Analysis of the Terra Ecosystem Crash

Background and Tokenomics of The Terra Ecosystem

In the year 2018, Do Kwon — a South Korean crypto whale — founded Terraform Labs in Seoul. Since the computational Proof-of-Work consensus mechanism has become inefficient in today’s world, Kwon adopted the proof-of-stake mechanism for its blockchain — Terra ecosystem. The ecosystem has two tokens: LUNA and UST. While the latter is a stablecoin, the former is a volatile one. Nonetheless, both of them are linked together. It behoves to note that UST is fundamentally different to other stablecoins like Tether and USDC which are claimed to be backed by real-world assets such as bonds. In the case of UST, it indeed has no real-world reserves, but it works through a complex system of minting and burning tokens to maintain price stability. A UST token is created by destroying some of the related cryptocurrency LUNA to maintain the dollar peg. When UST’s price is too high (>$1), the protocol incentivizes users to burn (destroy) LUNA and mint (make) UST. When UST’s price is too low (<$1), the protocol incentivizes users to burn (destroy) UST and mint (make) LUNA. That is how it works. But the extreme market volatility has put UST to the test, and it has been unable to maintain the peg.

Do Kwon’s Confidence In The Tokenomics of UST

Ever since the rise of the Terra ecosystem, Do Kwon has always displayed enormous confidence in the infallibility of both UST and LUNA. He once tweeted that those anticipating the depegging of UST might have to “wait until the age of man expires.” Two months ago, he even struck a bet with a crypto personality known as GCR to the tune of $10 million over the future price of Terra (LUNA). Both parties have sent $10 million in stablecoins (USDT for Kwon and USDC for GCR) to an escrow account, which is simply an Ethereum wallet held by a veteran crypto trader known as Cobie. GCR sent their funds over yesterday, Kwon has also sent his own Payment confirming the bet. The bet is founded on whether the price of Luna will be increased or decreased in one year. Kwon made a bet in favour of the price of LUNA, which is his project, while GCR is betting against it. The price of LUNA as of the time the of betting was accepted at $88. After acknowledging the escrow account had been filled for both bets, Cobie tweeted, “May the best degen win.”

The Story of The UST Coordinated Attack, How It Happened

On the 9th of May, the UST chart started diving below the $1 peg. But this didn’t arouse attention early enough since some other stablecoins do go a little bit below the value of their attached fiat currency at times. But it started getting serious when UST dipped below to $0.6 on the 10th of May. At this point, most investors and holders caught the FUD and were panic selling. While that was going on, some investors unfortunately mistook the crash to be a dip and pumped funds into it. But the crash became more evident on the 13th of May when its price action ridiculously dropped to $0.07.

Vitalik and CZ Have Some Thoughts on Terra’s Demise

Vitalik Buterin, the creator of Ethereum, critiqued the entire premise of UST, citing it as, from inception, intentionally misleading and inherently flawed. “‘Algostable’ has become a propaganda term serving to legitimize uncollateralized stables by putting them in the same bucket as collateralized stables like RAI/DAI,” Buterin tweeted on 14th of May. Changpeng Zhao, CEO of Binance, the world’s largest cryptocurrency exchange expressed his disappointment in the way Terraform Labs handled the recent LUNA and UST collapse. Zhao said that the team behind the Terra network hardly responded to Binance’s request to help them restore the network. “We requested their team to restore the network, burn the extra minted LUNA, and recover the UST peg,” he tweeted. “So far, we have not gotten any positive response or much response at all” He compared Terraform’s response to that of Axie Infinity’s, the project that was hacked for $622 million in March 2021, lauding the latter for its accountability at that time. “This is in sharp contrast to Axie Infinity, where the team took accountability, had a plan, and were communicating with us proactively” added Changpeng Zhao. “And we helped.”

Two Popular Plans to Bail Out UST and LUNA holders

Currently, two Terra governance proposals appear to be favoured for returning some value to stakeholders. They are the Revival Plan and the FatMan Plan. The Revival Plan calls for a hard fork in the Terra blockchain, resulting in the creation of 1 billion Terra 2.0 tokens, which will then be distributed among developers, holders and investors in the project. The FatMan Plan calls for the LFG to distribute its $1.5 billion reserves to all UST holders before the de-pegging- helping them recover at least some value on their investment. But the community is yet to vote on either proposal. Terraform Labs and Do Kwon have also shared a few details on the path forward.

What Next For LUNA and UST?

A high-ranking member of the Luna Foundation Guard (LFG) said on Monday that the foundation’s reserves are almost ready to be deployed, barring a few technicalities. Luna Foundation Guard (LFG), the non-profit organization holding Terra’s bitcoin reserves, confirmed on Monday morning that it had sold over 80,000 BTC over the past week to acquire TerraUSD (UST) in an attempt to defend its crumbling U.S. dollar peg.

Final Remarks

This unprecedented incident has caused a lot of ripple effects. After the fall of UST, Bloomberg announced that DEI — another stablecoin that its value was attached to the United States Dollar — had also lost its peg. Sequel to the progressive decline of major stablecoins, there was also FUD that the same might soon be the tale of USDT. To guard against this, various regulators are on their toes to give clear-cut directives towards the reserves of stablecoins and protect their citizens from unfortunate incidents of crash. At the moment, the Treasury Secretary of the United States — Janet Yellen — has set the motion for the regulation of stablecoins in the US. Similarly, the South Korean government has formed a committee to investigate the crash and have further summoned Kwon for questioning.



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Adam Tracy

Adam Tracy


Crypto Influencer | Blockchain Evangelist | Ex Pro Rugby Player | Find Me: