The Internet Computer vs Terra Luna: Investigating Good Token-setups & Bad Token-setups
The Terra Luna fiasco that sent the markets tumbling approximately three weeks ago sent a bitter shockwave throughout the crypto community. It reminded everyone, including all the investors, macro analysts, developers, marketers, VCs, average-joes, Web3 fanatics, blockchain enthusiasts, and crypto maxis that due diligence about a network and its activity is always needed. Never is it appropriate to get too excited about a specific project and hype it up, thus blinding ourselves to market disasters.
So given the collapse of the Terra blockchain and the network’s native stablecoin UST, let’s take a closer look at what happened and compare it to our favorite, the Internet Computer’s ICP and Cycles, which has a much healthier tokenomic organization.
What Happened To LUNA & UST?
First, to understand what happened it’s important to understand TerraUSD (UST) and the Terra blockchain’s native cryptocurrency, LUNA. UST is an algorithmic-backed stablecoin native to the Terra ecosystem, and Luna is the native cryptocurrency that’s used for staking, governance, and paying for transaction fees on the network. UST is a stablecoin meant to increase the use of payments and other economic activity on the blockchain. Most significantly, it’s an algorithmic stablecoin, which many people have their suspicions about.
To expand on that, the main crux and weakness around UST is that it operates using a seigniorage shares model, which requires LUNA to absorb the volatility of UST. Thus, what triggered the LUNA collapse was that a few large holders of UST began selling their UST. And the mechanism that occurs when an individual sells UST is that one USD-worth of Luna is minted, which means the demand for Luna is the backing for the value of UST. So when people started selling UST, it began a spiral of crazy minting for LUNA, therefore, the LUNA supply skyrocketed into the trillions. The chart below illustrates the supply change in LUNA as the UST selloff was happening.
However, this still doesn’t explain why people started selling UST. To answer this question, another problem with UST was that its demand was inorganic. The biggest source for UST demand and the main use case was for earning interest on Anchor Protocol. In fact, 70% of UST supply at the time was locked into Anchor, which gave those individuals 20% on their stake (among the highest interest earners on all stablecoins). This high APY was unrealistic, and many people pointed this out on Twitter. This resulted in a bank run on Anchor where users began to withdraw their tokens and cash out, which lowered Anchor’s TVL from $20 billion to around $6 billion in just two to three days.
In summary, there was a huge amount of on-chain selling on Curve, people then withdrew their UST from Anchor and other decentralized pools to the exchanges and began selling, which led to off-chain selling on centralized exchanges, and thus inflating the LUNA supply, which created an impossible-to-stop selling pressure on LUNA, thus causing it to lose its value, and then lastly, the Luna Guard Foundation was forced to liquidate its holdings of UST, Bitcoin, and AVAX.
It was a terrible collapse, and all because UST is under-collateralized with a peg driven entirely by on-chain incentives, which all decreased immensely when the triple entente of UST, LUNA, and BTC selling occurred.
As LUNA currently stands, its circulating supply is at 6.5 trillion tokens. Interestingly, just a month before the crash happened the supply was in the 300 millions. So from the second chart below, you can see how the coin’s supply increased almost 2 million percent, which is just an outrageous number.
TerraUSD (UST), on the other hand, has a supply of 11.3 billion tokens. As you can see in the chart below, UST’s circulating supply dropped once it lost its peg, which is of course, by design.
The underlying lesson is that for an ecosystem and stablecoin to work, there needs to have a healthier relationship between the two tokens, and one that’s not reliant on the positive demand for volatile assets and unrealistic APYs. Organic demand is really the “holy grail” for any blockchain project and DeFi offering.
The Internet Computer’s Tokens: ICP & Cycles
There are two native tokens involved in the Internet Computer. The first is ICP, which is the native governance token that’s used to manage the network, and the second is Cycles, a stablecoin that’s used to fuel computation.
The ICP token’s three functions are facilitating network governance, rewarding network participation, and producing Cycles for network computation. The first two functions are inflationary and the last one (producing Cycles for network computation) is deflationary. This last point is the key difference between ICP and Luna i.e., deflationary characteristics that match supply and demand.
The current total supply for ICP tokens is 482 billion and the circulating supply is 234 billion. Below we’ll get to what this means in the context of the network and if it’s a concern or not.
Why Does The Internet Computer Have A Better Tokenomic Setup Than Luna?
The answer is simple, organic demand. The Internet Computer’s tokenomics is based on organic demand, because in order for developers to create apps on the network, in order for smart contracts to run, and in order for services to operate, these functions need Cycles. Cycles is similar to gas and oil in the energy sectors. In order for the economy to run, for people to get to work, and to keep their houses heated during the winter, they need gas or “oil.”
So what happens in this context is ICP is converted into Cycles as fuel for computation by canisters, which are the “smart contracts” of the network. Software canisters must be charged with Cycles to run, which are then burned during the process of computation or memory management.
Metaphorically speaking, this means gas is burned when a person is driving their car. So when the fuel tank is empty, they need to recharge it — or environmentally-friendly speaking, a person needs to recharge their EV.
Therefore, as the amount of computation on the network grows, the demand to burn Cycles increases, and thus more ICP is burned. This kind of setup is most preferable for a competitive and market driven business.
Most importantly, it’s deflationary. Essentially, what happens on the technical side is data center and neuron owners exchange ICP tokens with canister owners and managers — and those canister operators convert ICP to Cycles, and subsequently use those Cycles as fuel to enable the Canisters to run. This process is shown in the picture below.
So now that we know how this process works, let’s look at the charts to see how this burning mechanism is run and if it’s healthy. The chart below shows that the total ICP burned has increased exponentially since the start of 2022, which means this year we’ve seen an increase in ICP burning and thus network use by various applications and services.
Conclusion
The ICP-Cycles relationship is positive and is a much better way of organizing a network compared to Terra Luna. But moving forward, if the ICP tokens that are burned gets into the hundred thousands, it’ll mean there’s much more adoption on the network taking place. So as more applications get developed on the IC, especially in the Web3, DeFi, NFT, and internet services sectors, this number will increase by magnitudes. When this happens, the price will reflect positively for ICP as well.
