What happened with Terra Lab’s stablecoin project and what happens next?
There have been many explainers regarding the recent downfall of Terra Labs’ algorithmic stablecoin project, Terra USD (UST), and its linked cryptocurrency, Luna. It is probably one of the largest implosions of a cryptocurrency to date, wiping billions of dollars from the market and having a cascading effect against all cryptocurrencies. There have been several rumors circulating about a deliberate attack against the project; but do they have any merit?
From our teams’ research, there have been many theories going around, but no on-chain evidence to support them. It’s also unlikely to be forthcoming; evidence of market manipulation, particularly when it has taken billions of dollars in value will be guarded closely by the perpetrator. This also presumes it was a single entity responsible, and not a consortium conducting a ‘bear raid’ style market attack.
A threat is generally understood to be a combination of capability, opportunity, and intent. On their own the theories are not indicative of any threat, but by looking across all areas we can gauge how credible a threat is. To that end, let’s evaluate some of these factors and see if there are any credible stories, and perpetrators.
Perpetrator Capability
According to the various theories circulating, an attacker would need to have amassed a significant amount of cryptocurrency, to the tune of billions. They would also need to be financially savvy enough to understand the flaws in the mechanism of UST/ Luna and to exploit them.
This would suggest that an attacker would need to be either a larger consortium of like-minded individuals/ firms, or it would need to be a large firm with funds to do so.
As a counterpoint, it is generally accepted that the larger the number of people involved in a conspiracy, the more likely it is that it will unravel at some point. This should also be considered applicable to large organizations; whilst online rumors have swirled about the involvement of large investment firms, such a level of coordinated action would invariably surface, though not necessarily in the immediate aftermath.
It is also worth pointing out that the firms involved have vehemently denied any such act.
Manipulation Opportunity
Stablecoins are preferable to other cryptocurrencies as they have a stable price – usually linked to a national currency, such as the United States Dollar (USD). They typically achieve this by using some form of collateral, either crypto, commodity, or fiat, that has an equal value to the token that they are issuing.
How does a stablecoin work, practically speaking? At the most simplistic level, if I have $100 USD, I can issue 100 tokens that can be redeemed for a dollar each; they can be traded, sold, and resold but if the token is returned to me, I can provide the same amount back in fiat currency. In the case of cryptocurrency collateralized stablecoins, they are generally over-collateralized to protect against price fluctuation.
What happened in the case of $LUNA and UST? Terra Labs’ proposal to solve the issue of price fluctuation was to have two separate, but linked currencies; UST, the stablecoin that should maintain parity to the USD, and Luna, the staking token that was used to control the price.
The protocol was, on the surface, quite simple. UST rose in price, away from its peg to the USD, the supply of the Luna was increased, causing the price to fall. As UST fell in price, the supply of Luna decreased, raising the price of UST to meet 1 USD. Wild movements on either side of the equation could cause the system to fail, particularly if you were able to crash the price of the cryptocurrency backing UST, Luna.
Which is precisely what happened; Luna was devalued so much that UST lost its peg with the USD, rendering it useless as a stablecoin. This would trigger a widespread sell-off as investors exited the project, causing the price to fall further.
Did anyone foresee this potential problem? Some had warned of this scenario previously, suggesting that a determined and financially capable attacker could affect the price of Luna so much that UST would fail. The algorithm was susceptible to manipulation – at least in part – due to the reliance on cryptocurrency as collateral.
For its part, Terra Labs tried to defend UST. The Luna Foundation Guard (LFG) sold a large amount of its bitcoin reserves to defend the value of UST, sending funds to Gemini and Binance. This act has also been met with criticism, as transparency of the trading activity on these exchanges has not yet been provided.
Likelihood of Intent
Terra Labs founder and CEO, Do Kwon, certainly had his detractors. A confident and charismatic figure, his reputation for labeling critics as ‘poor’ on social media interactions, as well as even going as far as to call for an attack along the lines of what materialized when warned about it in November 2021. This seems low on the scale of intent, as it boils down to a personal grudge against the founder or project.
Even when combined with an intent to make a profit from USTs demise by short-selling and maximizing returns by creating the conditions necessary for a significant price drop, seems unlikely. Some online commentators have suggested bumper returns, as much as $500 million in one thread, but these are not backed up by on-chain evidence.
Saga Summary
In summary, this whole saga is a watershed moment, particularly for ‘crypto Influencers’ who have had something of a comeuppance, and that’s not limited to just UST/Luna. The authorities are biting back and cracking down on them – and it appears that the market has no time for their claims either. Conspiracies are understood to last in proportion to the number of people involved, that is, the more people involved, the less time it takes for them to be exposed; and in the world of crypto, things often move much, much faster.
Light years faster.
