Columbus-5 Terra upgrade: LUNA’s deflationary moment explained
Columbus-5 is set to grow the Terra ecosystem by introducing DeFi apps and interoperability with Solana and Polkadot.
The Terra blockchain has seen an exponential increase in popularity and media coverage during 2021. Its native utility and staking token LUNA has made its way onto many investor’s shortlists. It has spent much of the latter half of 2021 in the top 10 cryptocurrencies by market cap, if you exclude stablecoins.
While the token has already enjoyed considerable growth since the start of 2021, there is a significant catalyst on the horizon that many in the cryptocurrency community are still unaware of: the Columbus-5 upgrade.
The Terra blockchain
Launched as a chain on Cosmos, Terra is an open-source blockchain focused on improving the global payment system’s efficiency. The blockchain facilitates a stablecoin ecosystem, which allows Terra to offer a fully connected payment service. When compared to the traditional disjointed system, the network greatly reduces transaction fees for retailers. Developers can also build decentralized applications (dApps) directly on the network.
Terra’s operations rely upon two key elements: the utility token, LUNA, and Terra stablecoins, such as TerraUSD (UST). Terra stablecoins are similar to USDC and USDT. However, instead of fiat currency reserves, Terra’s stablecoins remain pegged by a seigniorage (burning and minting) mechanism and a price-stability algorithm.
LUNA is used to maintain the peg of all Terra stablecoins. If the demand for Terra’s UST increases, UST prices will rise above $1. The price-stability algorithm would then incentivize LUNA token holders to burn LUNA and mint UST for a small profit. The influx of new UST reduces the price back to $1. Inversely, if demand for UST decreases and drags the price below $1, UST can be burned for $1 worth of newly minted LUNA – again, generating a small profit. This process keeps all Terra stablecoins pegged to their underlying fiat currencies.
As a result of the system’s tokenomics, demand for Terra stablecoins pushes demand for the LUNA utility token. Currently, $7.3 billion is locked within the ecosystem. However, the upcoming Columbus-5 upgrade could result in a substantial increase in capital within the Terra ecosystem.
Labeled as a game-changer by many, the Columbus-5 upgrade will consist of three main changes: a change to the burn rate of LUNA, the introduction of the Ozone insurance protocol and the Wormhole bridge to Solana, and the integration of the Stargate interconnection protocol. The three updates will improve value, scalability and interoperability for users.
New burning mechanism
LUNA is integral to the operations of Terra. As part of the current price-stability mechanism, any LUNA tokens burned to mint UST are transferred to a community pool. That pool is then used for rewards. However, the influx of LUNA is now too high.
To alleviate supply and increase value, all LUNA tokens used for price stability will be burned permanently rather than transferred. The new deflationary characteristic will provide stronger returns for LUNA holders and increase staking rewards.
Ozone and Wormhole
The second part of the upgrade focuses on Terra’s native application deployment.
As DeFi is becoming a fundamental part of Terra’s ecosystem, the Columbus-5 upgrade looks to tackle the challenge of insurance. A new insurance protocol, Ozone, will become the insurance protocol of choice for dApp developers. Developed internally by Terraform Labs, the protocol will cover assets locked within dApps, a process that may lock up a significant portion of UST.
Alongside Ozone, a bridge between Terra and Solana will also be activated. Better known as Wormhole, the bridge will allow seamless movement of UST into the Solana ecosystem, which could increase demand. The upgrade may also initiate the launch of several Terra-to-Solana exchange projects, again driving increased value for users.
The final part of the upgrade is the integration with Cosmos’s Inter Blockchain Communication (IBC) Protocol, Stargate. The integration will fully onboard Terra into the Cosmos ecosystem and allow for interchain asset transfer between other Cosmos blockchains, Solana and Polkadot, greatly widening the reach of the network.
The long-anticipated upgrade to Stargate will enable dozens of new applications to launch on the Terra network and allow a host of new dApps to utilize Terra’s stablecoin, UST. With increased interoperability, it could mean UST becomes the go-to stablecoin for much of the Cosmos ecosystem.
How will Terra be affected?
The launch of Columbus-5 has been closely followed by the Terra community. Many speculate a quick rally of LUNA prices due to the promise of increased economic activity. Although a tempting prospect, LUNA’s market value upon launch remains to be seen.
What is more certain is an increase in staking rewards. Thanks to the new burning mechanism, LUNA stakers are likely to see returns rise accordingly.
Although it is impossible to determine the impacts on price, the increased scalability and interoperability of Terra’s mainnet should enable wider use of UST. The wider use of UST could place the stablecoin as Terra’s answer to DAI, a competing stablecoin that uses a similar price-stabilization mechanic. If that becomes a reality, LUNA stakeholders could be in for a bright future.
The Columbus-5 upgrade is scheduled for 3:30 a.m. UTC on September 30. While the upgrade is being implemented, it is advisable to steer clear of all Terra-based applications. Although unlikely, transactions taking place at this time may run into trouble.
Disclosure: The author owns a range of cryptocurrencies at the time of writing