Can Terra Be Rescued, And How?
Abstract
Luna prices fell from US$87 on 7 May 2022 to US$0.0002 at the time of writing. Meanwhile, its widely adopted stablecoin UST fell from the peg of 1:1 USD to 0.1:1 USD currently. As a result of the ecosystem’s implosion, the TVL dropped from US$28.2B on 7 May to a current TVL of US$237mm. Luna co-founder, Do Kwon, has announced V2 of his plan to move forward.
What does it entail? And who stands to benefit?
In this report, we offer a quick take on the proposal and whether the Terra ecosystem can emerge from this crisis.
1 Aftermath of the Luna De-peg
On 17 May, Terra co-founder Do Kwon announced his proposal to move forward following the collapse of the UST to USD peg over the course of the last week.
The proposal will include the following:
• Fork the Terra chain into a new chain without the algorithmic stablecoin. The old chain will be called Terra Classic (token Luna Classic — LUNC), and the new chain will be called Terra (token Luna — LUNA)
• Luna to be airdropped across Luna Classic stakers, Luna Classic holders, residual UST holders, and essential app developers of Terra Classic
• TFL’s wallet (terra1dp0taj85ruc299rkdvzp4z5pfg6z6swaed74e6) will be removed in the whitelist for the airdrop, making Terra a fully community owned chain
• Allocate a large portion of the token distribution toward 1) providing emergency runway for existing Terra dapp developers 2) align interest of developers with the long-term success of the ecosystem
• Network security to be incentivized with token inflation. Target staking rewards of 7% p.a.
For the in-depth proposal and new token distribution, please see the link: https://agora.terra.money/t/terra-ecosystem-revival-plan-2/18498
2 Motivation and Timeline for the proposal
Over the past 12 months, there has been a significant amount of developer interest and activity which has spawned from the growth of Terra.
Currently, Terra’s app ecosystem contains hundreds of developers working on everything from DeFi to fungible labor markets, infrastructure and community experience. Terra Station (the ecosystem’s mobile wallet) has more than a million users.
As per Do Kwon, he believes “although [Terra is] distressed, [it benefits from a] strong brand recognition and a name that almost everyone in the world will have heard about.”
The timeline expected for this proposal is as follows:
• 05/17 — Announcement out
• 05/18 — Governance proposal out
• 05/21 — Terra Core release is cut, network launch instructions made available for validators
• 05/25 — Essential app developer registration completed
• 05/27 — Genesis file created from final launch snapshot
• 5/27 ~ Network launch
3 Analysis of the Proposal
With regard to the proposal by Do Kwon, there are several points which should be considered.
1. Why will 25% of the new token be airdropped to UST holders at “Launch” i.e. 27 May?
This seems to raise questions as to why a snapshot of the holders will only be taken post-event. Given the likelihood of UST holders changing hands during the depegging last week, this airdrop will only benefit those who have either held the entire time or those who just purchased UST in recent days.
2. Why will 10% of the new token be airdropped to LUNA holders at “Launch” i.e. 27 May?
Similar to point 1, following the depeg, the LUNA token began to hyperinflate while the majority of the early LUNA holders experienced severe dilution of their investments. Those who stand to benefit the most from this part of the airdrop will be those who purchased LUNA following the stoppage of the token’s hyper-inflation.
3. What does the 1-year cliff and vesting schedule achieve?
Given that the aim of the airdrop is to partially compensate those who were affected by the implosion of LUNA and UST, any type of lock-up would only delay the inevitable — holders looking to recoup as much of their lost investment as possible.
Given this overhang of supply and selling, this would likely disincentivize investors as any semblance of price appreciation would likely be dampened by the mountain of sellers.
4 Questions about the Terra ecosystem
Despite the fact that a number of teams and developers were attracted to build within the Terra ecosystem, given the overhang of debt holders (i.e. UST and existing LUNA holders), there will likely be significant headwinds in bootstrapping a new chain.
In addition, taking a look at the Top 20 apps within the Terra ecosystem by TVL, a number of these apps were built off of incentives provided by either for UST and/or MIR (synthetic assets denominated in $UST) and ANC (20% deposit rate).
5 Reserves are nearly depleted
Despite boasting a US$3B reserve only 10 days ago, this was quickly depleted over the course of the last week as Terra tried to maintain the UST to USD peg.
Without new funding, it remains to be seen where the value will stem from with the fork.
6 Potential alternative solutions
Given the points raised above, would there be a potentially better solution than Do Kwon’s proposal?
Consideration #1: Bitfinex / LEO
A case study worth considering would be the previous Bitfinex hack in 2016 which led to the exchange losing US$72million worth of assets at the time. The price of Bitcoin at the time of the hack was ~$625. Today, this hack would be valued at more than US$3.5billion.
In 2019, Bitfinex sold its LEO token, raising US$1billion in ten days, according to its CTO. The utility behind the token was mainly to lower trading fees when trading on Bitfinex.
However, the LEO token has one other unique property. In its whitepaper, Bitfinex noted that at least 80% of any recovered BTC from the hack would be used to purchase LEO on the open market and the purchased LEO would be burnt. The firm would also have 18 months to dispose of the Bitcoin, to avoid a large supply shock to the market.
