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With the Terra blockchain halted on May 12, both TerraUSD, an algorithmic US dollar stablecoin, and LUNA, its collateral token, are now officially laid to rest.
Over the course of a week, both tokens lost almost all their value, in one of crypto’s fastest and most spectacular crashes to date.
From a high of $22bn on Monday (May 9), the market cap of LUNA fell to about $200m, and from a high of $18bn on Monday, the market cap of TerraUSD fell to about $1.85bn at the time of writing.
Clearly, these numbers don’t add up. A stablecoin whose market cap is nine times larger than its collateral is, in practical terms, not really backed by anything, and is anything but stable.
The price of TerraUSD has also drifted further from its $1 peg than ever before, hitting as low as $0.16 at the time of writing.
"I am heartbroken about the pain my invention has brought on all of you," the project's founder, Do Kwon, wrote on Twitter.
"I still believe that decentralised economies deserve decentralised money – but it is clear that $UST [TerraUSD] in its current form will not be that money."
With the dust now beginning to settle, the sudden death of TerraUSD offers a case study in how badly things can go wrong when crypto’s high-risk experiments fail.
Among US regulatory agencies, it remains unclear as to what lessons will be drawn from the episode, but clues are already starting to appear.
As VIXIO reported on Thursday (May 12), a number of US regulators have opined on the crash, including Janet Yellen, secretary of the Treasury.
Yellen argued that the “current statutory and regulatory frameworks don’t provide consistent and comprehensive standards for the risks of stablecoins as a new type of payment product”.
Nellie Liang, undersecretary of the Treasury for domestic finance, said that stablecoins “could” be used for payments in the US, but that they come with old risks, including market failures.
To those in the crypto industry, it is clear that Terra’s demise may turn out to be a watershed moment in the evolution of crypto regulations.
Investor protections, or lack thereof
The issues at play may differ depending on the audience, but high on the list is investor safety and investor protections.
For example, Jim Preissler, managing partner at investment bank Tritaurian Capital and co-founder of SOMA.finance, a decentralised finance platform, told VIXIO that Terra’s demise underscores the need for crypto products to be regulated as securities.
"It looks like the 'unregulated' crowd got exactly what they wanted, and now they have no protections and little recourse,” he said. “If this goes to bankruptcy, maybe in five years, they could get pennies on the dollar.
“Algorithmic 'stablecoins' like TerraUSD could likely be deemed securities. If this was done compliantly, and issued through a broker-dealer or a bank, there would be disclosures and protections.”
Preissler suggested the Federal Deposit Insurance Corporation (FDIC), which covers bank deposits, and the Securities Investor Protection Corporation (SDIC), which covers brokerage accounts, as potential avenues for protection.
“Accounts would be segmented, and investors wouldn’t have to wait until the end of a court case or bankruptcy to see some scraps back," he added.
Similarly, Trey Zeluff, director of strategy and innovation at digital asset group LevelField Financial, said the Terra episode highlights a lack of risk disclosure that is endemic in the crypto markets.
"Stablecoins as a concept and application of distributed ledger technology carry with them the promise of a more efficient and accessible financial system,” he said.
“For stablecoins to deliver that future, they must exist in a regulatory framework that protects the public and demands a clear disclosure of the risks associated with these products.
“One could speculate that many people involved in TerraUSD did not understand the theoretical underpinning of its US dollar peg, but they had faith in the project due to the endorsements of people and entities that operate outside current regulations."
Without naming names, Zeluff drew attention to the way that high-profile crypto influencers and investors are often looked to for advice and guidance by newcomers.
These newcomers then buy coins based purely on endorsements rather than merit or understanding.
Mike Novogratz, the billionaire founder and CEO of crypto investment fund Galaxy Digital, for example, was a lead investor in Terra.
In January 2021, Novogratz helped raise $25m for Terra in a venture funding round, news of which led the price of LUNA to double over the following week.
A year later, in January 2022, Novogratz publicly declared himself a "Lunatic", a nickname given to the LUNA community, and revealed that he had tattooed himself as such.
But Novogratz’s tattoo, which depicts a wolf howling at the moon, now appears less than prudent in light of LUNA's collapse.
In April, only a month before LUNA and TerraUSD began to unravel, Novogratz spoke at the Bitcoin 2022 conference in Miami, where he bragged about his tattoo and his support for LUNA on stage.
Novogratz has almost half a million followers on Twitter, and regularly appears on business networks such as Bloomberg and CNBC, but he has not been seen or heard of publicly since LUNA collapsed.
And with so many investors now suffering huge losses, it is easy to see how regulators could argue that endorsements from influential figures could potentially obscure the risks and the experimental nature of projects such as TerraUSD.
Some of these issues around deceptive marketing were raised in New York’s crypto fraud bill covered by VIXIO earlier this month.
Legal status
The other question raised by Terra’s collapse is whether regulators will draw a legal distinction between algorithmic, decentralised stablecoins, such as TerraUSD, and conventional fiat-backed stablecoins such as Tether and USDC.
Nisa Amolis, managing partner at blockchain investor A100x and advisory board member of Global DCA, a crypto self-regulation association, said that as lawmakers rush to regulate stablecoins, they should honour this difference in law.
"Unquestionably, the call for regulating stablecoins is now accelerated,” she said. “At today's hearing Rep. Davidson (R-OH) suggested Tether is a money market fund (a common view on the Republican side).
“He highlighted algorithmic stablecoins like Terra have different risks than single fiat-backed stablecoins.
“Yellen agreed the risk depends on the backing and again explicitly called out Tether and Terra, highlighting they are different but did not indicate they will be treated differently.”
