I’ve read the Terra Whitepaper three times over the past few months and I still could not understand seigniorage until today. according to the whitepaper, seigniorage is defined as value of coin minted minus cost of production. In terra, the cost of producing a token is essentially zero, so it earns 100% the value of coin minted.
So what is the seigniorage for burning $1 worth of Luna to mint 1 UST ? Is it $1 worth of LUNA?
Yes it is!
Pay attention that it is actually $1 worth of LUNA, not 1 LUNA token. $1 worth of LUNA does not equal 1 LUNA token.
But how does the Terra protocol actually earned this $1 worth of LUNA if LUNA gets burned when UST is minted? Doesn’t burning mean sending the LUNA to a burner address and it is never recoverable?
Apparently, that definition of burning only applies to Ethereum at least, not Terra. Terra has a different mechanism or burning and minting token. Terra has a module for the minting/burning of its native tokens, aka LUNA or UST or the other stablecoins. This is a built in feature of Terra, right at the blockchain level, not in a smart contract,
Terra doesn’t use a burner address to burn LUNA. So basically, swaps are done all day long and the LUNA is burned, Terra keeps track of the burned LUNA and remints them at the end of each epoch. The reminted LUNA becomes the seigniorage that Terra earns. Prior to col-5, a portion of LUNA is reminted and send to the community pool. Now post col-5, no LUNA is reminted as all seigniorage is burnt!
As for the minting/burning mechanism of its native tokens built in the blockchain level, I didn’t find much info about it. those who know feel free to share. Otherwise, I feel so satisfied to get over this mental block of mine. Ethereum’s concept of burning was preventing me from understanding Luna’s unique burning and minting mechanism.