While the crypto world has moved on to the latest and greatest scandal with FTX, it’s important to fully digest and stick with stories as they evolve out of the headlines and into the long tail effects. This article is the fourth and final of a four-part series by YaaS Analytics discussing algorithmic stablecoins, with a focus on the UST crash and the resulting fallout. The series consists of four articles:
4. The Aftermath of the Terra Crash
The fallout resulting from the UST crash was, to say the least, quite immense. Almost every corner of the cryptocurrency industry took a huge hit post-crash. DeFi, for example, saw its total value locked in protocols drop as much as 59% from $205b on May 5 to $85b at the end of August 2022. It is important to note however that in many ways this significant drop in TVL is a feature of DeFi and not a bug. DeFi is entirely transparent and open so when yields drop, risk rises, DeFi insurance claims are paid out or if any number of events happen, users know about it immediately and are able to withdraw assets immediately. This is often in contrast to CeFi or TradFi where issues are only known months later and often disclosed too late for users to take appropriate risk mitigation strategies.
Luna Foundation Guard
Particularly devastated in the fallout of the Luna crash were the reserves of the Luna Foundation Guard (“LFG”), where billions of dollars in reserves were spent trying to defend UST’s peg. Total funds in the LFG reserves dropped significantly from around $3.33b immediately before the crash to around $78.13m at the time of writing, a 97.65% decrease. BTC reserves were most significantly depleted, dropping from 80,394 BTC to 313 BTC, a decrease of around $2.85b in value to $6.69m, or 99.8%. However, this depletion of the LFG reserves through selloffs did not cause the price of LUNA to rebound in the way that many had hoped. LUNA’s price dropped so dramatically that despite the total number of LUNA tokens increasing over 13,000% from 1,691,261 to 222,713,007, the value of these holdings has dropped around 99.98% from $123m to $23k. Pictured below is a graphic of the LFG’s reserves in December 2022.
Implications from the collapse of UST and LUNA meant that Terraform Labs and the Luna Foundation Guard had to take serious measures to try and salvage any additional parts of their operations. Many remedies were proposed in the immediate aftermath as potential solutions for how to move forward with UST and LUNA, but ultimately Do Kwon & Terraform Labs proposed a solution that was approved on May 25th; fork Terra without UST, essentially removing UST from the Terra ecosystem entirely. This move would also change the name of the current chain, now called “Terra Classic.” At the time of writing, LUNA’s price is sitting at $1.33, with a market cap of around $169m.
Since May, TerraForm has also put several measures in place to try and keep assets in their ecosystem while they examine the fallout. Specifically, Terra has been doing Airdrops of their LUNA and UST tokens, given to those who are still holding the assets as a reward for not selling them. These airdrops have happened twice, once on May 28th of this year and then once again on September 4th.
Do Kwon, who of course founded and ran Terraform Labs, was most recently interviewed by Laura Shin on October 18th on the Unchained podcast, where he was asked about various topics including the numerous allegations against him, his involvement with Basis Cash and whether or not Terraform Labs cashed out billions of UST on Degenbox (a program created by Abracadabra for trading non-interest bearing tokens that supported trading UST for “Magic Internet Money” or “MIM” another algorithmic stablecoin), amongst other things.
For context, a South Korean court currently has a warrant out for the arrest of Do Kwon under charges based on the Capital Markets Act in Korea. As well, on September 26, Interpol issued a red notice for Do Kwon, requesting law enforcement worldwide to locate and arrest him.
When asked about this, Do Kwon states that the charges levelled against him by the South Korean government are not applicable under the Capital Markets Act due to the government not regarding cryptocurrencies as securities, instead stating that they are in fact politically motivated. Immediately afterwards, he claims that he has been operating in cooperation with the investigation against him, maintaining that he is not on the run, despite keeping his whereabouts unknown in spite of the arrest warrant and red notice.
Do Kwon admits to cashing out $2.7b worth of UST through Degenbox in exchange for MIM before exchanging the vast majority of this MIM for USDT and USDC. He claims that this exchange was an arbitrage mechanism rather than an attempt at cashing out.
