It’s legitimate for regulators to try to bring crypto and DeFi into the fold: Terraform Labs CEO

Do Kwon, Terraform Labs CEO, talks the explosive growth of Terra which is up 5,600% on the year.

Video transcript

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ZACK GUZMAN: In today's Crypto Corner, a refresher on stablecoins and why they are so important. As we saw this week with the SEC stepping in to prevent crypto giant Coinbase from launching a way for investors to earn interest on their stablecoin holdings, there's a lot of regulatory attention on stablecoins now. It's worth asking, what are stablecoins exactly? They're special cryptocurrencies designed to stay stable in value or pegged to a base currency.

In the case of the largest stablecoins by market cap, that means staying pegged to $1 US. And that gives crypto investors an easy way to cash out into stability during times of volatility without having to cash out into real physical cash. But that also begs the question, how do these stablecoins stay stable. And one way is just to keep an equivalent dollar value in the banks. If you have a $20 billion in the bank, you've got 20 billion stablecoins.

USDC, the second largest stablecoin, just opted to do that. Or you can back your stablecoin with slightly riskier assets in the bank, so to speak, with a mix of corporate debt cash equivalents, which is what the largest stablecoin tether has done for years. And both of those stablecoins have seen billions of dollars flow into them this year.

In fact, Tether's market cap has more than tripled in 2021, while USDC has seen its market cap grow by a factor of six to more than $26 billion. And as wild as the growth has been for them, there is a stablecoin out there that has seen even more explosive growth in 2021. That would be Terra's UST stablecoin that has seen its market cap swell by 13 times this year to become the fifth largest stablecoin.

And unlike USDC and Tether, it's not backed by cash or other real assets. It's actually backed by cryptocurrency as well, Luna, which is up nearly 6,000% year to date. And for more on that, I want to bring on the man behind all of it at Terra, Terraform Labs Co-Founder and CEO Do Kwon joins the show here today.

And Do, appreciate you coming on to chat, man. I mean, it's fascinating to see how this all works because you basically kind of built a Federal Reserve system here, burning Luna at a rate that keeps UST pegged to the dollar. But talk to me about how that works and maybe why you've seen so much growth this year.

DO KWON: Yeah, Thanks for having me, Zack. So how Terra works is instead of keeping $1 in the bank account for every stablecoin that's issued, you have a reserve currency called Luna that helps to stabilize Terra's peg. So the idea is that at any given time in order to mint one unit of Terra USD, you need to burn $1 worth of Luna. And then vice versa, if you're trying to redeem out of Terra USD, you burn it and then get $1 worth of Luna in return.

So this is a completely decentralized system, where you can have stablecoins that are issued by a community of holders of the Luna token. So the reason why this is valuable is there's a lot of regulatory movement coming from jurisdictions all across the world to censor the underlying bank accounts under stablecoins.

And this puts the threat really like all the different DeFi applications that are built on top of blockchains, which means that even if the smart contract logic for these DeFi applications are decentralized, if the underlying money can be censored, then it sort of defeats the purpose entirely.

The reason why decentralized currencies like Terra are important in gaining lots of attention is because it's free from those things, in the sense that because there's no underlying sensorable deposit, the logic that's governing the monetary policy of these stablecoins are entirely free from censorship.

ZACK GUZMAN: Yeah, and I should note-- I mean, maybe someone first watching all this, you know, you're not the the only algorithmically-backed stablecoin out there. There are the ones out there. But you kind of have a large payment system there, in South Korea also, kind of making Terra a bit different. So talk to me about, you know, maybe how that sets this one particular project apart from other coins that have tried to do the same thing you're trying to solve.

DO KWON: Right. So it's partially the payment system. But what I will say is that there's a lot of algorithmic stablecoins out there. And to our critics' credit, most of them have failed. And the reason for that is is because building an algorithmic stablecoin, the main challenge isn't to design some clever algorithm. So that is important. Mechanism design is indeed critical. But it's really about building the use cases around the economy.

So for example, the monetary policy of the US dollar isn't necessarily more sophisticated than those that govern that of smaller currencies. It's because the US economy is the most robust. And that allows the US dollar to be more stable than other types of currency out there.

