The Terra Cryptocurrency Crisis Was Inevitable

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at the Mexican A north London restaurant a few weeks ago, a handful of small but remarkably astute retail crypto investors predicted the collapse of Terra and Luna a few weeks ago. Some of them scoffed at terra, or UST, a stablecoin whose price equivalency against the dollar is backed by algorithms and game theory rather than cash or collateral, and the idea that it will maintain its peg in the long run.

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They informed me that the “ponzinomics” of the project was too risky. Only one of the investors seemed optimistic, out of nihilism rather than faith in the solidity of the earth: he said that at some point the price of UST would rise well above one dollar per unit, and the promoters of the coin would decide to just leave it there and rebrand the stablecoin. as an “inflation-resistant cryptocurrency dollar”. The other shrugged, but admitted that all bets were off. “Until now,” he said, “this story has always followed the most humorous timeline.”

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I bet a lot of people don’t laugh today. UST has lost its dollar peg (at the time of writing it could be bought on crypto exchanges for $0.58) and sister asset luna has fallen from $82 last week to $0.02. Much of the investment in these cryptocurrencies, around $60 billion, was lost overnight, and more will follow as people try to get rid of their dwindling coins.

Meanwhile, the broader crypto market is in turmoil this week as bitcoin plunged to $27,000 after losing 8 percent of its value in 24 hours, with many other cryptocurrencies following its fall. Tether, the world’s largest stablecoin, fell below $1 on Thursday.

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As for Terra, we are seeing the collapse of a project based on the idea that you can create money – and assign value to it – if people are willing to accept that money has a value assigned to it by crypto companies, akin to a role-playing game in a video game. .

A small subset of hardline cryptocurrency advocates would argue that in the era of post-gold standard fiat money, most currencies are indeed just a collective delusion. But the point is that there is no government, no central bank, no economy, no actual land use. As Frank Musi, a research fellow at the Growth Research Laboratory at the London School of Economics, puts it, “It’s like bank runs, except they’re bank runs.” nothing“.

UST was marketed to the public as a stablecoin, a type of cryptocurrency whose value supposedly stays the same over time, creating a convenient advantage over the wild price fluctuations of other cryptocurrencies like bitcoin or ether. For most stablecoins, this stability is guaranteed by foreign exchange reserves – whoever creates a dollar-pegged stablecoin should theoretically store an equivalent amount of dollars in some sort of vault – or other collateral, including cryptocurrencies. Except that UST is an “algorithmic stablecoin” and has nothing like it. He is completely shielded from the real world and is proud of it.

On its own Terra blockchain, UST has a symbiotic relationship with its Luna satellite asset, which can be used to earn cryptocurrency rewards. It was always possible to exchange UST for the moon and vice versa, and the native blockchain code always made sure that terra traded at a dollar per unit, while the changing price of the moon was determined by market-watching algorithms.

It was assumed that this would help maintain price stability through the work of arbitrageurs, investors who are trying to profit from market inefficiencies. If a selloff of UST on cryptocurrency exchanges threatened to drop its price below $1, the idea was that smart arbitrageurs would rush to buy UST and use it on their native blockchain to buy the moon at a discount, propping up the price of UST in the market. process.

If the opposite happened and the price of UST exceeded $1 on the crypto markets, people would use their moons to buy UST at one dollar per unit on the Terra blockchain and resell it on other platforms, driving down the price of UST. This is smart architecture. It’s also the one that didn’t work and couldn’t work. “It’s a bit like a perpetual motion machine. People wanted to figure out how to get free energy. And these designs were complex — they had pulleys, they had magnets, they had levers,” Musi says. “With algorithmic stablecoins, it’s a bit of the same idea.”

Ryan Clements, assistant professor of business law and regulation at the University of Calgary, clarified the problems with this approach last year. paper on algorithmic stablecoins titled “Designed to Fail”. Clements explained in the article that one of the main problems with these stablecoins is that they can only work as long as there is demand for them; otherwise, all these incentives mean nothing. “UST has never been stable to begin with and has never been fully backed,” says Clements. “This required continued assurance that there would be sufficient (ongoing) interest in the various use cases for UST in the Terra ecosystem.”

Many crypto investors have started looking for a way out the door. Bobby Ong, co-founder of cryptocurrency analytics platform CoinGecko, says one possible explanation for what happened to UST is a “George Soros-style attack” after The famous bet of the Hungarian philanthropist and financier against the British pound in 1992. According to this theory, the ruinous decline in UST that began on Monday and escalated into a catastrophe on Wednesday was caused by a large institution throwing billions of UST into the market, destroying its peg. Another, simpler explanation is that the UST simply wasn’t sustainable, and it always had to be as soon as market sentiment changed.

This suggests that some crypto personalities blaming an alleged attack on an investment management company BlackRock and hedge fund Citadel. A little over a year ago Citadel has already been cast as the villain in another tale of financial madness, the so-called GameStop saga, when millions of retail investors began to massively buy shares in the ailing game store chain despite its dubious foundations, in a strange act of defiance of conventional finance. Several observers at the time welcomed the rise in meme funding, with asset values ​​no longer based on business prospects but instead determined by collective delusions, performative contradiction, and sheer nihilism (“Is [GameStop’s stock] worth $200+? That’s up to you to decide based on your own value system.” one investor commented on Redditwhere the uprising first broke out.)

The rise and fall of Terra is, in a sense, the end of this long stretch of strange finance. He may not recover and follow burst the NFT bubble and the fall of a large number of shares of memes and dog coins.

But it would be insincere to read all this through the prism of absurdism and pipe dreams. Terra’s explosion in popularity over the past six months has also been fueled by mind-blowing rewards schemes. “The big demand for UST was driven by the Anchor savings protocol on the Terra blockchain, which promised a 20% annual percentage return,” says Ong. People bought UST and hid it in Anchor, a software where they could store their coins, hoping that over time they would grow like a magical money tree. What’s even more worrying, Ong says, is that Terra has set an example for many other crypto projects that have also started promising absurd profits and are now at serious risk of collapse.

The ponzinomics were too obvious: when you pay money for nothing and hide your nothing in the protocol, expecting it to give you a 20 percent profit, all you get is 20 percent nothing.


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