Terra and Luna’s $85b collapse reveals a new kind of bank run

The collapse of the two currencies fueled a defeat in digital assets, which helped wipe out more than $ 300 billion of the combined value of all cryptocurrencies in the week ending May 13th. Bitcoin, which traded at more than $ 60,000 in October, is now down by half. At the moment, at least, the whole cryptographic building seems more unstable.

The holy grail

Not long ago, Luna and TerraUSD supporters spoke as if they had reinvented finance. The creator of the tokens, Do Kwon, a 30-year-old South Korean who studied computer science at Stanford, said he was not just making another form of digital money: it was going to be a new financial system, out of government control. which was cheaper and faster to use and paid higher interest rates to savers.

“Creating a decentralized form of money in which you can build a whole new kind of financial ecosystem without permission is the holy grail of cryptocurrency, and that’s exactly what Earth does,” Kwon said in a web promotional video.

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

Since they are designed to have a constant value, they are easier to use to pay for things in the real world. (Bitcoin and other currencies like him go up and down in price so much that the seller of a BMW can only end the value of Honda chips when the deal is made).

Kwon imagined that stable Earth currencies would be used for instant payments and transfers around the world, with Visa, Mastercard and Western Union being quoted.

The concept was not new. But unlike other stable currencies, TerraUSD has not even claimed to be backed by dollars or other assets in a bank account. Instead, it was supposed to be worth $ 1 because it could be exchanged for $ 1 of Kwon’s other token, Luna.

If Luna was worth $ 10, you could exchange a stable TerraUSD currency for 1/10 of a new Luna, which you could sell on an exchange for $ 1. If Luna was worth 10 ¢, you would get 10 Moons.

It is assumed that Luna itself would increase in value as the network became more popular because its owners accumulated usage rates. It was essentially a network of mullets: on the front, a boring, business-like stable coin, and on the back, Luna’s fast-growing party.

TerraUSD was launched in 2020, but gained little traction until March 2021, when Kwon introduced a third of the network: Anchor, an almost crypto bank where users could deposit their stable Earth coins and earn 20 percent interest. (As is typical in crypto, Kwon says his Singapore-based company Terraform Labs wrote the software, but all three legs of the system are “decentralized,” controlled by its users).

“Beautiful and decentralized”

Maybe this leads to an eyebrow? In fact, some people in the cryptographic world have argued that it was unsustainable. After all, 20 percent is higher than Bernie Madoff’s invented yields in his hedge fund. But Kwon presented it as a safe alternative to banks like Wells Fargo, even saying that someday other fintech companies like Venmo could deposit users’ funds there.

“The beautiful and decentralized thing about this system is that it doesn’t require any central intervention,” Kwon said in a podcast in January. “It combines very well using a set of theoretical game incentives.”

You can’t make more money out of nothing.

Steven McClurg, Chief Investment Officer of Valkyrie Investments

In 2021, the price of Luna has increased a hundredfold, and stable TerraUSD coins worth nearly $ 10 billion have been created.

On Twitter, Kwon, whose avatar was an armored Iron Man hero, said Earth was unstoppable and trolled anyone who questioned his ideas. “This community bought Luna, so they’re definitely not as poor as your broken ass,” Kwon tweeted to a critic in March.

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

Fans began calling themselves Lunatic. “I’m officially a lunatic !!!” Mike Novogratz, founder of Galaxy Digital he tweeted in January, after tattooing his left shoulder with the word “Moon” next to a wolf howling at the moon.

“My tattoo will be a constant reminder that investing risk requires humility,” the billionaire said in a letter posted online on May 18th. (Company records indicate that the sale of Luna tokens contributed $ 1 billion in profits last year to Galaxy).

But TerraUSD had a flaw, one that it shared with money market funds or banks before the invention of deposit insurance. If users lose confidence in the system, they could rush to sell or exchange their coins, and others could continue, fearing that they would not be refunded their dollars for tokens if they waited too long.

In theory, the network could always issue more Luna tokens to those who wanted to go out. But that was also a risk. The more tokens are issued, the lower the price of Luna, which in turn would mean that the network would have to issue even more, aggravating the decline. On Wall Street, this is called the “death spiral.”

“The idea was, ‘We’re going to print more Luna out of nothing to support the price of the stable currency,’ and that doesn’t really work,” said Steven McClurg, Brentwood, Tennessee-based investment director at Valkyrie Investments. . “You can’t create more money out of nothing.”

“Watching my own house burn”

The crisis began on May 7. Luna had already been declining as part of a general fall in asset prices. After a trader made a large exchange of TerraUSD for rival stable currencies, its price dropped to US99 ¢, prompting speculation that the dollar was at risk. Kwon had amassed a few million dollars in Bitcoin as a reserve to support TerraUSD in the event of an emergency, and on Twitter projected confidence in its stability.

“Those of you who are waiting for the earth to become unstable, I am afraid you will be waiting until the age of men expires,” Kwon. he wrote on May 8th. But the next day, Earth’s redemptions continued, forcing the Moon to issue more tokens.

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

Kwon urged fans to hold on. “As I approach … sit strong, moody,” he said he tweeted. But there was no stopping the spiral of death. On the morning of May 13, 6.5 trillion moons were in circulation and the price had dropped to $ 0.00001834. The price of TerraUSD has dropped below 20 ¢ because even if it could be exchanged for a huge stack of Luna chips that were hypothetically worth $ 1, no one would buy them.

Iyamuosa, the Nigerian investor, says the days have passed since the disbelieving accident. Until her last $ 20, she’s still on Twitter and on the Discord chat app, looking for a cryptocurrency project to get her money back.

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

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

“It feels like I’m watching my own house burn down or something,” said an investor in an audio support group on Twitter Spaces. “You’re not an idiot, you’re not nasty,” the host said. “Please don’t make hasty decisions guys.”

Kwon did not reply to messages seeking comment. “My heart is broken by the pain that my invention has caused to all of you,” he said he tweeted on May 13th. He said he has a plan to revive his financial system, this time without a stable currency.

The cryptocurrency market seems to be stabilizing. Tether, the most popular stable currency, which is said to be fully backed by solid investments, has fallen below $ 1 before recovering.

But the collapse of Earth has amplified the demands for rules for stable currencies in the United States, the United Kingdom and South Korea. South Korean authorities have revived a financial fraud investigation unit to investigate the collapse of Earth, the news reported.

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

“A lot of people thought that a stable currency was only going to be as good as a dollar,” Rohit Chopra, director of the U.S. Consumer Financial Protection Bureau, said last week. “But they’re learning that’s not the case.”

Bloomberg Businessweek

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