Try Quests to earn cryptoMarket Module
This dashboard explores the inner working of Terra's Market Module and looks at how well it has been performing its stated goals.
Terra's Market Module enables swaps between its native stablecoins, and between its stablecoins and LUNA. It aims to ensure an available liquid market, fair prices, and fair exchange rates. It also aims to maintain the price stability of Terra's stablecoins.
Terra's Market Module maintains liquidity through the use of a 'Constant Product' algorithm. A Constant Product, CP, is set to the size of the Terra pool multiplied by the fiat value of LUNA. For example, if there is Terra pool with 1000 SDR, and the exchange rate between LUNA and SDR is 0.5, the LUNA pool's size would be 2000 LUNA. The main advantage of using the Constant Product mechanism is that users can make successful swaps regardless of size.
Terra uses validator price oracles to determine the current prices of assets. These oracles determine the price of assets with a one-minute delay from reported and real time price. To ensure that this temporary price difference cannot be taken advantage of the Market Module includes the Tobin tax and minimum spread swap fees. The Tobin tax is a minimal swap fee of around .35% that is paid by the swapper for each transaction. The minimum spread fee is .5% and follows a similar logic as the Tobin tax.
Price stability of Terra's stablecoins, such as UST, is achieved through the minting and burning of its governance token, LUNA. When the price of UST drops below its peg of $1, users can take advantage of the arbitrage opportunity by burning 1 UST for $1 worth of LUNA. When the price of UST is above $1, then LUNA holders can burn $1 worth of LUNA to get 1 UST. This method takes advantage of market forces and arbitrage incentives to keep the peg of stablecoins.
The UST supply has been steadily increasing over the past six months, as the LUNA supply has been decreasing. This shows Terra's minting and burning mechanism in action, as the supply of UST increases, the supply of LUNA contracts. This is because as UST demand increases, the price of UST rises, and so LUNA is burned to mint UST to meet the growing demand and to earn a profit for arbitragers.
As the UST supply has been steadily increasing over the past six months, the price of LUNA has also significantly increased, despite a dip in February. The UST supply increased from about 3.3 billion in October of 2021, to over 18 billion in April of 2022, while the price of LUNA increased from about $37 to over $100. This is because as the UST supply increases and LUNA supply contracts, the price of LUNA in turn increases.
Over the past six months, UST has been holding its peg to the US dollar very closely except for a few significant fluctuations, specifically on February 23rd, when UST fell ~.6% below its peg. Besides this dip and a few others, UST usually stayed within .1% of its peg, which is only about $.001 off of the dollar, a negligible difference when it comes to trading.