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When discussing LUNA and its future these days, it is impossible not to discuss the complicated legal situation it finds itself in. So, let's dig in!
Regulation
For the crypto market, regulation continues to be a large gray area. As the crypto market continues to grow in popularity, so too does the attention being paid to it by governments and regulating agencies. In the U.S., crypto is at the mercy of the Financial Services Oversight Council (FSOC) and its 10 voting members. There’s the Federal Reserve (Fed), the Department of Treasury, the Commodities & Futures Trading Commission (CFTC), the Securities & Exchange Commission (SEC), the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Commission (FDIC), the Consumer Financial Protection Bureau (CFPB), and a couple of others that are less directly relevant to crypto.
The FSOC’s duties include identifying risks and emerging threats to the financial system. This gives the FSOC the authority to organize a policy response to emerging tech like cryptocurrencies. The committee is led by Treasury Secretary Janet Yellen and aims to create and enforce a “proper” U.S. financial regulatory framework. As the U.S. makes up ~40% of the world’s financial market, the FSOC’s impact is far-reaching and critically important to the global economy.
The SEC's laws on the marketing and sale of securities are intended to prevent certain mischief: insiders and promoters of a business will have more information than investors (information asymmetry). This is remedied by the SEC requiring truthful and comprehensive disclosure in a regulated format.
The Howey test, the main case law on the features of a security, remains the best measuring stick despite its many shortcomings when applied to crypto assets. For the purposes of this analysis, understand that the degree of decentralization of a protocol is a significant factor in determining which, if any, United States securities regulations apply.
“When a promoter, sponsor, or other third party (or affiliated group of third parties) (each, an “Active Participant” or “AP”) provides essential managerial efforts that affect the success of the enterprise, and investors reasonably expect to derive profit from those efforts, then this prong of the [Howey] test is met.
There are essential tasks or responsibilities performed and expected to be performed by an AP, rather than an unaffiliated, dispersed community of network users(commonly known as a “decentralized” network).”
-SEC guidance “Framework for ‘Investment Contract’ Analysis of Digital Assets
There's rapidly developing regulatory clarity around the world regarding cryptoassets outside of Bitcoin or Ethereum. While no official statements have been made regarding $LUNA, $LUNC, or Terra as a project explicitly, there have been comments from the SEC on Ethereum previously, declaring it to not be a security.
The CFTC has made comments publicly that Ethereum is viewed as a commodity. However, due to a new U.S. administration and regulatory bodies in power since 2021, there's always uncertainty regarding comments from past administrations being continued. Only time will tell how accommodating or restrictive they will be.
Regarding the Terra ecosystem directly, the U.S.SEC filed a subpoena enforcement action against Terraform Labs and Do Kwon, seeking an order directing them to comply with investigative subpoenas for documents and testimony regarding Mirror Protocol.
Mirror enabled users to trade mAssets including U.S. securities. While this system of tokenization of real-life assets—such as shares of Netflix or Tesla—lowers the barrier of entry for international traders and is open 24/7, the SEC is investigating whether Terraform Labs, Kwon, or others have violated U.S. securities laws by not registering the offer or sale of securities. This would be possible by selling security-based swaps outside of a regulated U.S. exchange, acting as an unregistered broker or dealer, or by engaging in securities transactions by an unregistered investment company.
The filing states that, based on its ongoing investigation, the SEC has reason to believe that Terraform Labs and Kwon participated in the creation, promotion, and offer to sell mAssets and MIR tokens to U.S. investors.
In response, Kwon and Terraform Labs filed suit against the SEC in Oct 2021 to contest the subpoenas and allege the SEC violated its own rules and hired an outside private process service company to deliver the subpoena at a crowded conference in New York City as a means to “publicly intimidate and embarrass.” This violates the SEC’s own rules to keep formal orders of the investigation confidential, according to Kwon, a South Korean citizen, and resident.
In regards to the LUNA token itself, it can be deemed a security if it satisfies certain properties based on the common interpretation of the Howey Test, the standard legal test applied to assets to determine whether or not they're securities to the U.S.SEC.
The questions governing the Howey Test are:
- Is there an investment of capital involved?
- Is there an expectation of future profits?
- Is the investment of capital in a common enterprise?
- Do any profits come from the efforts of a promoter or third party?
