Risks and Rewards when Staking Luna on the Terra Network
This article is an overview of staking on the Terra network. It covers risks to consider and rewards to expect, as well as how to participate.
First, let’s start with a basic description of what the Terra network is. Terra centers around an economy of price-stable cryptocurrencies that are integrated into various applications and processed on the network, e.g. via their mobile payment application CHAI. The network’s token Luna ($LUNA) mainly fulfills three purposes:
Luna is used…
- …to mint Terra stablecoins.
- …to ensure these stablecoins stay at their peg.
- …as a staking token on the network.
Price Stability
The Terra protocol includes an automated market maker, a mechanism designed to algorithmically guarantee that Terra stablecoins stay at their desired peg. This is achieved as follows: the protocol enables arbitrageurs to exchange stablecoins and Luna at a fixed peg rate, which allows them to profit from deviations in the market. The protocol automatically mints or burns Luna tokens (expanding or contracting the supply) depending on how external parties interact with the protocol. Terra relies on arbitrageurs exchanging tokens with the automated market maker and trading on the open market to dynamically return Terra stablecoins to their peg. There are multiple resources that cover this mechanism in-depth, e.g. our whitepaper walkthrough or the official documentation. A key insight is that Luna is used as the lender of last resort should a stablecoin lose its peg downward. Luna holders are diluted to absorb this type of volatility.
Staking Rewards
The Terra design counters this in multiple ways. For one, rewards earned from transactions processed in the network are distributed to those staking Luna tokens. A larger portion of Luna tokens staked results in a larger share of the tx fees received. Transactions on the network charge a 0.1–1% fee per tx (capped at 1 TerraSDR). The percentage dynamically adjusts based on the demand for transactions on the network to smoothen economic cycles. Rewards are largely received in stablecoins, as most transactions on the network happen denominated in stablecoins.
Additionally, the protocol charges a small spread for atomic swaps between Terra stablecoins. These fees are distributed to validators that correctly vote on Terra price oracles (more below). Atomic swaps are capped to limit the volatility in Luna supply. Currently, the spread taken increases linearly from 2% up to 10% when the daily cap is reached.
Furthermore, the protocol also burns a portion of Luna (currently 5%) sent to the protocol when issuing Terra stablecoins. Burned Luna indirectly rewards Luna holders by contracting the overall supply. The official Terra documentation expands on these topics.
Finally, a recent change introduced an equivalent of block rewards to support the staking ecosystem while the network is in its growth phase. A community initiative that pays out a part of the Luna treasury to those staking was implemented. In the first year 21.7mn Luna have been committed to this effort. This corresponds to a ~10% staking yield at the current staking ratio (at the time of writing there are ~225mn Luna at stake, see e.g. here). In total 100mn Luna have been committed to keep staking yields competitive in the short to medium term. You can learn more about Project Santa here.
Other Features
The Terra protocol includes a sophisticated oracle design to maintain the exchange rate between stablecoins and Luna. This design is still in flux. Core to it is that validators cast votes on price feeds and receive rewards from swap fees based on the correctness of their votes (measured by considering deviations from the median of all votes).
Finally, Terra uses the remaining seigniorage (Luna sent to the protocol for minting stablecoins) to stimulate growth of the Terra economy. This is out of scope for this article (more on this can be found here or in the whitepaper).
Key Factors to Consider when Staking
The following will focus on summarizing the factors that have an influence on the staking lifecycle, as well as provide details on the currently implemented values that need to be considered.
As Terra is using a design similar to that of the Cosmos Hub, refer to our more comprehensive Cosmos Staking Primer in case you are new to staking or unclear about what is meant with some of the following terms.
Reward Factors
- Staking Ratio. The higher the share of the supply staking in the network, the lower the rewards given to those staking. Staked and total supply can be found here.
- Transaction Fees. The protocol charges fees of 0.1–1% (capped at 1 TerraSDR per tx) on transactions happening in the network. These fees are distributed pro-rata to stakers. Higher transaction volume results in growing staking rewards for stakers.
