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In another landmark case for the global crypto industry, the creators of the TerraUSD stablecoin have entered into one of the largest settlements in the history of the US Securities and Exchange Commission (SEC).
After a nine-day trial, a New York jury returned a unanimous verdict that those behind TerraUSD had “intentionally and recklessly” defrauded investors of billions of dollars.
South Korean developer Do Hyeong Kwon, 32, agreed to the settlement as an individual defendant, while Terraform Labs, the company he founded in 2019, agreed to the settlement as a corporate defendant.
Do Kwon, who is currently in custody in Montenegro awaiting an extradition decision, did not appear in court during the trial.
Under the proposed settlement, Terraform must pay $4.47bn in monetary remedies, consisting of $3.5bn in disgorgement, $466m in prejudgment interest and $420m in civil penalty.
In addition, Terraform must file a Chapter 11 liquidation plan in its ongoing bankruptcy case, and Do Kwon must transfer at least $420m to the bankruptcy estate for distribution to victims.
Separately, Do Kwon must pay $204m in monetary remedies as an individual defendant. He will also be permanently banned from trading in crypto-asset securities or inducing others to do so, and from serving as an officer or director of any public company.
Christopher Carney, trial counsel for the Securities and Exchange Commission (SEC), said the proposed settlement will provide “meaningful and speedy recovery” to the victims of the multi-billion-dollar fraud.
“A jury found Kwon and Terraform liable for orchestrating one of the largest securities frauds in US history,” he said.
“If approved, the proposed judgment will send an unmistakable deterrent not only to those who engage in brazen misconduct, but also to all those who seek to evade the requirements of the federal securities laws.”
According to Stanford Law School, the settlement would be the third-largest in SEC history and the largest to date between the SEC and crypto defendants.
Celsius, a crypto lending platform that collapsed partly due to the unravelling of TerraUSD, still holds the record for the largest crypto settlement in the US.
In August 2023, Celsuis settled with the Federal Trade Commission (FTC) for $4.7bn after being found liable for deceptive advertising, market manipulation and misappropriation of customer funds.
Later, in November 2023, Binance agreed to pay $4.3bn to settle criminal charges related to anti-money laundering (AML) failures, sanctions offences and operating as an unlicensed money transmitting business.
A multi-dimensional crypto fraud
The TerraUSD fraud began in April 2019, when Do Kwon’s newly founded company launched the Terra blockchain and issued 1bn units of LUNA, a new crypto-asset security. This was followed by the creation of TerraUSD, an “algorithmic” stablecoin.
LUNA acted as a collateral token for TerraUSD, allowing investors to convert from one to the other on demand.
When a new unit of TerraUSD was minted, $1 of LUNA would be algorithmically "burned", i.e. taken out of supply. Conversely, when a unit of TerraUSD was redeemed, $1 of LUNA would be minted.
In theory, this was supposed to ensure that the value of TerraUSD remained fixed at $1, while the value of LUNA could fluctuate based on supply and demand.
In practice, however, the value of TerraUSD would also fluctuate, and it required the help of arbitrage traders to keep it stable.
The SEC argued that the defendants had defrauded investors by lying about the stability of TerraUSD — an argument the jury accepted.
In 2021, for example, when the value of TerraUSD fell below $1, Terraform secretly arranged for a high-frequency trading firm to place arbitrage trades to restore its value.
But in public to investors, Terraform claimed that the stablecoin had "self-healed" due to its proprietary algorithm.
In another element of the fraud, the defendants also lied to investors by falsely claiming that the Terra blockchain was processing retail payments in South Korea.
In June 2019, Terraform partnered with Chai, a South Korean payments app, which at the time had about 500,000 users.
Terraform claimed that it would “rebuild” Chai’s payments stack on the blockchain to “simplify” it and reduce transaction fees for merchants.
In reality, the SEC found that the Terra blockchain was never used to process any Chai payments; instead, the defendants simply copied genuine transaction data from Chai and pasted it to the Terra blockchain.
This gave the impression that Terra was being used in a retail payments context. As one investor put it during trial, such real-world usage was considered the “holy grail” for blockchain success.
The algorithmic stablecoin that ended in tears
In May 2022, TerraUSD lost its peg to the US dollar once again. By that time, however, the "Terra-LUNA" duo had grown to a combined market cap of $40bn, posing systemic risks to the wider crypto markets.
On this occasion, the speed of the depegging was such that arbitrage traders did not show up in sufficient numbers to restore its value.
Instead, holders of both TerraUSD and LUNA rushed, en masse, to dump their tokens at the same time, creating a “death spiral” where a devaluation of one devalued the other.
In a last-ditch effort to prop up the two tokens, Terraform sold $3bn of Bitcoin from its treasury and used the proceeds to buy LUNA and TerraUSD.
The scheme failed, and ultimately both tokens crashed to near-zero. The price of Bitcoin also crashed at the same time, triggering a cascade of liquidations across the crypto markets.
"Numerous institutional investors incurred millions of dollars of write-downs, and many retail investors, including working families like those that testified at trial, lost their life savings," said Carney.
"Defendants, on the other hand, retained hundreds of millions of dollars from the Terra ecosystem that they still control."
As covered by Vixio, the Terra-LUNA collapse not only triggered a crypto contagion, but also led to a chain reaction among regulators, who responded with urgent calls for new guardrails.
In a rare intervention at the time, US Treasury secretary Janet Yellen told Congress that the case illustrates the “risks to financial stability” posed by unregulated stablecoins. “We need a framework that’s appropriate,” she said.