Note that many digital assets lack clear utility and purpose outside of price speculation or investing. $LUNA has a clear use case on the Terra platform in the form of securing the Terra network and ensuring the price stability of Terra stablecoins through its role in collateralizing the mechanisms.
According to the Howey Test questions above, it can seem that Terra’s early stages, the strongest argument for LUNA possibly being classified as a security is its involvement and issuance from a “third party,” Terraform Labs, whose efforts are around a “common enterprise” and the investment of capital is involved.
Therefore at first glance, LUNA may seem to fit the description of a security, especially since Terraform Labs is the developer and promoter of Terra, and investors do expect profits from the enterprise.
Note that Terraform Labs is a South Korean-based company with an office in Seoul. With Ripple getting sued by U.S. regulators in 2020, investors question whether authorities could pursue legal action against other cryptoassets with similar compliance profiles. The Ripple lawsuit explicitly mentioned having offices in New York City as one factor for regulatory action.
Unlike Ripple, anyone can technically run a Terra node and verify transactions themselves as a validator, so as far as regulators are concerned, while Terraform Labs are the formal issuer of the LUNA token, the technical operation of the Terra network does not depend on a given legal entity, unlike with Ripple.
LUNA would not exist without Terraform Labs, but LUNA and UST can exist and function without Terraform Labs given that it’s now released and functioning in a decentralized model.
Road Map
Terra was initially born with the support of the Terra Alliance, 15 large e-commerce companies in Asia that collectively process $25 billion in annualized transaction volume and serve 45+ million users. Terra’s roadmap contains a longer-term vision to create a massive payment network and adoption such that a blockchain payment network can run at scale with more powerful decentralized applications built on top.
Terra made significant upgrades since its Columbis-1 mainnet launch in April 2019, which also involved the release of Terra Station (wallet) and Terra Finder (blockchain explorer). In June 2019, Columbus-3 launched with an upgraded oracle to reduce front-running and validator key exposure, implement atomic swap safeguards, and other features.
The most significant growth for the Terra ecosystem was in 2021: at the start of 2021, the total market cap of LUNA was only $300 million, and that of UST was $500 million, sixth among other stablecoins. Terra first gained a reputation for its payment and savings app, serving users like CHAI and Memepay.
By the end of 2021, the market cap of LUNA had soared to $34 billion (up 113x), and there were significantly more dApps present on Terra, with the number of projects on Terra growing from ~20 to over 200 during 2021.
At the beginning of 2021, Terra continued to focus on its development of payment and saving apps serving end-users, using UST as the primary currency instead of building trendy DeFi apps to attract crypto user capital.
Terra’s DeFi ecosystem saw surges of growth in 2021, with key protocols such as Anchor and Mirror deployed. At the end of 2021, the NFT, metaverse, and gaming trends started to emerge on Terra as well, albeit with limited use cases. Terra announced its entry into the Korean gaming market. Top NFT marketplaces include Random Earth and Talis Art.
At the end of 2021, UST’s market cap had grown to $10 billion and it ranked fourth among stablecoins; Terra's TVL was second only to that of Ethereum, with roughly $20 billion in TVL.
Notable elements of the roadmap and development accomplished in 2021 include:
- Raised $25 million from Galaxy Digital, Coinbase Ventures, and Pantera Capital in January
- Terra Station Wallet released its mobile version in Feb.
- Anchor Protocol released in March
- Mirror Protocol reached $2 billion in TVL and MIR listed on Binance in April
- LUNA dropped over 45% from its peak earlier in the spring amidst crypto market pullback
- The first IDO happened on Terra’s Pylon Protocol
- Terra expanded the bridge to offer the Harmony ONE network
- UST arrived on Polygon and Solana in July
- The Columbus-5 proposal, which brought deflationary effects to LUNA, was passed in August and updated the following month successfully
- Founder Do Kwon served by U.S. SEC in regards to concerns involving Mirror Protocol
- Columbus-5 officially launched in October as well as Wormhole and the IBC
- 88 million LUNA were burned and Terra entered Korean gaming market
- LUNA token passed $100 in price and UST flipped DAI stablecoin in market cap. UST had been listed on most major cryptocurrency exchanges by this point
While 2021 was successful for Terra’s adoption and the thriving DeFi ecosystem, the UST and LUNA collapse has all but put the nail in the coffin for Terra in 2022.
To follow progress and developments from the Terra team and its new token, follow their Medium for announcements.
