Terra has been designed as a family of stablecoins that are frictionlessly swappable. UST, pegged to the USD, can be swapped to KRT, pegged to KRW, with little to no friction. The motivation for the design was two-fold:
- We plan to make Terra widely used in multiple markets, each with its own regional currency. A locally pegged Terra is key for low-friction everyday use.
- There is substantial need for low-friction cross-border transfers, usually involving currency exchange. The $700 billion global remittance market is a key use case.
An unintended consequence of this design is that it also permits frictionless forex trading, allowing speculators to make positional bets on their favorite currencies. For instance, a speculator who wants to bet that the USD will appreciate relative to KRW could sell her KRT for UST, later sell the UST back for KRT in hope of a profit. The system profits when they lose, and loses when they profit. There is little reason to believe that the savviest of forex traders will move their business to the Terra platform. In fact, there are limitations to forex trading via Terra swaps, which we describe soon, that make this method fundamentally inferior to alternatives. Nonetheless, the ability for speculators to profit from exchange rate fluctuations against the system represents a downside risk that we want to minimize. Facilitation of speculative forex trading was never the goal of Terra swaps. A lengthy discussion of the problem is available here.
We are therefore faced with the following problem: how do we design Terra swaps in such a way that cross-border money transfers are frictionless, while at the same time discouraging speculative trading?
A handful of observations:
- The cost of remittance is substantially higher than the cost of forex trading. While the global average cost of remittance is a usurious 7%, the cost for a retail investor to trade online a relatively liquid currency pair like USD/CHF, including market spread and broker commission, is on average less than 2 basis points, i.e. 0.02%. The cost of remittance based on those numbers is 350x the cost of trading, two orders of magnitude larger.
- The average remittance amount is substantially lower than the average size of a forex trade. The global average monthly remittance from developed to developing countries is $200. Average forex trade sizes are significantly larger – usually in the $100K’s for retail investors and in the high millions for institutionals, in other words, three or more orders of magnitude larger.
- The majority of forex trading, including retail, is highly leveraged, meaning that trade sizes are large multiples of account balances, often as high as 400x. The provision of margin for leveraged trading is an essential service that brokers provide to their clients. Leveraged remittance, on the other hand, has not been invented yet.
It is clear from the above observations that remittance and forex trading differ vastly in terms of their transaction amounts, cost and required services. It seems that to facilitate the former, while discouraging the latter, cross-Terra swaps should:
- be substantially cheaper than remittance, yet more expensive than forex trading
- be frictionless for small amounts, yet penalize large amounts
In addition to the above, the lack of a margin offering tailored to forex trades makes trading with Terra swaps a priori uncompetitive to existing options. When a liquid Terra lending market does emerge, the above measures ought to make sure that Terra swaps are a strictly inferior option to traditional alternatives.
What is a reasonable cost that we should target for Terra swaps? Are those measures enough to achieve our objective of frictionless remittance and expensive trading? Other suggestions?