Altcoins come and go, but the Terra Blockchain, it's token LUNA, and it's Stablecoin UST, were supposed to be one of the core building blocks of this new digital finance world.
No one saw this coming. The run-on-the-bank, the fraud, and the collapse of a network everyone bet big on. This is the story of how to make and lose $15 billion in 3 years.
Background
In January 2018 Do Kwon and Daniel Shin former Stanford University computer science grads launch the Terra network with plans to develop Chai, an e-commerce payments application, similar to PayPal, using a price-stable cryptocurrency instead of major fiat currencies to facilitate transactions.
In order to facilitate digital payments on their new system they would need a ledger. In the world of cryptocurrency that ledger is called a blockchain and in April of 2018 they created Terraform Labs and incorporated it in Singapore, this would be the birth of the Terra network.
They would spend the rest of that year perfecting the blockchain and their new digital finance platform. On January 30th 2019, LUNA the token for the Terra network, was sold via an ICO or initial coin offering to investors. Terraform Labs charged $0.18 per token during a seed round, and $0.80 per token during a private sale. In April of that year Do Kwon and several co-authors published the Terra Money white paper.
On the white paper the founders said that the Terra Smart Contract platform was built on the cosmos SDK which is known for its interoperation ability between chains, ultimately allowing them to communicate with each other. Terra will also have bridges to other blockchains such as Ethereum, Binance Smart Chain, Harmony and Osmosis, allowing for the seamless transfer of data and tokens between non-native ecosystems.
Although there had been talk within the community about the transfer of data and tokens between non-native ecosystems, we had never seen it before. There were several other blockchain companies experimenting with this but Terra was the first. This created a lot of publicity and hype about Terraform Labs, it's token LUNA, and its entire smart contract platform.
Although the ICO had offered LUNA a year earlier, it never reached an exchange until February 24th 2020. By July 6th Nicholas Platt, the head of research at Terra, introduced the Anchor Protocol. A platform built on Terra that allows investors to earn a high yield of 20% on their LUNA deposits and can also borrow against their crypto holdings on the Protocol. Then only two months later on September 21st, UST the Terra blockchain stablecoin was publicly announced.
Capitalising on the industry wide hype of crossing blockchains, Terraform Labs were pumping out products that seemed to be too good to be true, yet people were making so much money with LUNA increasing in value by the day, and Anchor Protocol offering stupidly high yields, on reflection, how did we not see what was going to happen? Simple... blinded by greed.
What happens when you buy a token?
The people that advocate for regulation in cryptocurrency are the people that point to the Terra collapse as a reason why it's important.
When you buy a token, let's say for $1, you give that $1 to the provider of the token. The same if you deposit $1 to a bank, you expect when you ask for that $1 back that they have it somewhere, and they haven't spent it. In the real world, banks and other such companies invest that $1 attempting to make a return before you withdraw it. The only time when this can ever be a problem is when there is a run-on-the-bank, this means more than the average amount of people ask for their money back at exactly the same time and the banks can't withdraw it from their investments fast enough or they've lost that investment.
While the rest of the world was enjoying the fruits of Terraform Labs hype train, there were a select group of people that realised that Terraform Labs was spending and not investing the money people were giving them for their token and didn't have any obvious reserves. The bonus of cryptocurrency is there is always a ledger, record, or a wallet, that should have all your holdings for the public to see. From the beginning, there were people claiming that the cross-chain technology wasn't there yet. Those same people decided to follow the money, this is when people started realising they had very limited reserves.
The Luna Foundation Guard
As a response in early 2022, Do Kwon announced the launch of the Luna Foundation Guard, it would be an organisation mandated to build reserves supporting the UST peg, amid volatile market conditions. A peg is when a stablecoin is 'pegged' to the dollar. 1 UST = $1 precisely. The Singapore based LFG raised a billion dollars through the sale of LUNA tokens to buy Bitcoin for its UST's reserve system.
Over the coming months, up until April 2022, LFG has purchased 39,897 Bitcoin worth an approximate $3.6 billion. This can clearly be seen in an open wallet along with $100 million worth of AVAX and $820 million worth of LUNA tokens.
By April 5th, LUNA had reached its all-time high of $119 per token. A 14,775% increase on its ICO three years earlier. To put this into context if you had of purchased $67 worth of LUNA in 2019, you would currently be a millionaire in 2022.
Supporters of LUNA pointed to the open wallet with billions of dollars, as proof that Terraform Labs has finances to back all tokens and stop their stablecoin UST from de-pegging from that single dollar mark.
Critics said the $3.6 billion isn't enough to cover 1/4 of the tokens in circulation. Crypto trader Algod likens UST/LUNA to a Ponzi scheme and bet Do Kwon $1 million the price of LUNA would be below $88 by the following year and would crash the year after. Another crypto trader Gigantic Rebirth bet $10 million “against Kwon and the LUNA Ponzi scheme succeeding”.
