1/ This is what happened (and is happening) with Terra/Luna, in plain English. 🧵
2/ Terra consisted of two parts: the TerraUSD coin (UST) which was meant to always be worth $1 and the Luna token was meant to grow in value as the Terra/Luna ecosystem grew.
3/ Terra was effectively a bank: UST functioned somewhat like a bank deposit and Luna a bit like shares of equity in the bank.
4/ The reason people wanted to deposit money at the Bank of Terra was because it paid depositors a 20% per year interest rate. More on this later.
5/ Most banks keep a certain amount of cash on hand in case customers want to withdraw deposits. Terra did not.
6/ Rather than keeping cash on hand Terra allowed customers to withdraw deposits by burning UST in exchange for Luna. Destroying one UST would create $1 worth of Luna at the current market price.
7/ In that sense the value of UST was supported by the value of Luna (since you can burn UST to mint Luna) and the value of Luna was supported by the value of UST (since excess demand for UST creates price pressure for Luna).
8/ This arrangement "works" in a bull market because rising prices support rising prices, but in a bear market the opposite is true. The problem is that people tend to lose confidence in the deposits (UST) and the collateral (Luna) at the same time.
9/ Letting people exit their UST position through Luna is like trying to reassure panicking customers during a bank run by offering them shares in the failing bank instead of cash.
10/ If you bought $1M worth of Luna at its peak price of ~$120/LUNA your portfolio is now worth ~$0.64, assuming you can still find anyone willing to buy it.
11/ Terra/Luna was effectively a ponzi scheme and the collapse was inevitable, but there are a few reasons it happened now rather than later.
12/ First, the Luna Foundation Group (LFG) was seeking to build a reserve of Bitcoin to defend the UST peg, just as central banks defend fiat currency pegs. The goal was to accumulate $10B worth of Bitcoin and become the largest single holder outside of Satoshi.
13/ To do that they had to raise money. They could have sold Luna but selling Luna would lower the market price and ponzis require growth to survive. So instead they burned Luna into UST and bought BTC with the UST.
14/ That meant the Terra bank had lots more liabilities/deposits (UST) and a lot less capital/equity (Luna). They had increased their leverage.
15/ They also had been listed in most of the major centralized exchanges at that point. When UST was only tradable on the Terra blockchain they could manage redemptions and impose capital controls. Once liquidity was available on Binance/FTX/ETH DEXs they no longer could.
16/ Finally the defenses around the UST peg were lowered because Terraform Labs was migrating capital from 3pool to 4pool on Curve. During the migration the order books for UST were unusually thin and it was much easier to attack the peg.
17/ Attack is a deliberate choice of words. Stablecoins are locked in an incredibly fierce zero-sum, winner-take-all competition.
18/ In other words, Terra:
- built a ponzi
- loaded it up with leverage
- turned off their capital controls
- removed most of the liquidity
- triple-dog-dared anyone to come at them
19/ Terra founder @stablekwon should have known this was coming - he's done this before anonymously with a failed algorithmic stablecoin called Basis Cash. coindesk.com/tech/2022/05/1…
20/ Unfortunately this ponzi is not like previous ponzis. Here's a quick comparison:
- Bitconnect: ~$2.4B
- PlusToken: ~$3B
- OneCoin: ~$4B
- Terra/Luna: ~$40B
21/ Terra/Luna was also much more deeply integrated into the rest of the crypto economy, with a large downstream ecosystem and a lot of institutional investment.
22/ The ripple effects are pummeling the whole crypto market right now. Even Tether (USDT) is struggling to keep it's peg.
(Note: Tether is a collateralized stablecoin, not an algorithmic stablecoin. It has risks but not the death spiral that killed Luna)
22/ The fallout from this collapse will be brutal. $40B of wealth was wiped out in Luna alone. The startups and projects built on the Terra blockchain will fail. Funds with exposure to UST/Luna are being forced to fire-sale other assets to de-risk their wounded portfolios.
23/ Eventually regulators will begin using Luna as a cautionary tale and an excuse to intervene. We will probably still be discussing the consequences of this moment for years to come.
19/ If you liked this thread I wrote more about Terra/Luna in my newsletter: somethinginteresting.news/p/autopsy-and-…
20/ I also accept free dopamine in the form of likes and RTs! 😄
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