- Swap Fees & Oracle Voting. The protocol charges a spread between 2–10% on swaps between Terra stablecoins. Currently, every minute swap rewards are redistributed to validators that voted within 2% of the median of all price oracle votes in the previous minute. Validators consistently and faithfully participating in the price oracle are able to increase rewards for their delegators.
- Seigniorage. 5% of Luna sent to the protocol to issue Terra stablecoins is burned, indirectly rewarding Luna holders by contracting the supply.
- Block Rewards. At least 21.7mn Luna will be paid out to stakers in the first year of operation to subsidize the staking ecosystem in the growth phase of the network. In total, 100mn Luna have been committed to keep staking yields competitive in the short to medium term.
- Compounding Rewards. Rewards made while staking in Terra accumulate in a pool and need to be withdrawn. Frequently withdrawing, converting these rewards to Luna, and re-staking them will increase returns through compounding.
- Commission Rate. Each validator on the Terra network specifies a percentage that he is charging on rewards earned on delegated tokens. A higher commission rate results in lower rewards for delegators.
Risk Factors
- Stablecoin Peg Adjustment. In case of stablecoins lose their peg downward, LUNA will be minted to stabilize the price. This mechanism dilutes Luna holders, who absorb this type of volatility.
- Equivocation Slashing. Validators double-signing a block will lose 1% percent of their total stake (validator and delegators!).
- Downtime Slashing. Validators missing 9,500 blocks within a window of 10,000 blocks (95%) lose 0.01% of their stake. In human terms this translates to being offline for about 15 hours and 50 minutes within a window of 16 hours and 40 minutes.
- Jailing. When reaching the downtime threshold, validators are jailed for at least 10 minutes. During this time they won’t participate in consensus and will need to send a message to the protocol to unjail themselves again. When jailed, no rewards are earned.
Automatic Unbonding. There are scenarios in which delegators unbond from their validators and stop earning rewards from staking as a result. In all of these cases, delegators need to manually stake their tokens again. Scenarios are:
- Validator gets tombstoned (taken out of the validator set) after double-signing.
- Validator shuts down his operation (sets self-bond below the specified minimum self-bond).
- Validator falls out of the fixed validator set of 100. If a validator’s stake falls below the 100th spot in terms of total stake, he will no longer participate in consensus.
Other Considerations
- Unbonding Period. The waiting period when withdrawing stake from a validator enforced by the protocol for safety reasons is 21 days. Only after 21 days have passed withdrawn stake can be accessed. During those 21 days, no staking rewards are earned.
- Re-Delegation. Delegators can change their validator without having to unbond. At maximum 7 re-delegations per account can take place at a time. Each re-delegation happens instantly, but the same stake can only be re-delegated again after one unbonding period.
How to Stake
To stake Luna, you need to first obtain $LUNA tokens. CoinGecko e.g. lists available exchanges. The easiest tool to stake your Luna currently is through the official Terra Station wallet. The Terra team released this guide that walks you through the wallet. Terra Station will soon also have Ledger support, meaning you can store and stake your Terra tokens on a Ledger.
Conclusion
Chorus One is operating a highly available and secure validator on the Terra network. Stake today to start earning while supporting our work. Visit our website to learn more about our Terra validator!
To re-iterate, returns from staking Luna depend on a variety of factors. Some of which are dependant on the performance of the validator you choose to delegate to, others depend on network activity and various parameters in the protocol. Do due diligence on the project and validator(s) you aim to delegate to. Take into consideration the various implications described in this article before obtaining and staking Luna.
Many of the variables described in this post are subject to change and will be governed by Luna holders to optimize for the success of the Terra economy. At Chorus One, we are excited to contribute to the success and health of the Terra network. By staking with our validator, you are supporting our contributions and the effort we put into helping Terra succeed. Follow us on Twitter or join our Telegram to stay informed and in case you have questions!
Resources
Terra Website
Official Terra Documentation (best to understand the actual protocol)
Terra Agora Forum
Chorus One Terra Whitepaper Walkthrough
Chorus One Interview with Terra Co-Founder Do Kwon
Originally published at https://blog.chorus.one on August 28, 2019.