How UST de-pegged from $1
It's important to remember that despite LFG claiming they had $3.6 billion worth of Bitcoin, it is a volatile asset. If you've spent the last 6 to 12 months purchasing Bitcoin from its all-time highs of $69,000 in November 2021 to $45,000 in March 2022, and now in May 2022 the price is $35,000, that's a loss. Yes, you still have 39,897 Bitcoin, but they are worth half the amount you paid for them six months prior. You’re losing vast amounts of capital. Now this is absolutely fine, as long as you aren't forced to sell them and take the loss.
On the night of May 7th, Terraform Labs withdrew 150 million UST from 3pool, a decentralised stablecoin exchange, as part of a planned, public effort to move these funds to another holding. This made the pool of UST available more “shallow,” i.e. prone to volatility.
Thirteen minutes later, one trader, perhaps taking advantage of this vulnerability, swapped 85 million UST for USDC, a stablecoin on a different network. Over the next hour, another trader then swapped a total of 100 million UST for USDC in increments of 25 million.
In response, Terraform Labs withdrew another 100 million UST from 3pool. This was intended to “rebalance” the ratio. It had the opposite effect.
These large trades – and a number of much smaller ones – had already broken UST’s peg. Not by much, but instead of being pegged at $1, it was at $0.975.
Investors panicked, the sell off began, and holders with UST deposited in Anchor Protocol started to withdraw their funds.
Peg repairs are usually successful but short lived. To repair the peg, three unidentified UST supporters swapped a combined $480 million USDT for UST on May 7th, 8th, and 9th.
It was reported that over 70% of UST was held in Anchor Protocol by investors wanting their 20% yield. This was fine while LUNA prices were rising, Terraform Labs was making a fortune even with handing out 20%. However, in recent months the market had dropped drastically from it's all time highs and prices across the board were falling. Having said that, LUNA had reached an all time high in April and was still holding firmly above $80.
Then, on May 9th, the Luna Foundation Guard (LFG) sold billions worth of Bitcoin from its reserves to swap for UST, to supply all of the withdrawals from investors from Anchor Protocol. This was sold at a loss as their Bitcoin had been purchased for a much higher price than the 35,000 they were selling it for. They didn't have enough reserves to cover what people were withdrawing. Add this to the fact that all wallets are public, it took a matter of minutes before word got out that LFG had sold their reserves and wouldn't be able to for fill all withdrawals.
This then caused the run-on-the-bank, everyone wanted their money out of the de-pegging UST currently priced at $0.67, then selling their LUNA tokens as the price was dropping significantly by the minute. No one believed that LUNA was going drop significantly enough to make it a redundant token, so as the price dropped over the next 24 hours to about $30, the coin rallied, it held firm there for 12 hours, before the next crash. Within the next 24 hours a coin that had being trading at $100 on April 24th was now trading at $0.40 two weeks later.
During this, all exchanges refused to pay out on LUNA, they simply couldn’t deal with the number of transactions or with the money people were asking for. Terraform Labs could no longer pay out for UST on Anchor and people had to watch as their tokens collapsed to 0.
It was reported the over $15 billion was lost on May 9th and 10th with several wallets showing they've lost over a billion each the most being $3.5 billion.
Do Kwon and Terraform Labs remained bullish saying "a plan is in place, we will repair UST" & "LUNA will rise again". In actuality, it's more likely that when they sold off they're Bitcoin on May 9th, they weren't doing that to re-peg UST, they were doing it to cash out and run.
The LUNA token continued to collapse over the coming days becoming a percentage of 1 cent per token. Most people only able to withdraw their tokens after this collapse had happened.
Hindsight Analysis
The catastrophic collapse of LUNA and UST on May 7-10, 2022, was a series of unfortunate events that started with an unprecedented un-staking of UST. Over $2 billion worth of UST was rapidly taken off the Anchor Protocol, causing a cascading effect that would ultimately lead to the downfall of both UST and LUNA.
As a significant portion of the un-staked UST got liquidated (cashed out) the value of UST fell below its peg, dipping to $0.91 from its stable $1. This devaluation sparked a frenzy among traders who, seizing the opportunity and started exchanging 91 cents worth of UST for $1 worth of Luna from Anchor Protocol.
This arbitrage opportunity, created due to the de-pegging of UST, led to more UST being sold, causing further devaluation.
The panic selling of UST led to an excessive minting of LUNA, resulting in an unexpected surge in LUNA's circulating supply. The over-supply, coupled with the under-demand, caused a sharp decline in the value of LUNA.
The situation worsened when crypto exchanges started delisting Luna and UST in response to the de-pegging and the free fall of LUNA's value. This move effectively stranded LUNA, leading to its abandonment as it became virtually worthless.
In this scenario, one might expect LFG to step in, selling off their bitcoin holdings to buy LUNA, stabilising the market. However, the funds in the LFG's war chest were limited. If LFG sold all its bitcoin, it couldn’t support LUNA and UST. So where did Terraform Labs profits go from the sale of their bitcoin? Why didn't they pay back their token holders UST with the Bitcoin sales? who was culpable?
