The “road to hell is paved with good intentions,” but that’s no comfort to the many people who have lost all their money as a result of the estimated US$50 billion Terra UST/Luna crash, a crash that took place in just three short days. A decentralized stablecoin designed as the ultimate payments system “combining the price stability and wide adoption of fiat currencies with the censorship-resistance of Bitcoin” that didn’t require any financial collateral seemed fine in principle, but when it stopped working, human collateral damage was the end result, both in terms of loss of savings and devastation of lives.
The repercussions are just starting to be felt, from talk of government regulation from U.S. Treasury Secretary Janet Yellen, to Tether temporarily losing its 1:1 peg to the dollar to as low as US$0.95, and the impact on the price of Bitcoin thanks to Terra selling off its collateral reserves in a vain attempt to shore up the value of its UST stablecoin.
To confirm the basic point driving one of the biggest collapses in crypto’s short history, last Thursday Terra’s pegged Luna token dropped in price from its high in April of US$118 to US$0.09, while TerraUSD (UST) hit US$0.04. And despite all that, plenty of self-styled #LUNAtics — the project’s fans, including developers and Terra itself — refused to admit the party was over. In a Twitter thread on Wednesday, May 11, the ever-confident Terra co-founder Do Kwon tried to sound reassuring, telling the Terra community: “I understand the last 72 hours have been extremely tough on all of you — know that I am resolved to work with every one of you to weather this crisis, and we will build our way out of this. Together.” That didn’t work.
“You can’t mint your way out of bankruptcy all the time,” tweeted Binance CEO Changpeng Zhao, also known as CZ, after Terra announced that their blockchain had resumed block production as if there’d just been a technical hitch.
Part of the core problem is that what drove Terra’s initial success is what also helped drive it into the ground. Do Kwon’s aim to build a payments platform better than Bitcoin and with an ecosystem of dApps to rival Ethereum, according to one analysis, meant it targeted a “stablecoin product built to compete directly with traditional financial settlement networks on a customer basis,” and that unlike other third-generation blockchains, “it isn’t necessarily competing for developers and cryptocurrency native users — it’s going after real-world people.” The other component, highlighted by CoinRoutes CEO Dave Weisberger, is Kwon’s pivotal role in silencing critics and avoiding transparency: “He publicly tried to humiliate critics that pointed out risks. That, considering the power of social media & his notoriety, was VERY problematic.”
Taking a step back from this mess, what caused the collapse of the UST/Luna system? And what happened to the US$3.5 billion Bitcoin that Terra had bought to steady the ship? Rumors that either the hedge fund Citadel, the asset manager BlackRock or crypto exchange Gemini created the crash have been rejected by the companies, and persuasively shot down by B2C2 founder Max Boonen.
Any discussion of the cause of the crash cannot ignore that as an algorithmic stablecoin not pegged to any collateral, it used a two-token system, allowing users to swap Luna to Terra’s UST and vice versa for a guaranteed price of US$1, with the difference that it was based on its own layer-1 blockchain. And Terra’s UST was itself propelled by a key dApp on that blockchain called Anchor, which was offering yields of 20%. Anchor’s total value locked (TVL) grew from US$8.65 billion on Jan. 1 to US$17.05 billion at its peak on May 6. And as UST began to show signs of strain in late March, a team in the form of the Luna Foundation Guard (LFG) started to buy Bitcoin, amounting in total to US$3.5 billion between January and May this year.
It should also be noted that as an algorithmic stablecoin, UST is not a decentralized stablecoin. Terra used a consensus mechanism called “delegated proof of stake” (DPoS) that meant control was in fact concentrated in the hands of “a few validators” — no doubt the same hands that controlled the Bitcoin collateral. On May 9, LFG announced that it would “Loan $750M worth of BTC to OTC trading firms to help protect the UST peg,” which, according to Elliptic, was followed by a further US$930 million, to the same address, and the 52,189 BTC was sent together to a Gemini address. CZ tweeted on Sunday May 15, “I would like to see more transparency from them. Much more! Including specific on-chain transactions (txids) of all the funds. Relying on 3rd party analysis is not sufficient or accurate. This is the first thing that should have happened.” This was eventually confirmed by the LFG on May 16 in a tweet: “Transferred 52,189 $BTC to trade with a counterparty, net of an excess of 5,313 $BTC that they have returned, for an aggregate 1,515,689,462 $UST.” With just 313 BTC remaining (approximately $9 million, plus other assets) as highlighted by Laura Shin on May 16.
What is needed now is a plan to solve this crisis, which is not just for Terra and its users who have lost so much but also to restore confidence in the wider crypto market, which has suffered tremendously both materially and in loss of trust. Terra’s collapse has potential longer-term impact on Tether USDT — the world’s largest stablecoin — which has the wider financial markets spooked. It has seriously impacted DeFi (decentralized finance) as well. For example, Venus Protocol reportedly suffered a US$13.5 million loss because the Chainlink oracle stopped updating the price of Luna below US$0.1 while the market price was US$0.01, allowing users to lend $LUNA and borrow against it 10x more assets than normally possible. It’s for these reasons I strongly believe a self-governing council should be established to investigate what went wrong, exercise some control, produce findings, and provide insights to address specific issues. To be clear, this body needs to be impartial, objective, and transparent. If we fail to take such proactive action as an industry, the impact of government regulators may be far worse.
For the sake of transparency and for the crypto community as whole, not just for UST/Luna users who have lost so much, Do Kwon needs to come clean about a few things. He needs to own up to his troubles with the U.S. Securities and Exchange Commission and his involvement in Basis Cash, a previous failed stablecoin project. He needs to give a frank disclosure as to what has happened with the US$3.5 billion Bitcoin collateral, to show where it is now. He needs to talk in terms of these specifics and not provide warm words and simply talk of re-launching Terra in some form or another. If he cannot learn from his past mistakes then he’s doomed to repeat them in some form or another, and the rest of the industry will suffer the consequences.
Certainly, in the interim, we should welcome the positive attitude of SEC Commissioner Hester Peirce, who recognizes that the market does need room to allow for trial and error, but also adds that due to the variation in types of stablecoins, it’s also “difficult to craft a regulatory framework.” I’m less optimistic about Terra’s plans to resurrect the platform by forking, as CZ tweeted “forking does not give the new fork any value. That’s wishful thinking.”
In the latest twist on May 16, CZ confirmed Binance had received 15,000,000 LUNA (at a peak worth US$1.6 billion) plus had US$12,000,000 in UST from staking. “To lead by example on PROTECTING USERS, Binance will let this go and ask the Terra project team to compensate the retails users first.”
While it is important to protect users first, users also have to understand this is neither the best outcome nor should it set a precedent for the future for a repayment plan and having the community think that it is okay to fail like this with no legal ramifications.
For the sake of both Terra users and the wider crypto community, things need to be sorted out as soon as possible. Practically speaking, the devil is in the detail, and that’s what we need to grapple with now, for the sake of everyone involved.