proposal, instead of fees being awarded to miners, the base fee is set by the Ethereum protocol automatically, and the fee is removed or “burnt” by the network.

The burning mechanism of EIP 1559 will reduce the inflation of ethereum and during periods of high activities, might even make ethereum deflationary as it burns faster than it is being mined. This is controversial because of its potential to reduce miner revenue.

While many are hyped up about EIP 1559, many people are unaware of Terra’s Columbus 5 upcoming upgrade which is going to change Terra even more than EIP 1559 is going to change Ethereum. So if you’re bullish on $ETH because of EIP 1559, you should be bullish on $LUNA as well.

Here’s why.

Columbus-5 is the 5th big upgrade for the Terra ecosystem, hence the name, and it comes with a few main upgrades.

  1. Burn all seigniorage 🔥
  2. Upgrade to Stargate (IBC) 🪐
  3. Launch of Ozone protocol 💨
  4. Launch of the Wormhole bridge 🌀

Let’s go through each of them, but before that, let’s visit how Terra works again as this article is meant for newcomers.

Wait what is Terra? (Skip if you are a #LUNAtic)

Terra is a decentralized blockchain payment network that mints and uses fiat-pegged stablecoins for stable and fast global transactions. It is like our existing international payment network, but with near-instant settlement, cheaper and can be used by anyone, anywhere, without permission.

It was founded in Jan 2018 with the support of the Terra Alliance which is made up of 15 large e-commerce companies in Asia that collectively process 25 billion USD in annualized transaction volume and 45 million users, allowing it to have strong real-world adoption from the beginning.

The Terra network tokens is made up of $LUNA and other stablecoins such as UST(TerraUSD), EUR, CNY, JPY, GBP, KRW, and the IMF SDR. The TerraSDR (Terra Special Drawing Rights), aka $SDT, is actually its flagship stablecoin, as it exhibits the lowest volatility against any one fiat currency.

The $SDT is similar to the International Monetary Fund’s Special Drawing Rights (SDR) which is a basket of other currencies and acts as a reserve asset as it can be converted to other currencies. The SDT is used to ensure price stability in Terra’s stablecoins as well.

But Terra’s stablecoins relies primarily on $LUNA, its utility and staking token, to collateralize and give value to its stablecoins to secure price stability. This means that $LUNA has an elastic supply that fluctuates according to the demand of Terra’s stablecoins.

$UST is the most popular stablecoin of the Terra network where 1 $UST = 1 USD and this is achieved because $UST is collateralized by $LUNA’s value.

But! $LUNA does not explicitly collateralize UST — it simply absorbs the short-term volatility of UST. UST long term value is primarily backed by the demand to use Terra’s dapps like Mirror, Anchor, Chai, Pylon, etc.

This is why if $LUNA’s marketcap drops below $UST, it does not create a death spiral bankrun unlike other algo stablecoins.

During times of high demand for Terra’s stablecoins, i.e. UST goes to $1.10, Terraform Labs and other market participants can swap SDT, other stablecoins, or $LUNA, into UST via the protocol directly in order to profit from the price arbitrage while increasing the supply of UST and bring UST down to $1 again.

Quick math example:

The protocol mechanism will always value 1 UST = $1 worth of $LUNA using oracles to determine the market price of $LUNA.

If UST = $1.10 on the market, swap $1 of $LUNA into $UST in the protocol.

You spent $1 of LUNA to get $1.10 worth of $UST on the open market. Sell your overpriced UST to earn 10% risk-free profit, repeat until 1 UST = 1 USD.

If UST = $0.90 on the market, swap $UST into $1 of LUNA in the protocol.

You spent $0.90 to get $1 worth of $LUNA on the market. Sell your $LUNA for UST and repeat to earn 10% risk-free profit until 1 UST = 1 USD.

Okay you now have a basic understanding of Terra, and here is the takeaway:

Terra aims to pave over banks, credit networks, and payment systems like PayPal with one uninterrupted and rewarding blockchain experience. It is focused on bringing real-world use cases into the blockchain thanks to its stablecoins which makes this transition and adoption easier!