Where is Do Kwon?
Following the catastrophic failure of Terraform Labs and the collapse of LUNA and UST, the life of founder and ex-CEO Do Kwon was tumultuous, marked by legal challenges and international intrigue.
In April 2022, with the collapse of the two digital currencies imminent, Kwon departed for Singapore, leaving behind a trail of financial devastation. It’s estimated that around 200,000 investors suffered significant losses, with the entire ecosystem crashing from $60 billion to ashes.
Do Kwon was not to be found in the wake of this financial disaster. He became an international fugitive, with the Interpol issuing a red notice for alleged fraud and financial crimes connected to the collapse of LUNA and UST. Kwon’s trail led investigators to Serbia, where he established a new firm. However, the law finally caught up with him in the neighbouring country of Montenegro.
On March 23, 2023, Montenegrin authorities arrested Kwon and another South Korean citizen, identified by the surname Han, while attempting to board a flight to Dubai using Costa Rican passports. Han Chang-Joon is believed to be Terraform Labs’ former Chief Financial Officer.
Kwon, under his full name Kwon Do-Hyung and Han were charged with using forged personal documents. The local court in Montenegro set bail for each at 400,000 euros ($437,000).
Yet, before any potential extradition to the US could occur, Kwon’s legal journey in Montenegro is needed to reach its conclusion. As per the statements of his Montenegrin lawyer and the country’s justice minister, Kwon would first have to stand trial for traveling on fake documents. He could face up to five years in prison in Montenegro if found guilty.
Amid these legal proceedings, Kwon made a surprising move. He remained silent when asked about his financial assets and how he intended to pay the bail. Instead, he stated that his wife, co-owner of a $3-million apartment in South Korea, would handle his bail. This move fuelled suspicions that Kwon might have hidden large amounts of money obtained from the alleged crypto fraud in South Korea and not Singapore as investigators had previously thought.
Currently, Do Kwon remains in Montenegro under police surveillance, facing the consequences of his actions.
What has been learnt from this saga?
Its interesting, because no more that 4 months later, we had the Sam Bankman-Fried & FTX fraud (something I've written another article about). Some people quick to jump on the bandwagon proclaiming 'crypto hasn't learnt anything from Terra'.
I believe that the cautionary tale of Terra, and the due diligence of traders, exposed the FTX fraud and allowed people to discover their illegal dealings. Maybe nothing would have happened until people had been burnt and learnt to be more vigilant.
One major positive that has come from these events is the self-regulation of the industry’s most well-respected companies. Crypto exchanges such as Binance, Bybit & Coinbase have created open wallets/accounts which hold reserves, which cover all the money held on that exchange.
This offers traders security when it comes to trading on their platforms, knowing that if there is a crash of any token, everyone will have the ability to take all their money out without a run-on-the-bank.
This self-regulation has also entered the crypto companies Ethereum, Solana, Polygon Avalanche & Ripple all have funds in dedicated wallets, again offering security to those who hold tokens belonging to those companies.
This finally also applies to stablecoins, Tether & USDC being the most widely used, both have funds which secure the pegging of their stablecoin to $1.
Some believe this self-regulation is a front, and crypto is prime for another fraud one day soon. However, I have a different view, despite there being many people in crypto willing to perform illegal acts for money (which is no different to the current financial sector), I believe the masses will choose the self-regulated platforms and tokens.
They will essentially vote with their cash. For example, Binance was leading the way with the self-regulation after the FTX scandal, proving an open wallet with funds. This gave so much security to traders that their business grew by 30% in the following month.
This then gave the impetus to other companies to create open wallets. But more importantly, it showed the companies that did not create open wallets. Those companies that had been spending their clients deposits, no different to a Ponzi Scheme. Therefore, people started withdrawing funds from those exchanges and adding it to exchanges that did have open wallets.
This is the type of regulation crypto needs. If you bring in mass adoption and Wall Street, then of course, some more legal based regulation is needed. But for now, self-regulation might just be what crypto needs to move through the next bull market.
This industry is 15 years old, it's also the most lucrative industry in the world. You would be naive to believe that fraudsters would not take advantage of this. It's no different to the real world where bankers and other people commit crimes for financial gain. The important part is the industry learns, grows and secures itself against the illegal activities of fraudsters.
We are in our infancy, in 50 years all of this will be normal. Clear regulation from governments, buying your groceries with a stablecoin or a CBDC, holding a single Bitcoin worth $5 million. All of this will be normal. But no different to the California Gold Rush of 1849, make no mistake, if you want to create generational wealth, now is the time. Waiting for government regulation to reduce the risk only reduces the profits. Only you know how much risk you're willing to take. I believe we now have the right mix of risk & reward.
Disclaimer - None of what is written on this website is financial advice and only descriptions of how the author trades and for entertainment purposes.
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