Similarly, the way that we've sort of built out the Terra ecosystem is that there's a bunch of use cases leveraging Terra stablecoins from cases from savings, to payments, to synthetic price exposure investments. And I think those use cases really make the stablecoin more stable, because there's a stickiness to the sort of retail base use cases for Terra stablecoins.

In terms of payments, we launched the payment app called Chai in South Korea about two years ago. And to date, it's processing over $1 billion in payments per year. And it's being used by about 3 million users in the country. So I think these use cases sort of reinforce the stability of the Terra stablecoin and make it more useful as a currency overall.

ZACK GUZMAN: Yeah, and we're seeing it up another 3% or 4% today. I mean, the moves have been volatile in a lot of these projects that are looking to solve real problems. But I mean, to your point, something that catches a lot of retail investors' attention is the idea of that savings protocol anchor, as it's called in your ecosystem, that promises, what, 20% return on deposits.

And anyone watching this, anyone kind of critical of cryptocurrency might say, any time you've got guaranteed returns out there, people shout Ponzi scheme from the rafters. But why is it different? How do you offer, I guess is the main question I always hear people asking about Terra and Anchor, how you offer that 20% on deposit?

DO KWON: Sure. So right now, we have a savings protocol called Anchor, whereby you can deposit Terra stablecoins into a smart contract. And right now the interest that you earn on those stablecoins is close to 20%.

So reason why this is possible is because beneath the hood, Anchor is really just a money market, whereby there's sort of like another set of users that are taking out loans in Terra stablecoins that are collateralized by staking positions across multiple blockchains. So the interest rate for Anchor is really powered by block rewards that are coming in from blockchains, such as Ethereum, Terra Solana, and soon Polkadot and Cosmos.

So the proof of stake returns that are accruing to the underlying collateral gets conferred to the lender in the form of a stable interest rate. It does sound pretty complicated. But basically, the idea is that we've managed to stabilize the yield that is coming to multiple blockchain systems, so that allows you to earn a higher yield than what you would get at Wells Fargo.

Yeah, what is interesting too though, is that all of this is kind of a little bit more open, right? Coinbase got blocked from trying to offer 4% on a stablecoin, and as you're saying there, 20%. But it's because a lot of this cuts out the middleman. DeFi has been doing that. And it's kind of the intriguing piece to watch here and a question I think is important to answer, so I appreciate you answering it.

Of course, as you guys have kind of looked to build this all out, it's been important to, as you say, attract more users and see more activity in the ecosystem. And now you guys are committing a significant amount of money to kind of build that out, $150 million here, to try and continue to see people build and, I guess, design things for the Terra ecosystem. Talk to me about how important that is and why you're making that investment now.

DO KWON: Sure. So in order to become basic financial infrastructure for tens, hundreds of millions of people to use, you need a system that is stable and isn't susceptible to security breaches. So what we're going to be spending the $150 million on is to stabilize the infrastructure that underpins the Terra blockchain.

So we're going to be investing it into things like allowing the validator nodes that are running the blockchain to become more sophisticated and diversified, to make sure that the price feeds that are being used by our DeFi applications are robust and comes from multiple different sources, and to make sure that the core technologies that are sort of animating the Terra blockchain can be future proofed and become more sophisticated.

ZACK GUZMAN: And obviously, you know, I guess there are-- I'll just end on some risks here, as you see them around, kind of regulatory headwinds as maybe the SEC steps things up, as the Fed looks at stablecoins, I mean, how do you assess maybe those risks relative to what you're trying to build out, given that you guys aren't US based? How do you see those risks?

DO KWON: I think they are significant. And I think a lot of the recent movements by regulators trying to bring crypto and DeFi into the fold is legitimate. And I think investor protection is indeed important. So as an industry, I think we can do two different things.

Number one, we can decentralize, so if you actually run a broker dealer platform, sort of decentralization theater, if you will, and you're profiting tons of money at the expense of your users by being exposed to risk that they don't understand, then that's probably not appropriate.

But what we can do is to make sure that we can self-regulate as an industry and to make long term investments to make sure that our platforms are secure, that our investors have the full gamut of information of the risks, that they have to face and to make sure that in whatever ways that are possible, we work with regulators to make sure that we check off all the boxes, then I think that's basically putting the best foot forward in such an early industry.