Now let’s go through Columbus-5!

1. Burn all seigniorage

Wow hold up what’s this sophisticated word?

This is how Google defines it:

Profit made by a government by issuing currency, especially the difference between the face value of coins and their production costs.

Terra’s core use case is its decentralized and algorithmic stablecoin backed by $LUNA. The most popular stablecoin is $UST, and anyone can mint $UST by burning $LUNA (you swap with the protocol and the protocol burns it).

In Teras’s case, whenever the demand of $UST goes up, to maintain the peg, the market burns $LUNA to mint $UST. This reduces the supply of $LUNA and increase the value of $LUNA, which is now owned by the system. This profit is called seigniorage and represents the profit gained from minting Terra stablecoins (and it costs next to nothing to mint!).

Currently a portion of the $LUNA burnt goes to the community treasury pool and oracle reward pools.

Columbus-5 will burn all $LUNA that is used to mint $UST. Considering how big the community pool is worth now (about $600m @ $8.15 / $LUNA), the extra burn is probably going to significantly drive up the price of $LUNA if the demand for $UST goes up.

Current community pool:

Note: To clarify, this amount won’t be burnt, but additional $LUNA earned from the seignorage on future swaps will be burned.

2. Stargate Upgrade (IBC)

IBC stands for Inter-Blockchain Communication Protocol. It enables Cosmos SDK based sovereign blockchains (Zones) to communicate with each other and transfer tokens across zones and run multi-chain smart contracts.

The cosmos ecosystem is huge with popular dapps such as Thorchain, Zilswap, and Demex on it.

Once more protocols enable IBC, they can start to interact with each other more seamlessly. This will allow for the entire ecosystem to grow and capture more value due to stronger network effects. This will likely also increase the $UST adoption as a truly decentralized stablecoin that is lacking in the cosmos ecosystem.

Not to mention the upgrade also increases transactions per second (TPS) by up to 10–100x, making it more scalable.

There is currently no established stablecoin in Cosmos DEXes such as osmosis dex. If $UST enters cosmos, it is possible that $UST becomes the defacto stablecoin of cosmos used for liquidity, and you can see $LUNA price mooning as much as how $BNB went from $30 to $300.

Not financial advice of course.

No stablecoins available on osmosis, one of the Cosmos Dexes:

3. Ozone Protocol

Ozone is an insurance mutual protocol that facilitates levered coverage of technical failure risks in the Terra DeFi ecosystem by Terraform Labs (TFL).

If you have seen the large number of exploits on ETH, BSC, and Polygon, and you are worried that Terra might be next, Ozone helps to insure against that.

Ozone will require a huge amount of $UST to be locked up as part of its insurance pool, and this will bring additional safeguard to the whole ecosystem while increasing the demand for Terra’s dapps.

4. Wormhole

I’m personally excited for this as I participate in the Solana ecosystem as well and wormhole is a bridge that connects Terra with Solana.

Solana is a high-performance blockchain used by builders around the world that is creating crypto apps that scale as they support over 50,000 transactions per second with block times of just 0.4s making it suitable to run apps that need to be updated near real-time and used by thousands of users.

Saber and Mercurial finance are two major stableswap Solana projects that have already started adopting $UST with more collaborations to come. The problem is that they only bridge wUST (ERC-20 wrapped UST) from the ethereum network which makes it expensive to bridge over due to eth fees.

Wormhole would make the ease of bridging much better, encouraging lots of $UST to flow into Solana and be adopted by Solana projects, increasing demand and adoption for $UST, which is bullish for $LUNA.

Conclusion

Columbus-5 would increase the use cases, adoption, and demand for Terra’s ecosystem and its $UST stablecoin, which in turn will result in a lot of $LUNA being burnt, which is bullish for its price.

There is no due date for Columbus-5 but it is expected to come Soon™.

Thanks to @terra_money, @coindicator, @sungjae_han, @coinkoio for inspiration and content for this article.