Luna and the Lunatics
We are living through unprecedented times.
During the past few weeks, we have seen the biggest crypto meltdown in recent memory, and the biggest downward explosion of a project since the Bitconnect ponzi collapsed years ago. Luna Terra, a project which claimed to be trying to create ‘Programmable Money For The Internet’ and deploy a suite of algorithmic decentralized stablecoins, collapsed dramatically. The project token itself, known as Luna, drew down 98% from its trading price of $87 on May 5th, currently bottoming at less than a dollar. The stablecoin that was issued by Luna Terra, known as UST, became ‘de-pegged’ from the dollar and cascaded into a massive bank run which sent its value down 77%, to around $0.23. The Terra foundation has created more Luna in an attempt to use it to buy UST and stabilize the price, but has so far been unsuccessful at bringing the value of the coin back to a dollar, and it sits now at $0.54. Terra also had bought massive amounts of Bitcoin in prior weeks with the assumption that they could buy or sell it to maintain their peg, but has been largely unsuccessful in doing so.
How did this happen? How did a token with a market capitalization of over 40 Billion dollars lose 99% of its value within a few days?
Free markets are like lions. They are wild killers which sniff out weakness and exploit it to their own personal benefit. Any asset which attempts to maintain an artificial peg ends up with a task similar to trying to get a monkey to balance a plate on its head. People don’t quite understand this reality, because traditional finance and the government have tried to tame the markets and create a false sense of stability for investors. However we can see this violent and unhinged action happening in every market. Even todays Consumer Price Index serves as a reminder that free markets cannot be suppressed. If we had in the past assumed we could peg goods to a ‘stable price’, as congress mandates the Federal Reserve to, we should know by now that this is impossible. The peg, or ratio, between the dollar and real commodity goods is decoupling right before our eyes. And it is not long before the debt ponzi that our government runs will blow up as well.
All that aside, let's turn back to Luna Terra. This is another classic example of an organization which doesn't maintain sufficient collateral and is punished for it. It was a complicated scheme, which isn’t sufficiently clear and easy to understand at this time, but it essentially went like this. Terra issued a stablecoin (UST) which could be bought for USD or other assets on exchanges. This stablecoin was supposedly supported by algorithmic trading between it and the projects token LUNA. If it started trading above a dollar, they would sell UST and buy more LUNA, stabilizing it. If it started trading below a dollar, which is much more dangerous, they would sell LUNA and buy UST, and normally this would work to stabilize the peg. Now the problem came in when there was a third protocol introduced called Anchor, which essentially allowed for locking up or ‘staking’ of UST for a yield, often as high as 10% or greater. This was very attractive to investors, naive or experienced, and is likely the true source of the ponzi dynamic and the lack of sufficient collateraliztion. When there wasn’t enough collateral left to support the peg because all of the creation of UST through artificial yield, all it would take is some poorly (or intelligently) timed sell pressure on UST to send the whole system cascading down to zero.
There is a lot of speculation that the actors which caused the cascade to start were Blackrock and Citadel. We can see that in the time before this cascade began, Blackrock and Citadel borrowed over 100k Bitcoin from Gemini. They then swapped 25k Bitcoin for UST. Now supposedly, after they had sufficient capital established, they contacted the founder of Terra Luna, a man named Do Kwan, and proposed that they would sell him large quantities of Bitcoin over the counter (so as to not affect the spot price) at a discount for his UST. He was interested, and excitedly bought Bitcoin from them in the weeks leading up to this event. To do so he sold massive amounts of UST, which lowered the liquidity of the token significantly. Blackrock and Citadel both then dumped their UST and Bitcoin into an already fairly illiquid market, causing an immense amount of slippage and a chain of position liquidations which compounded to drive Bitcoin under 30k and UST way under its dollar peg. Since they knew that there was certainly not sufficient collateral within the Anchor protocol to support 10% or 20% APY, they expected that forced withdrawals from such a downturn would expose that Anchor would not be able to repay everyone who had claims. Blackrock and Citadel can now repay their Bitcoin loans on the cheap, potentially establish better positions for themselves, and push central control of stablecoins to ‘prevent events like this from harming retail investors’. All in a good days work.
To be clear, these rumors are unsubstantiated, and there is nothing inherently wrong with what happened and the cascade that followed. If true, these institutions were simply able to take advantage of the flaws in these systems. Terra is a foundation, with a leader in Do Kwan, and is similar to many other crypto projects which are DINO, or Decentralized in Name Only. These weak and fradulant systems will be weeded out with time, and the process will be painful. Already there are huge risks of contagion from the collapse of UST, which was the third largest stablecoin by market cap and likely the instrument which supported many other yield projects like Celsius. We will see much more insolvency in the weeks to come. But that is what a free market does — weed out the scams, frauds, and weak projects and encourage the growth of solid ones, leading to more sustainable wealth in the future. 99% of the crypto tokens which exist today are scams or weak centralized projects, and will not be around in another 10 years.
For anyone who didn’t understand the risks of what they owned and have lost significant money from this event, I feel for you. This is a terrible lesson for everyone, and an example of just how ruthless markets can be. The strong will learn, adapt, and build back on a better foundation of knowledge and practice. Just like how weak projects which are run in unsustainable or fraudulent ways fail, the same is true for people.
At the end of the day, the lesson is simple. People are corruptible, markets can be manipulated, and real growth and innovation must occur naturally. If it sounds too good to be true, like 10% APY, it likely is. There is no such thing as a risk free investment, as risk cannot be prevented, only distributed from the individual to the system itself.
Don’t be a Lunatic. Don’t trust a man like Do Kwan, or a foundation, or a bank, or a government, to secure your wealth. Do research on the way systems function, understand the risks, and make decisions you can justify with sound reasoning and conservative financial thinking.
The Bitcoin Maxis, including myself, have warned of risks like this. In times where liquidity is drying up and the tide is going out into the ocean, we will see who is swimming naked. If you’d like to leave this system of broken trust, debt, leverage, and scam, you must hold bearer assets which are rooted in sound money.
Faith in Crypto, Altcoins, and finance in general will likely take months at a minimum to be restored. But I can assure you, a new block will continue to come every 10 minutes. While people watch weeds around them being pruned, let’s all work to educate each other and understand the value of truly decentralized money like Bitcoin.