Terra and Luna’s $85 Billion Collapse Reveals a New Kind of Bank Run

The collapse of the two coins fueled a digital asset rout, helping to wipe out more than $300 billion from the combined value of all cryptocurrencies in the week ending May 13. Bitcoin, which was trading for over $60,000 last October, is now going for half. For now, at least, the whole crypto edifice looks more fragile.

The Holy Grail

It wasn’t too long ago that Luna and TerraUSD backers were talking as if they had reinvented finance. The tokens’ creator, Do Kwon, a 30-year-old South Korean who studied computer science at Stanford, said he wasn’t just making another form of digital money – it would be a new system. financial, beyond the control of the government. which was cheaper and faster to use and paid higher interest rates to savers.

“Creating a form of decentralized currency on which you can build a whole new kind of financial ecosystem without permission is the holy grail of cryptocurrency, and Terra does just that,” Kwon said in a web video. promotional.

The system around the coins was complex. Start with the stablecoin. These coins have become an important part of the crypto world as a substitute for traditional cash.

Since they’re designed to have a constant value, they’re easier to use to pay for things in the real world. (Bitcoin and other coins like it jump and dip in price so much that the seller of a BMW might end up with only the token value of a Honda by the time the deal closes).

Kwon planned to use Terra stablecoins for instant payments and transfers worldwide, at the expense of Visa, Mastercard and Western Union.

The concept was not new. But unlike other stablecoins, TerraUSD didn’t even claim to be backed by dollars or other assets held in a bank account. Instead, it was supposed to be worth US$1 as it could be exchanged for US$1 of Kwon’s other token, Luna.

If Luna was worth US$10, you could trade a TerraUSD stablecoin for 1/10th of a new Luna, which you could sell on an exchange for US$1. If Luna was worth 10¢, you would get 10 Lunas.

Luna itself was supposed to increase in value as the network became more popular as its holders racked up usage fees. It was basically a network of mules: in the front, a boring, professional stablecoin, and in the back, the Luna get-rich-quick party.

TerraUSD launched in 2020, but gained little traction until March 2021, when Kwon introduced a third part of the network: Anchor, a quasi-bank for crypto where users could deposit their Terra stablecoins and earn 20 % interest. (As usual in crypto, Kwon says his company, Singapore-based Terraform Labs, wrote the software, but the three branches of the system are “decentralized,” controlled by their users.)

“Beautiful and decentralized”

Maybe that raises an eyebrow? Indeed, some people in the crypto world have argued that it is not sustainable. After all, 20% is more than the returns invented by Bernie Madoff for his hedge fund. But Kwon touted it as a safe alternative to banks such as Wells Fargo, even saying that one day other fintech companies like Venmo could deposit user funds there.

“What’s beautiful and decentralized about this system is that it doesn’t require any central intervention,” Kwon said in January on a podcast. “It’s just sort of beautifully combined using a set of game-theoretic incentives.”

You can’t just create more money out of nothing.

Steven McClurg, Chief Investment Officer at Valkyrie Investments

In 2021, the price of Luna has increased one hundred times and almost $10 billion worth of TerraUSD stablecoins have been created.

On Twitter, Kwon, whose avatar was an Iron Man-style armored hero, said Terra was unstoppable and followed anyone who questioned his ideas. “This community bought Luna so they sure aren’t poor like your broke ass,” Kwon tweeted to a reviewer in March.

Galaxy Digital founder Mike Novogratz described himself as an “official Lunatic” in January. Twitter

Fans started calling each other Lunatics. “I’m officially crazy!!!” Mike Novogratz, founder of Galaxy Digital tweeted in January, after having his left shoulder tattooed with the word “Luna” next to a wolf howling at the moon.

“My tattoo will be a constant reminder that investing in venture capital requires humility,” the billionaire said in a letter posted online May 18. (Company filings indicate that the Luna token sale contributed $1 billion in gains last year for Galaxy.)

But TerraUSD had a flaw, which it shared with money market funds or banks before the invention of deposit insurance. If users lost faith in the system, they might rush to sell or trade their coins, and others might follow, fearing they might not get their US$1 per token back if they waited too long.

In theory, the network could always issue more Luna tokens to those who wanted them. But it was also a risk. The more tokens that are issued, the lower Luna’s price will fall, which would mean that the network would have to issue even more, which would make the drop worse. On Wall Street, it’s called a “death spiral.”

“The idea was, ‘We’ll just print more Luna out of thin air to support the price of the stablecoin,’ and that’s not really working,” says Steven McClurg, chief investment officer at Brentwood-based Valkyrie Investments in the UK. Tennessee. . “You can’t just create more money out of nothing.”

“Watching My Own House Burn”

The crisis began on May 7. Luna had already tumbled as part of a general fall in asset prices. After a trader made a large trade of TerraUSD against rival stablecoins, its price plummeted to US99¢, prompting speculation that the dollar peg was in jeopardy. Kwon had amassed a few billion dollars worth of Bitcoin as a reserve to back TerraUSD in an emergency, and on Twitter he projected confidence in its stability.

“Those of you who wait for the earth to become unstable – I fear you wait until the age of men expires”, Kwon wrote on – May 8. But the next day, Terra redemptions continued, forcing Luna to issue more tokens.

Luna fell more than half, to less than $30, then lost another two-thirds of its value the next day.

Kwon urged fans to hold on. “Coming closer… stay strong, crazy,” he said. tweeted. But nothing stopped the death spiral. By the morning of May 13, 6.5 trillion Lunas were in circulation and the price had fallen to US$0.00001834. The price of TerraUSD fell below US$20¢ because even though it could be exchanged for a huge stack of Luna tokens with a hypothetical value of US$1, there was no one to buy them.

Iyamuosa, the Nigerian investor, says he has spent the days since the crash in disbelief. Until his last $20, he is still on Twitter and the chat app Discord, looking for a crypto project that will make him money.

Her dream of moving to Canada to study seems out of reach. “There is literally nothing else left for me,” he says. “I don’t know, man. Honestly, there’s no work, there’s nothing.

Other investors also say they were prepared for ups and downs, but never imagined such a rapid collapse. Senior Bernier, 24, a flooring contractor in Montreal, says he lost about $250,000. “Do Kwon is a guy I’ve always believed in,” he said.

“I felt like I was watching my own house burn down or something,” one investor said on an audio support group on Twitter Spaces. “You’re not an idiot, you’re not unlovable,” the host said. “Please don’t make any rash decisions guys.”

Kwon did not respond to messages seeking comment. “I’m sorry for the pain my invention has caused you all,” he said. tweeted May 13. He said he has a plan to relaunch his financial system, this time without a stablecoin.

The crypto market appears to have stabilized. Tether, the most popular stablecoin, which says it is fully backed by strong investments, fell below US$1 before recovering.

But Terra’s collapse has amplified calls for stablecoin rules in the US, UK and South Korea. South Korean authorities have revived a financial fraud investigation unit to investigate Terra’s collapse, according to reports.

Regulators say a meltdown like this could pose risks to the wider financial system if crypto and the complex DeFi ecosystem continue to grow.

“A lot of people thought a stablecoin was going to be as good as a dollar,” Rohit Chopra, director of the US Consumer Financial Protection Bureau, said last week. “But they learn that’s not the case.”

Bloomberg Businessweek

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