Terra and Luna’s $85 billion collapse reveals a new breed of bank run


The collapse of the two coins led to a flight in digital assets and helped wipe out more than $300 billion from the combined value of all cryptocurrencies for the week ended May 13. Bitcoin, which traded for more than $60,000 as recently as October, is now going for half. At least for now, the whole crypto edifice is looking shaky.

The Holy Grail

Not long ago, Luna and TerraUSD supporters talked like they had reinvented finance. The token’s creator, Do Kwon, a 30-year-old South Korean who studied computer science at Stanford, said he wasn’t just making a different form of digital money — it would be a new financial system, one outside of government control that was cheaper and quicker to use and paid higher interest rates to savers.

“Creating a decentralized form of money on which you can build an entirely new breed of permissionless financial ecosystem is the holy grail of cryptocurrency, and that’s exactly what Terra is doing,” Kwon said in a promotional web video.

The system around the coins was complex. Start with the stablecoin. These coins have become an important part of the crypto world as a replacement for traditional cash.

Because they are designed to have constant value, they are easier to use to pay for things in the real world. (Bitcoin and other coins like it, bouncing and falling in price so much that the seller of a BMW might only get a Honda’s worth of tokens by the time the deal closes).

Kwon envisioned Terra stablecoins being used for instant payments and remittances around the world, underperforming Visa, Mastercard, and Western Union.

The concept wasn’t new. But unlike other stablecoins, TerraUSD didn’t even claim to be backed by dollars or other assets in a bank account. Instead, it was supposed to be worth $1 because it could be redeemed for Kwon’s other token, Luna, worth $1.

If Luna was worth $10, you could redeem a TerraUSD stablecoin for 1/10th of a new Luna, which you could sell on an exchange for $1. If Luna was worth 10¢, you would get 10 Lunas.

Luna itself would increase in value as the network grew in popularity due to its holders charging usage fees. It was essentially a mullet network: a boring, no-nonsense stablecoin on the front and the Luna get-rich-quick party on the back.

TerraUSD was launched in 2020 but gained little traction until March 2021, when Kwon launched a third part of the network: Anchor, a quasi-bank for crypto where users could deposit their Terra stablecoins and earn 20 percent interest. (As is typical of crypto, Kwon says his company, Singapore-based Terraform Labs, wrote the software, but all three branches of the system are “decentralized” and controlled by their users.)

“Nice and decentralized”

Maybe that raises an eyebrow? In fact, some people in the crypto world argued that it was unsustainable. After all, that’s 20 percent higher than Bernie Madoff’s invented returns on his hedge fund. But Kwon pitched it as a safe alternative to banks like Wells Fargo, even saying other fintech companies like Venmo might deposit user funds there one day.

“The beauty and decentralization of this system is that it doesn’t require centralized intervention,” Kwon said on a podcast in January. “It’s just nicely combined together using a number of game-theoretic stimuli.”

You can’t just create more money out of thin air.

— Steven McClurg, chief investment officer at Valkyrie Investments

In 2021, Luna’s price increased 100-fold and nearly $10 billion worth of TerraUSD stablecoins were created.

On Twitter, Kwon, whose avatar was an Iron Man-style armored hero, said Terra was unstoppable and trolled anyone who questioned his ideas. “This community bought Luna so they definitely aren’t as poor as your broken ass,” Kwon tweeted to a critic in March.

Galaxy Digital founder Mike Novogratz called himself an “official lunatic” in January. Twitter

Fans called themselves Lunatics. “I’m officially a maniac!!!” Galaxy Digital founder Mike Novogratz tweeted in January after tattooing his left shoulder with the word “Luna” next to a wolf howling at the moon.

“My tattoo will be a constant reminder that risk investing requires humility,” the billionaire said in a letter posted online May 18.

But TerraUSD had a flaw that it shared with money market funds or banks before the invention of deposit insurance. If users lost confidence in the system, they could quickly sell or redeem their coins, and others could follow, fearing they won’t get their $1 per token back if they wait too long.

In theory, the network could issue more and more Luna tokens to those looking to get out. But even that was a risk. As more tokens are issued, Luna’s price would fall further, which in turn would mean the network would have to spend even more, exacerbating the drop. On Wall Street, this is what they call a “death spiral.”

“The idea was, ‘We’ll just print more Luna out of thin air to support the stablecoin’s price,’ and that doesn’t really work,” says Steven McClurg, chief investment officer at Valkyrie Investments, based in Brentwood, Tennessee. “You can’t just create more money out of thin air.”

“Watching My Own House Burn”

The crisis began on May 7th. Luna had already drifted lower as part of a broader asset price slump. After a trader extensively swapped TerraUSD for competing stablecoins, the price fell to $99, prompting speculation that the dollar peg was at risk. Kwon had accumulated a few billion dollars worth of bitcoin in reserve to back up TerraUSD in case of an emergency, and on Twitter he expressed confidence in its stability.

“Those of you who are waiting for the earth to become unstable – I’m afraid you will wait until the human age is over,” Kwon said wrote on – May 8th. But the next day, Terra redemptions continued, forcing Luna to spend more tokens.

Luna fell more than half to less than $30 and lost another two-thirds the next day.

Kwon urged the followers to persevere. “Come closer…stay strong, lunatics,” he tweeted. But the death spiral was unstoppable. By the morning of May 13, 6.5 trillion lunas were in circulation and the price had fallen to $0.00001834. The price of TerraUSD fell below $20 because even if it could be redeemed for a huge pile of Luna tokens with a hypothetical value of $1, there was no one to buy them.

Iyamuosa, the Nigerian investor, says he has spent the days since the crash in disbelief. Barring his last $20, he’s still on Twitter and chat app Discord, hunting for a crypto project that can help him get his money back.

His dream of moving to Canada to study seems unattainable. “There’s literally nothing else for me,” he says. “I don’t know, man. Honestly, there is no job, there is nothing.”

Other investors also say they were prepared for ups and downs but never envisioned a collapse so quick. Senior Bernier, 24, a floor fitter in Montreal, says he lost about $250,000. “Do Kwon is a guy I’ve always believed in,” he says.

“It felt to me like I was watching my own house burn down or something,” one investor said in an audio support group on Twitter Spaces. “You’re not an idiot, you’re not unpopular,” said the host. “Please don’t make hasty decisions, boys.”

Kwon did not respond to messages asking for comment. “I am heartbroken by the pain my invention has caused you all,” he said tweeted on May 13th. He said he has a plan to revitalize his financial system, this time without a stablecoin.

The crypto market seems to have stabilized. Tether, the most popular stablecoin rumored to be entirely backed by solid investments, fell below $1 before recovering.

But the collapse of Terra has increased calls for stablecoin rules in the US, UK and South Korea. Authorities in South Korea have revived a financial fraud investigation unit to investigate Terra’s collapse, news reports said.

Regulators say such a collapse could pose risks to the broader financial system as crypto and the complex DeFi ecosystem continue to grow.

“A lot of people thought that a stablecoin would only be as good as a dollar,” Rohit Chopra, director of the US Consumer Financial Protection Bureau, said last week. “But they’re learning it’s not like that.”

— Bloomberg BusinessWeek


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