Pros to consider
Compared to the original proposal submitted by Do Kwon, this would first of all not be an entirely new fork, but a token raise in the form of an IOU.
This is important to distinguish as earlier discussed. The airdrop cliff and vesting schedule of this new LUNA fork token would be a large overhang on the ecosystem and an unattractive incentive scheme for new investors and/or developers.
Instead, isolating the debt piece of the equation from the underlying ecosystem token would reduce the sell pressure and allows for an easier path for price appreciation once the Terra ecosystem is fully functioning again.
Key situational differences
The main difference between LUNA’s situation and the Bitfinex crisis was the fact that the latter suffered from a legitimate hack and loss of funds which are potentially recoverable at a later date.
In LUNA’s case, the majority of the funds lost via LUNA’s price and UST was due to capital destruction. There is no counterparty holding any lost funds that LUNA could recover. As such, there is no silver lining to look forward to that would result in a significant windfall like the Bitfinex situation when they recovered 94,000 BTC in February of this year which totals close to US$3 billion in value.
Consideration #2: Combination of new fork with a fundraise to repay 99% of the wallets which held UST
Community member “Wassielawyer” proposed an interesting combination of 2 proposals to rescue Terra.
The proposed solution would see the issuance of 1 billion new tokens in Terra 2.0 with allocation as follows:
• 20% to the developers
• 40% to LUNA holders at the time of de-pegging
• 10% to LUNA holders at the end of the old chain
- 30% to the rescue financiers or angel investors. (“Angel Investors”)
Pros to consider
Compared to the original proposed solution, the 30% allocation to Angel Investors would aim to raise US$1–1.5 billion of capital from investors. This was the amount discussed earlier last week when the initial de-peg commenced for LUNA.
The motivation behind the raise would be to use the proceeds to make “whole” an estimated ~99.6% of the smallest wallets which held UST (initial plan proposed by community member “Fatman”). Making these wallets “whole” would benefit holders of UST whose primary purpose was to earn a stable yield, in contrast to LUNA holders who tend toward the opposite end of the spectrum.
Making these wallets whole versus offering this cohort a new speculative token would be in the interests of the token holders as Angel Investors would be motivated to seek upside in the network rather than only to recoup their losses.
Key points of consideration
This proposal would value the new chain at a fully diluted valuation of US$3–5 billion. At the moment, the market is valuing LUNA at around US$1 billion and UST also at approximately US$1billion.
This proposal is contingent on several factors:
1. Builders see value in remaining within the Terra ecosystem to rebuild rather than migrate to another Cosmos L1 chain or bootstrap their own.
2. Angel Investors would supply the necessary capital, especially given that a number of these institutions have taken massive losses in the last weeks. This may become the equivalent of “throwing good money after bad”.
Using current market prices, the market has priced the intangible value of the Terra ecosystem at a value of approximatelyUS$2 billion. However, the likelihood is that the actual valuation is lower given that there is insufficient liquidity for large capital holders to exit at the market price and they would likely have to take significant haircuts.
We have observed such a dynamic in many “ghost chains” which were raised previously in 2017 where the majority of the outstanding supply is tightly held by large holders and institutions. As such, although the price may reflect a project to be worth billions, there is insufficient organic demand to absorb all the supply, should these holders wish to sell their entire positions.
Regarding factor #2, should the team be unable to raise sufficient funds via Angel Investors, an alternative might be to consider offering the new LUNA token to those who purchase UST in the open market.
In addition, on the new fork, a buyback and burn model for UST should be considered for a portion of the fees from the new network.
7 Concluding Thoughts
In traditional markets in the US, when a business is unable to service its debt obligations (in this case UST), the business or its creditors can file with a federal bankruptcy court for protection under either Chapter 7 or Chapter 11.
• In Chapter 7, the business ceases operations, a trustee sells all of its assets, and then distributes the proceeds to its creditors. Any residual amount is returned to the owners of the company.
• In Chapter 11, in most instances the debtor remains in control of its business operations as a debtor in possession, and is subject to the oversight and jurisdiction of the court.
In the case of LUNA, following a Chapter 7 playbook would require liquidation of all LUNA & UST tokens as well as any remaining reserves held by LFG for either other stablecoins or USD, for distribution back to UST holders. Given the dynamic mentioned above in Consideration #2, this would result in immense capital destruction (likely writing off the value to 0) as there is insufficient exit liquidity.
In the case of a Chapter 11 situation, this would be similar to the playbook mentioned in Consideration #2. Questions would surround the amount that can be raised to save the Terra ecosystem. Without this new funding, there are likely insufficient incentives to drive builders and other participants to support the new project. The outcome would result in UST holders seeing a haircut in the value they can recoup but at least some value can be recovered. The new project would be able to move on and start afresh without the debt overhang.
At the end of the day, there will be no easy, all-encompassing solutions given the capital destruction that has occurred, and it will be a long road to recovery for the Terra ecosystem as a whole.
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