Today I’m setting aside my belief that all crypto is doomed to fail. It is, but that’s a medium-term diagnosis — at least for now, and ignoring the day-to-day bugs that occur in all software, blockchain technology certainly works as advertised. It’s actually super-cool and worth reading up on; my articles on crypto theory and implementation are just two of many reasonable places to start.
But sadly, even if you suspend disbelief about the technology itself, it’s being used to build a ton of straight up con games. That’s maybe a bit harsh — there are obviously true believers out there, but they’re so mixed up together with the con artists that it’s harder and harder to tell the difference. And honestly, when it’s my money on the line, that “difference” doesn’t really matter anyways.
In just the latest example, willful misuse of the world “stable” tanked somewhere between 92-100% of value for “investors” in UST and LUNA tokens — that’s about $45 BILLION USD. And despite an (ever-shrinking) number of frantic screeds to the contrary, that money ain’t coming back, ever. Too bad, so sad.
In the crypto world, a ton has been written about this crash already. Most of those folks know way more than I do, but I thought it’d be useful to create something for the more casual observer, one that doesn’t live and die by their hardware wallet and is curious how things could implode so quickly and so completely.
The short story is just that it was all bullsh*t to begin with, but let’s take a closer look.
The first thing anybody new to cryptocurrency asks is “but why do people think it’s worth anything?” This tends to quickly become a philosophical conversation, because there is no real answer other than “belief.” People believe that it has value, and they believe that others will agree when it comes time to trade that value for goods or services or whatever. So long as nobody looks at it too hard, all is well. It seems ridiculous when you say it that way, but that’s basically how the US Dollar works too, ever since 1933 when the US government abandoned the gold standard. For that matter you can go even further down the rabbit hole — why is gold itself worth anything? Sure there are some commercial use cases for the metal, but that’s just noise — really it just comes down to belief.
But despite that semi-logical equivalence, there is definitely a huge popularly-perceived difference between cryptocurrencies, which can be created on a whim by deploying a new blockchain (or just a smart contract), and “fiat” currencies that are backed by a government or similar supposedly-reliable entity. “Stablecoins” were invented as a solution for folks that like the mechanics of cryptocurrency (anonymity, smart contracts, etc.) but want the confidence that comes with traditional money.
Stablecoins are honestly just about the only thing in the crypto world that are truly easy to understand. It’s just the gold standard for 2022 — somebody “mints” new crypto tokens and promises that each one is “backed” by actual reserves of some fiat or hard currency. For example, Tether tokens are minted by Tether Holdings Limited, a company registered in Hong Kong, and are guaranteed to be backed 1:1 with real world reserves. Each of their USDT tokens is backed by $1 USD, so at least theoretically you can always swap one for a crisp new Washington. This makes them “stable” — their value should never fluctuate more than the reserve currency does.
Of course, to trust the token you have to trust the entity holding the reserves — despite its price stability Tether hasn’t made a lot of friends in the New York AG’s office. There will always be good companies and bad companies out there, and the balance with regulators is a never-ending dance. But at least the concept makes sense and is fundamentally sound.
Alas, true stablecoins are just too simple for some folks. It is true that they are only as “safe” as the entity that vouches for them. And the asset centralization they require does run contrary to crypto’s power-to-the-people vibe. One attempt at addressing these issues is the so called “algorithmic stablecoin,” an interesting concept that unfortunately doesn’t deserve its moniker. Until a few days ago, the most popular algorithmic stablecoin was UST or “Terra.”
Here’s how it worked. At first, UST wasn’t backed by any reserves at all. Instead it was launched with a sister coin, a traditional cryptocurrency called LUNA. Terra is the earth and Luna is the moon, get it? The trick was that you could always trade LUNA for UST as if UST was worth exactly $1 USD. Trading from one coin to the other was destructive — that is, you destroy one LUNA to get one new UST or vice versa.
