In the chaos of launches, quirky models and shutdowns that characterize the world of stable-coins, it is almost never pointed out that, to the mainstream user, stable-coins are inferior to fiat currency. No matter how carefully designed the mechanism, their price stability can never exceed that of the fiat currency they are pegged to. The user experience of acquiring and using them is quite terrible compared to the dollar-based Venmo and Stripe; and many might not make best friends with the SEC, IRS & co. Is the promise of lower fees and “being on the blockchain” the best feature that stable-coins have to offer? Or can we do better?
Perhaps the answer can be found in the economics of stable-coins. All stable-coins are built around the following “solvency rule,” which simply states that the system must have sufficient collateral at hand to absorb falls in stable-coin demand.
collateral + demand floor >= outstanding currency
The most popular flavor of stable-coins these days are those that are 100% fiat collateralized, such as Tether, Circle, Gemini and Paxos. Several decentralized stable-coin projects such as MakerDao go even further, and maintain well over 100% reserves in cryptocurrencies. Though this is a responsible approach in designing fault tolerant systems, I think it’s also equally uninspiring; such systems make zero assumptions about the demand floor for their currencies because they were not designed with serious consideration of go-to-market strategies to capture long-term demand. Here we can do better. If we could somehow drive deterministic demand for the stable-coin, we could lower the cost of collateral and capture value by printing money.
seigniorage = new minted currency - cost of acquiring collateral
Seigniorage refers to the value of newly issued currency less the cost of issuance, which for a stablecoin would be the cost of acquiring external collateral such as fiat. Though this may sound too good to be true, it is also a universal feature of every fiat monetary system. Central banks follow the solvency rule (more or less) just like any stable-coin, and capture a secondary tax income stream through minting new currency. And just as in taxation, a significant portion of this income is used to finance fiscal spending in the form of subsidies, tax breaks, government projects, and investments pursuant to a broad mandate of social betterment.
At Terra we see seigniorage as fuel with the potential to make stable-coin applications fundamentally superior to fiat-based counterparts. If we can find a way to bootstrap steady demand for Terra and capture healthy seigniorage, Terra could finance fiscal spending of its own and subsidize its dApps. Seigniorage subsidies will change the value proposition for Terra dApps to make them fundamentally superior to fiat based systems. For example:
- For a payments app, users can get a discount on the goods purchased compared to goods purchased via Visa
- For a credit app, seigniorage can be used to make interest rates more competitive
- Insurance apps on Terra can charge lower premiums
- Non-financial businesses can see a valuable source of revenue in seigniorage
To scale seigniorage, we present a blueprint of how we will bootstrap steady demand for Terra, and how the system will deploy seigniorage effectively to drive even more demand.
How to Bootstrap Demand
Terra’s initial growth will be bootstrapped by an e-commerce payment gateway, TerraX, that is slated to be integrated into checkout processes of 15 e-commerce platforms across Asia collectively processing 25 billion USD in volume and 40 million monthly active users. (For list of partners, check out our website at www.terra.money). TerraX’s UX is pretty simple: the user “tops up” Terra by linking their bank accounts to TerraX, and can expend Terra by buying goods and products at partner e-commerce websites. The amount of Terra held by the system at any given time is a sum of tokens not yet redeemed by customers, and not yet settled, i.e. payments received by TerraX but not yet wired to merchants.
The amount of Terra locked in TerraX’s user accounts & settlement processes forms the initial demand floor for Terra. As TerraX grows its transaction volume, the amount of Terra locked up in the system also increases, driving up demand in the Terra money market and resulting in the issuance of more currency.
A significant portion of Terra seigniorage will be used to fund transaction discounts on TerraX. For payments, the single most tangible benefit to consumers is to make the very product they are about to buy cheaper. Discounts are a tactic generally used by most pay services starting off, but none are able to provide it on an ongoing basis because discount promotions are also the costliest. For TerraX, Terra is able to reinvest economic growth to provide ongoing discounts to consumers, forcing any smart consumers who compare prices to switch. This will eventually result in a virtuous positive feedback loop for Terra demand, where growth begets seigniorage and discounts beget further adoption.
Furthermore, Terra adoption initially rests on the shoulders of the one of the fastest growing industries on the planet: Asian e-commerce. The e-commerce market is projected to grow by 15% in Korea and 30% in SEAsia over the next 10 years. The SEAsian market in particular is expected to be a huge growth driver for us, seeing as economies in the region are amongst the fastest growing in the world and people are gaining access to the web at a staggering rate. One of our SEAsian e-commerce partners, for instance, grew its volume by 4x over the past 6 months alone. This is a massive tailwind for Terra: we get to ride this growth simply by retaining volume share in our Alliance partners.
We have high expectations for TerraX’s growth, bootstrapped by a launchpad of partners doing 25 billion USD in GMV, and with an ongoing promotional tool that make goods it carries cheaper relative to the competition.
How to Scale Stable Demand
An interesting property of payment systems is their “stickiness”; once consumers lock into a means of payment, they rarely switch to others. The steady growth of Visa, Paypal, and Alipay is a testament to this. This means that for adjacent settlement periods of the payment gateway, we can expect high retention in transaction volume; 100M in volume in a given month is extremely unlikely to drop down to 5M in the next month. As TerraX grows and adds merchants operating in diverse industry verticals across many countries, its volume volatility will decrease as volume churn in any single merchant will be smoothed out by the larger group.
As Terra’s economy grows beyond TerraX and becomes more diversified, Luna will start to pull its own weight as Terra’s principal reserve asset. Luna is the PoS mining token for Terra, and therefore miners staking Luna capture transaction fees from all Terra dApps. Diversification in the underlying Terra economy means Luna derives fees from many sources with low correlation, and therefore can remain resilient while financing contractions for Terra. Beyond e-commerce, currently Terra is working with the Mongolian government to reshape the country’s financial services landscape with a pilot payment program in Ulaanbaatar City; this program will eventually be used to enable utilities and tax payments, as well as everyday retail payments under the auspices of a sovereign state. Terra is also working with a handful of large businesses looking to tokenize their loyalty points businesses, a premium sushi restaurant chain, a carbon cap exchange, and many more at various stages of development.
After Terra achieves sufficient scale and diversification, it can reach a frontier that Ant Financial or PayPal can never match: a zero fiat reserve. There are limits to how much payments juggernauts can leverage negative working capital, as risk is contained to the balance sheet of a single company. On the other hand, Terra will be a currency infrastructure to be shared with tens of thousands of fintech businesses across the world in a permission-less format. Such an infrastructure should be considered to be analogous to a national currency regime rather than a private fintech platform; risks and contractions are absorbed by the entirety of the alliance of Terra dApps and its users rather than by one entity.
Stable-coins entail risks that by default make them inferior to fiat currencies. We think that Terra can change that equation by re-investing seigniorage back into the economy, thus rewarding users and incentivizing innovative applications to be built on its platform. Sustainable seigniorage for a currency depends on two factors: growth in the money supply and limited dependence on fiat collateral. We are extremely optimistic about Terra’s growth, both because of its innovative strategy to re-invest seigniorage and because of the powerful growth tailwind behind Asian e-commerce. We further expect Terra to rely on fiat collateral less and less as it grows: demand for Terra should become increasingly sticky and diversified, and Luna should become increasingly robust collateral to replace the need to fiat. We see sustainable seigniorage as a force to propel Terra’s economy to the scale and self-sufficiency only fiat currencies have been able to achieve, yet with the innovation and transparency that few national governments can aspire towards.
Special thanks to Terra’s Nick Platias for his assistance in writing this post.