Algorithmic Stablecoin Blame Yourself

Crypto winter was tough on crypto. It was terrible for algorithmic stablecoins and stablecoin investors. In just one week in 2022 the TerraUSD stablecoin and its sister token Luna collapsed and took roughly $40 billion in value with it. This crypto collapse started a series of collapses in a crypto domino effect. One of the last dominos to fall was the FTX crypto exchange along with its various subsidiaries. Terra is being sued for fraud by the SEC. They are asking the judge to let them to subpoena FTX in hopes of aiding in their defense. In the end it is a matter of algorithmic stablecoin blame yourself.

Terra Luna Algorithmic Cryptocurrency

The Terra network was launched in 2019. Its most prominent parts were the TerraUSD (UST) and Luna cryptocurrencies. These cryptocurrencies were pegged against the US dollar. Thus they were to be stablecoins. Rather than having sufficient assets in hard currencies to back the value of their stablecoins, the system relied on programming within the blockchain.

TerraUSD and Luna were linked. The TerraUSD algorithmic stablecoin was, by definition, worth $1 in value of Luna. The rationale was that anyone holding TerraUSD could sell their tokens for $1 each. However, the number of Luna tokens in any swap for TerraUSD could vary according to the market. The system was meant to incentivize arbitrage by traders which was designed to maintain a TerraUSD value close to or at $1.

What Went Wrong with TerraUSD and Luna?

In order for the TerraUSD and Luna system to work there had to be an incentive to buy these tokens in the first place. That incentive was a lending project called Anchor which offered interest rates up to 20% for TerraUSD deposits. Along the way, Terra accumulated reserves in Bitcoin and the cryptocurrency Avalanche but not enough to satisfy investors who likened the whole thing to a Ponzi scheme. Terra paid obscene amounts of interest and could not keep mining and selling sufficient Luna to make up the difference. The system went in to a financial death spiral as a couple of large withdrawals spooked other investors who started pulling out. There was the equivalent of a run on the bank. Terra used almost all of its Bitcoin reserves and did not succeed. Within a week the whole system collapsed and the fallout spread across crypto.

What Does the SEC Say Terra Did Wrong?

Not only did Terra collapse taking investor money with it but the Securities and Exchange Commission took Terra and its boss to court. The SEC says that Terra and its CEO Kwon misled investors again and again. The gist of the complaint is that Terra failed to provide “full, fair, and truthful” disclosure of the risks of their product and how it worked. The SEC says Terra committed fraud in issuing false statements meant to build trust but which actually were lies meant to mislead investors. The SEC blames those lies for losses experienced by TerraUSD and Luna investors.

Terra Got in Trouble Because Its Business Failed

Prior to crypto winter there were rumblings by regulators about the need to reign in the crypto industry. Much of this was ignored as profits soared and investors got rich. Then a lot of people lost a lot of money. Crypto values plummeted and crypto businesses collapsed. In the aftermath of massive losses, folks started pointing fingers. The usual marketing hype that a given company, token or way of doing business is safe becomes, in retrospect, fraudulent. The problem at the root of the TerraUSD Luna mess was the algorithmic stablecoin approach on one hand. On the other hand it was the naïve assumption that crypto would go up forever without some major corrections. Terra can look at trades in FTX for some type of collusion. But the problem lies in the assumption that no matter what forces act on the crypto market that a little programming in the blockchain system will be all it takes to stay out of trouble.

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