In theory, this dynamic would cause behavior that always kept UST right around that $1 USD “peg.” This stuff is really hard for me keep track of, so here’s how it breaks down:
- Say UST is trading at $1.01 (USD) and LUNA is at $10.
- I buy 1 LUNA token for $10 USD.
- I swap my LUNA for UST. Because this is always done as if UST was worth $1, I get 10 new UST tokens and my original LUNA token is destroyed.
- I sell my UST and receive $10.10 USD.
Woo hoo! I’m now $.10 richer than I was (at least if you ignore the transaction fees). Critically, because there is now more UST in the world, it has become less scarce which will naturally push the price down towards $1. People will keep making this trade and taking profits until it hits the peg again.
The reverse works just as well. If UST is trading for $.99, I can start with a UST purchase, swap to LUNA and then sell that for USD. I make the same profit, but UST becomes more scarce this time, pushing the price back up towards $1. Since the LUNA side of the algorithm isn’t pegged to anything, it is free to swing up and down with the market, just like BTC or any other cryptocurrency. In this way LUNA was said to “absorb volatility” for UST.
As long as people stay interested in UST, it should keep its peg and LUNA will thrive. The “Anchor” protocol was the third leg of that stool — a scheme by which folks could deposit their UST tokens in return for an annual interest rate of 20%. Compared to anything in the “traditional” finance world, that is an insane guaranteed rate of return. Where did it come from? Anchor acts as a traditional money market for UST and additionally uses its holdings to earn staking rewards on other proof-of-stake blockchains (see here for a little jargon relief). To be fair, Anchor tweaked things over time, but that’s it in broad strokes. People were incented to buy UST and deposit it with Anchor — something like 70% of the entire UST supply lived there.
All this is very cute, but it’s still just part of the larger crypto shell game. Neither UST nor LUNA was actually backed up by anything but belief. Folks did actually notice this, creating demand that at the start of this year resulted in the founding of the “Luna Foundation Guard.” The LFG was created to help backstop the UST/LUNA ecosystem, primarily with $3.5B in BTC. Now sure we’re backing crypto with crypto — but it is fair to say that of all the crypto out there, Bitcoin is probably the “safest” (yeesh, I just threw up a little writing that).
Between their algorithms, Anchor and the LFG it seemed like UST/LUNA was riding pretty high, with a combined market cap of about $60B USD just last month. Of course $3.5B against $60B is nothing like a true stablecoin reserve, but it was something, and was met with real enthusiasm. (In an amusing-for-some-of-us anecdote, LFG acquired about $1B of that reserve by trading UST to Genesys!)
Right around May 7, a few huge investors started dumping UST (for example this swap of $85M into the actual stablecoin USDC). Most of these dumps came out of Anchor deposits, which eroded trust in future Anchor yields and cascading exits. LFG did what it was supposed to and deployed resources to shore things up, but it didn’t help. And as the supply of UST kept going down, the supply of LUNA exploded — more than 6,000 BILLION new LUNA tokens were minted this month, which of course destroyed its value too.
As of today, the LFG resources are exhausted and the Korean police are sequestering their remaining assets. Meanwhile, the asshat crypto-bro that started all this just keeps on rolling and is trying to convince people to jump on board with his new “Terra 2.0” … holy crap.
Anonymity being what it is, it’s not entirely clear why things collapsed as quickly as they did. I’ve read speculation that it was an orchestrated attempt by BTC shorts — forcing LTG to sell its holdings all at once created downward pressure on Bitcoin that others could take advantage of. But it’s all basically guesses, and you don’t really need a conspiracy theory to explain the implosion. Belief-based value is only good as long as people keep believing. The whole market has been on shaky ground — and the mostly-unregulated crypto market is incredibly vulnerable to panic.
TLDR, saying something is “stable” doesn’t magically make it so.
Look, I’m the farthest thing from a financial genius. But what I believe is this — the most reliable way to lasting value is to build things that improve the world. For sure some new things are coming out of the crypto world, and those will last. But most of it? Garbage.