Terra-Luna Meltdown - It's Not Bitcoin
Collapse of "Algorithmic Stablecoin" Ripples Through Crypto
“The key about the story….is that everyone knew this was nonsense.” -
David Gerard, author, “Attack of the 50-Foot Blockchain.”
That was David Gerard’s assessment of the “algorithmic stablecoin” TerraUSD and its sister coin, Luna, both of which collapsed in spectacular fashion this week. The meltdown dragged down the entire crypto market, including Bitcoin.
So What’s an “Algorithmic Stablecoin” Anyway?
Stablecoins can be described as a digital form of the US dollar, a cryptocurrency that’s pegged to the $1.00 value. The assumption had always been that these coins were backed 100% by cash, so the coins wouldn’t fluctuate in price. Until recently, that is.
These more recent creations, dubbed “algorithmic,” use a complex mix of other coins and code to attain the 1-to-1 peg with the dollar. That’s where the Luna comes into this story. Luna is the governance coin of this project, while TerraUSD was to be the stablecoin. The two tokens were supposed to work in concert to achieve a balancing act to support the stablecoin. It failed.
By comparison, the more stable of the stablecoins, if you will, Tether and Gemini USD, are backed entirely by cash and short-term commercial paper. Both are audited on a regular basis, Gemini’s every month. Both have held their peg.
Here’s What Happened
The biggest reason for investors to buy TerraUSD was to get the 20% interest yield offered in something called the Anchor protocol. I know what you’re thinking, “if it sounds to good to be true…..” And indeed, 75% of all TerraUSD was deposited with Anchor. But in March, Anchor adjusted its yield to a variable rate, not the 20% fixed rate. Massive amounts of TerraUSD were withdrawn from Anchor, and many Terra holders burned them, creating more Luna. This forced the supply of Luna up dramatically, causing its price to plummet, along with Terra’s.
Basically, the balancing act between TerraUSD and Luna stopped functioning.
A good old-fashioned bank run had started, just like the run on the Bailey Bros. Building & Loan in “It’s a Wonderful Life.” This time in digital format.
Luna’s price per coin dropped from a high of $120 this year to nearly zero, a fraction of a penny. The “stablecoin” TerraUSD dropped to below 10 cents.
How Were Bitcoin and other Cryptos Affected?
The panic rippled through the broad crypto markets, and no coin was spared. Bitcoin dropped to below $26,000, its lowest level since December 2020. Ethereum crashed 22% in one day. Solana, Cardano, XRP and others lost between 25% and 33% in just over a day.
None of these were stablecoins, and none of major stablecoins failed to hold their $1.00 peg. And this situation had nothing to do with Bitcoin.
The stock of Coinbase, one of the biggest crypto exchanges in the world, fell 35% over the course of the last week.
In all, more than $400 billion in crypto wealth had been wiped out.
Suicide watch. Many online forums, including Reddit and TerraLuna Forum, have been providing support services for investors who report contemplating suicide over the devastating losses. Investors told stories of being wiped out, faced with losing their homes, and attempted suicides. Not surprising, since Terra and Luna holders have lost over $42 billion in a week.
Rescue plan? Terra Luna co-founder Do Kwon says he has a plan to rebuild Terra, to compensate the holders of Terra and Luna, and make a better stablecoin. However, observers say that Do Kwon may first have to deal with accusations that this was just another elaborate Ponzi scheme. He may be forced to account for all of the assets that once backed Terra.
Regulation coming. This debacle will undoubtedly prompt swift action from Washington in order force more reporting by these stablecoin projects. This step has already been touted by Sen. Elizabeth Warren and by Rep. Jake Auchincloss, both from Massachusetts. Auchincloss is drafting a bill to require that stablecoins be federally audited. He’s in favor of keeping stablecoins, though, feeling that they may help keep the US dollar the world’s reserve currency.
Will VC Firms Run Away? Private equity and venture capital firms may be quite leery to back another project like this one. It’s doubtful that any similar algorithmic model will attract any serious investors. Two other algo projects, Frax and believe it or not, Magic Internet Money, saw massive drops in their coin prices.
David Gerard, quoted above, gave this awesome definition of an “algorithmic stablecoin” -
“You have sort of a messy, lower-quality reserve. It’s a way to claim you’re building a stable thing out of unstable things.”
Remember, it’s important to distinguish between Bitcoin and everything non-Bitcoin. And this mess had nothing to do with Bitcoin.
Thanks for reading. And please share this issue.
How Are You Celebrating Bitcoin Pizza Day?
May 22, 2010. It will go down as one of the most iconic days in the history of Bitcoin. That’s the day that computer programmer Laszlo Hanyecz succeeded in spending 10,000 Bitcoins for two Papa John’s pizzas. (Not a typo.)
Laszlo first made known, on May 18, that he was willing to pay Bitcoin for pizza. He got a response from a Florida Papa John’s franchise a few days later. It was the first known commercial transaction of cryptocurrency, and a Bitcoin was worth less than a penny then. Way less. Since then, he has become internet famous, and each year Bitcoiners celebrate Bitcoin Pizza Day every May 22. His story is recounted on all sorts of Bitcoin and investment sites, each year. There are even websites and Twitter accounts that keep track of the value of those famous 10,000 Bitcoins, or rather the value of the two pies.
He has no regrets about his 2010 purchase. "It wasn’t like Bitcoins had any value back then, so the idea of trading them for a pizza was incredibly cool," Hanyecz told the NY Times. He won’t say how many Bitcoins he held onto after that 2010 transaction. He has also not disclosed what toppings he ordered.
Recommended Bitcoin Tools, Platforms, Podcasts:
Gemini - My choice for buying and HODLing Bitcoin, rated tops for safety and security. User-friendly platform and phone app. Earn Bitcoin rewards as well with the Gemini Credit Card.
Arculus - The crypto hardware wallet from Arculus is one of the best products on the market for storing your coins. Very easy to set up and to use, and very affordable.
Lolli - The Lolli shopping app lets you earn great Bitcoin rewards on practically everything you buy, whether you’re shopping on your phone, computer, or in-person.
Twitter - Follow The Bitcoin Files on Twitter at @BitcoinNewslet1 for all of my articles, commentary and links to my contributions to Bitcoin Magazine.
Medium - Check out my writings on Medium, including articles not featured in the newsletter. Join my 500 other followers who read and write about crypto. medium.com/@rickmulvey
Podcasts - To hear the top names in Bitcoin, and learn more than you could imagine, check out The Pomp Podcast with Anthony Pompliano, What Bitcoin Did with Peter McCormack, and The Wolf of All Streets Podcast with Scott Melker.
Issue No. 57, May 20, 2022
Rick Mulvey is a CPA, forensic accountant and crypto consultant. He writes about all things Bitcoin, and yells at the Yankees and Giants. He also runs marathons and makes wine, neither professionally.
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