As the stormy waters recede from this month’s crypto market bloodbath, one blockchain network has been washed ashore dead: Terra.
The network’s co-founder, Do Kwon, has forfeited any attempt at restoring the current chain to its former glory. He’s now advocating to hard fork and start anew with a different cryptocurrency – a highly questionable approach with no guarantees of recovering value to harmed investors.
What’s certain, however, is that neither TerraUSD (UST) nor the LUNA governance token will ever recover. The former now trades over 90% down from its intended dollar peg, while the latter has arguably suffered the most explosive and sudden collapse in the history of currency.
Financial implosions of this magnitude are virtually unheard of – even in crypto. How could the billions of dollars stored within such a widely supported protocol utterly evaporate within a week – not least from a so-called “stablecoin”?
Now would be a good time for the entire crypto community to re-examine its assumptions about stablecoins, investing, and developers alike. Here a five valuable lessons we can glean from the corpse left behind by the Terra network.
1. Stable Assets Require Stable Reserves
Stablecoins are designed to provide the best of both the new and old financial worlds: the decentralization and speed of cryptocurrency and the value stability of fiat currency.
However, the most successful stablecoins available right now don’t use an entirely “decentralized” model. Tether (USDT) value backs its stablecoin with non-decentralized, highly liquid, stable reserve assets (commercial paper, treasury bills, etc.). These reserves must be regularly audited by private companies to ensure that USDT is indeed fully backed and convertible.
TerraUSD, however, was an algorithmic stablecoin. It followed an alternative model whereby the token was programmatically backed by cryptocurrency – specifically LUNA – instead of dollars.
Any UST holder could redeem their stablecoin for one dollar worth of freshly minted LUNA at any time. Conversely, LUNA holders could always burn their holdings in return for a UST count equal to the exact dollar value of LUNA burned. This mechanism created stabilizing arbitrage incentives similar to USDT so that the market price of the stablecoin could always redirect back to one dollar.
However, unlike USDT, the asset “backing” UST was not nearly so stable nor liquid as actual dollars. In other words, if many UST holders were to redeem their holdings at once, the value of LUNA could significantly decline after exchanges were flooded with excess supply.
This is, unfortunately, the exact scenario that took place this month after wealthy UST holders commenced a short attack against the stablecoin. Investors were incentivized to redeem their UST holdings for LUNA en masse, hence creating an oversupply of the token. The result was a death spiral whereby the value and credibility of both UST and LUNA crumbled to nothing.
This phenomenon likely would have been prevented if UST was backed by an asset with a deeper market and less shaky value under pressure.
2. Buy Value, Not Hype
Just because something has a high market value doesn’t mean it’s a reliable investment. Do not rely on the “wisdom” of the greedy, bullish mob to tell you where your money should go. Do your own research.
This point cannot be stressed enough. In retrospect, Terra collapsed due to a flawed stabilization mechanism open for all to examine and scrutinize from its outset. In fact, previous coins with similar stabilization models had already been tried – and failed – many years ago.
Such details didn’t matter much to most investors – nor did the unusually high 20% yield offered to UST holders through Anchor protocol. When given the opportunity to escape the flood before it happened, thousands of investors failed to use due diligence.
Even trusted billionaires across the crypto community aped into Terra without a second thought, inspiring more to follow. Mike Novogratz, who had a LUNA-themed Tattoo emblazoned across his arm in January, now calls the artwork “a constant reminder that venture investing requires humility.”
This month’s events prove that even experienced investors know little more about what’s safe in crypto than you do. They should not be relied upon.
As the Bitcoiners say: Don’t trust; Verify.
3. Crypto Isn’t All “Decentralized”
Terra’s devs pedaled a lot of hype about creating “decentralized money” for a “decentralized economy.” But when push came to shove, the community revealed its highly centralized and opaque governance structure underneath.
Between Do Kwon, Terraform Labs, and the Luna Foundation Guard (LFG), the average user held virtually no power during Terra’s final moments. The aforementioned parties made numerous hasty and monumental decisions in an attempt to rescue the network – all of which failed anyhow.
For example, on May 9th, Do Kwon and merely six other members of the LFG voted to deploy $1.5 billion from its reserve pool to defend the value of UST. The Guard then left the community with no updates until May 16th, when it explained that virtually all reserve assets – including 80,000 BTC – had been sold.
Furthermore, on May 12th, Terraform Labs collaborated with validators behind the scenes to freeze the Terra blockchain without warning. This was done without community consent – ironically with the stated goal to “prevent governance attacks.” For context, Terra’s chain only has 130 validators.
Even Do Kwon himself retweeted a post stating that the LFG was indeed a centralized system (which he planned to transition away from in time).
When it comes to “decentralization,” there’s a difference between “can’t” and “won’t.” If a small party can take control of a blockchain network whenever it deems that control necessary, is it truly decentralized?
4. Stay Humble, Even If You’re Rich
On one hand, it’s in poor taste to kick a man while he’s down – especially when he’s already faced with lawsuits and multi-million dollar fines.
On the other hand, it can be quite entertaining watching companies die – especially when governed by people who were once so brazenly rude and self-assured.
Don’t take it from me. Take it from Do Kwon himself. Mere days prior to Terra’s meltdown, he spoke with a popular streamer about the crypto industry, claiming there would be “entertainment” in watching 95% of industry startups die over time.
This was no lighthearted joke but a dangerous demonstration of self-certainty and condescension towards Kwon’s competitors and critics. This was made clear in the days to come when Kwon publicly attacked multiple people that tried warning him about his protocol’s security flaws.
“You could listen to CT influensooors about UST depegging for the 69th time, or you could remember they’re all now poor, and go for a run instead,” he tweeted on May 7th.
The following day, Kwon suggested that those fearing a UST de-peg would be “waiting until the age of men expires.”
Yet the worst of Kwon’s behavior was at the height of crypto’s bull market in November. When a Twitter user-outlined a process by which he predicted Terra would fall due to a short attack, the co-founder called it “the most retarded thread” he’d read this decade. He then deemed the user “stupid” and invited his “billionaire” followers to try out the attack.
If Terra’s collapse were truly a black swan event, Kwon might have been able to salvage his reputation from its remains. But after repeatedly mocking his critics for being poor, openly inviting whales to short attack the network, and losing a $200 million “bet” on LUNA’s demise… is it any surprise that his followers are short of sympathy?
His actions haven’t affected him alone: for better or worse, Kwon was Terra’s biggest leader. The implicit responsibility of guiding the community out of a crisis has fallen on his shoulders.
But after destroying his own credibility, the crypto scene is largely unwilling to unite behind his last resort hard fork plan. Some even distrust the legitimacy surrounding the ongoing governance vote for his proposal, believing the vote to be rigged.
Whether such claims have any merit is beside the point. Trust is fragile – especially in an industry already rife with scams and bugs. Earning it is an uphill battle, and losing it is as easy as a few stupid tweets.
Conclusion: Learn Now, Not Later
Crypto is home to a potential revolution in financial innovation. It also suffers from a gross lack of regulation, market manipulation, hacks, thefts, anonymity, lack of transparency, and a reckless FOMO culture.
The investors whom you think know what they’re buying do not, in fact, know much more about crypto than you do. The developers who assured you that everything was under control could not, in reality, control the market around their stablecoin.
Take what you can learn from Terra’s failure, and see if you can understand the inner workings of your other crypto investments a little bit better. Nobody is doing the learning for you, and likewise, nobody will save you if those investments fall apart.
