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*Note: Due to the recent collapse of LUNA 1.0 and the subsequent creation of two separate versions (LUNA and LUNC), this report slightly strays from the traditional CryptoEQ format. To understand the new chain(s), understanding the rise and fall of LUNA 1.0 is vital. The first half of this report covers LUNA 1.0 before the collapse so readers can fully understand;
- What an algorithmic stablecoin is
- The relationship between UST and LUNA
- The Cosmos tech stack upon which it was built
- The mint/burn and arbitrage incentives at play with the tokenomics
- And more
LUNA Strengths
- Being built within the Cosmos ecosystem enables greater interoperability and network effects than compared to being a siloed, monolithic blockchain
- Vast amounts of notoriety and media attention due to the epic 2021 rise and equally epic 2022 crash
LUNA Weaknesses
- Absent the 20% Anchor yield and draw of a decentralized stablecoin (UST), Terra offers little market differentiation from other L1 smart contract blockchains
- The collapse of 2022 and the pain suffered by users/developers cause most to swear off the blockchain and move to other chains
- Do Kwon has proven to be more of a liability than a visionary, and looming lawsuits/regulations around him and Terraform Labs leave much of the near future uncertain for LUNA
Post-Crash Aftermath
In the days and weeks following the crash, regulators from the United States, United Kingdom, and South Korea gave closer attention to the crypto markets. Terraform Labs continues to face class-action lawsuits and other legal troubles, with plaintiffs accusing them of making misleading statements about the cryptocurrency, fraud, and illegal fundraising. Law enforcement in South Korea is exploring allegations of fraud and potential charges of breach of trust pending further investigation. Various Terra employees have also made allegations of money laundering by Do Kwon and his reluctance to reduce the interest rate on Anchor.
A few days after the collapse, U.S. Treasury Secretary Janet Yellen called for increased investor protection via stablecoin regulations. While it's still unclear whether this was an 'attack' on LUNA and UST, it was always entirely possible that this sort of depegging event would have happened eventually anyway. The U.S. SEC is also looking into possible violations of federal investor protection rules in regards to Terraform Labs' marketing of UST. South Korean authorities have launched several investigations into a forensic analysis of the event and price manipulation behind the collapse.
In a report by blockchain security firm Uppsala, there have been allegations that claim forensic analysis shows that the address behind UST's collapse is linked to Terraform Labs. The report insinuates that Terraform Labs or LFG made a financial transaction that caused Terra to collapse on its own. However, other investigators refute this claim and comment that it doesn't prove a connection between LFG and UST's 'attacker.' In late June 2022, Do Kwon claimed to be devastated by the collapse and he had lost nearly all of his net worth in the crash. Supposed insiders from the Terra ecosystem forums claim Do Kwon cashed out $2.7 billion over the span of months using Degenbox, converting it to USDT and USD, but this hasn't been confirmed by other parties or LFG.
The market will likely continue to seek shelter in centralized and backed stablecoins, such as USDC, for the time being. In fact, since the collapse, the circulation of USDC has increased from $45 billion to over $55 billion, signaling investors and users consider it to be a more safe stablecoin option in the market.
The implications of the LUNA and UST collapse were far-reaching in the rest of the crypto market due to the firms that were exposed to it. In June, multi-billion dollar crypto hedge fund and venture capital firm Three Arrows Capital (3AC) became insolvent partly due to its exposure to LUNA and UST. Since crypto is a highly leveraged industry, the leverage causes fragility in a domino-like reaction of interconnected firms with liabilities. In turn, crypto lenders Voyager and BlockFi were exposed to 3AC's debt, and 3AC defaulted on this debt in late June, officially declaring bankruptcy. Many of the projects that were developing on Terra were staking their treasuries on Anchor Protocol to receive more money for development, and this has implications for the health and development of these projects whose treasuries may have been lost.
Market and investor attitudes towards Terraform Labs and Do Kwon are mixed. Some claim it was always obvious that Do Kwon was always running a sophisticated scam and that Terra 2 isn't to be trusted, while others maintain a high opinion of him and his efforts. Many critics, such as fund managers, academics, and crypto analysts, had warned of Terra's vulnerability to collapse based on the fate of the peg of previous algorithmic stablecoins, such as Iron Finance, that also resulted in a death spiral. Do Kwon had originally dismissed these critics with abrasive language on Twitter and has since stated he regrets having made such statements.
Finally, UST's collapse severely altered the stablecoin market and its constituents. Below is an image of the stablecoin market as of Q3 2022.
Post-Collapse Reflection on Vulnerabilities
The Terra ecosystem wasn't decentralized in many regards, but most egregiously regarding the monetary policy and those that could sway/alter it. Terra initially sourced funding from LUNA token issuance apportioned to Terraform Labs at inception. Also funded by Terraform Labs was the creation of the Luna Foundation Guard (LFG) to help maintain the functioning of the UST system despite having no vote from the community. A new entity was single-handedly created that fundamentally changed the way the entire mint/burn arbitrage system without so much as a community vote or poll.
Beyond that, it became increasingly clear the organization was explicitly controlled by Kwon as his power became evident as the collapse worsened. During the depegging, Kwon had the LFG liquidate its reserves to support the peg, remove the cap on the pace of LUNA issuance, and ultimately halt the blockchain via simple coordination of a small node validator set. This level of undue influence from one actor on an entire blockchain network showcases the originally centralized nature of the Terra blockchain and the role this played in the collapse of UST and LUNA.