When asked about his involvement in a previously failed algorithmic stable coin Basis Cash, Kwon maintains that “all I did was to join Telegram rooms and shitpost.” When repeatedly pressed about whether or not Terra investors would have had an interest in knowing that he had worked on a previous stablecoin that had failed, he avoids directly answering the question, repeatedly stating that “Basis Cash is not something that I designed or operated. It’s something that I encouraged.”
When asked about what he would do differently if he could go back in time to before the crash, the first thing Kwon mentions is that he would have tried to build BTC on-chain reserves earlier so that the reserves would have been more significant.
Contagion from the Crash
Unfortunately, the number of people and protocols affected by the crash is far too many to list in just one article. Rather than try to name all of those affected by this event, we will provide a breakdown of the three most notable fallouts that occurred in the wake of the Terra LUNA crash:
· Celsius Network
· Three Arrows Capital
· Voyager Digital
Each of these organizations have filed for some form of bankruptcy or insolvency in the wake of the Terra crash, with each having a unique ripple effect throughout the markets.
Celsius Network is a crypto lending firm based out of NYC. Founded in 2017, Celsius worked on a ‘CeFi’ model, meaning that they took in investments and allocated from a central authority, rather than through a protocol using smart contracts such as Compound or Aave. At its peak, Celsius had upwards of $12b worth of assets under management, had issued loans amounting to almost $8b, and was worth about $3.25b at its most recent funding round — less than a year ago, when the crypto market was at its peak.
Celsius, while facing a large amount of scrutiny over the years, was backed by some very reputable firms, including the Canadian pension fund Caisse de dépôt et placement du Québec (CDPQ), who invested in mid-2021. For a long time Celsius was seen as a leader in the open-lending world, and the platform had nearly 2m users.
However, the market conditions shifting upon the collapse of Terra caused a massive ripple effect through the industry that the Celsius team would later dub the “domino effect”, eventually leading to their bankruptcy. Terra’s collapse caused a massive sell-off across the industry. This massive sell-off led to a bank run-style series of events where many Celsius users all at once requested their money to be withdrawn from the network, something Celsius was not able to accommodate. As a result of this, on June 12th Celsius froze withdrawals, swaps, and transfers in a move which stoked major fear among the 1.7m Celsius users that their assets may remain frozen indefinitely.
The Celsius fallout is still ongoing, and their team had been working to free up capital locked up in various loans to return to users. Celsius has laid off a significant amount of their staff, hired restructuring lawyers, and filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court in the Southern District of New York. On October 13, 2022, a tool coined Celsius Networth publicly revealed customer losses in a game style leaderboard that retrieved private customer data, likely from the public bankruptcy court filing, further damaging their reputation. This tool revealed that Celsius owes around $4.7 billion to its users.
Three Arrows Capital
Three Arrows Capital (“3AC”) is a cryptocurrency hedge-fund based out of Singapore. Founded in 2012, 3AC was a massive institutional player who borrowed billions of dollars to fund trading, lending, and other operations. At its peak, 3AC managed about $10b, and did business with many of the largest CeFi players in the industry.
Much like many other CeFi lenders, 3AC would rehypothecate money posted as collateral for their loans in order to drive additional interest. Unlike other institutional desks however, 3AC would take these rehypothecated funds and lend them out to projects with higher risk profiles like DeFi platforms — including, of course, to Luna.
After the Terra Luna collapse, many creditors reached out to 3AC to inquire about their exposure to the collapse, with high-up people in 3AC including founder Su Zhu stating that there is “nothing to fear”and that their Luna positions are publicly known with no leveraged long positions. However, in mid-June Three Arrows Capital did in fact confirm that liquidations in their lending book did cause a 3AC collapse and resulted in insolvency of the platform. This collapse was seen as a surprise as many creditors were told that the exposure was minimized, and in early July 3AC confirmed that they had filed for Chapter 11 bankruptcy.
Currently, 3AC has appeared to have lost at least $3.5bn in total from at least 33 lenders, with many firms coming out publicly to confirm their specific exposure to the Three Arrows team including Genesis, BlockFi, Crypto.com, and Galaxy Digital. US regulators are still investigating the fallout and looking into whether 3AC mislead investors about the strength of its balance sheet as well as whether or not they had registered with the SEC. According to the filings, the founders whereabouts are still unknown, mimicking Do Kwon’s disappearance in the aftermath of the Terra Luna collapse.
Also worth noting in relation to the collapse of 3AC is the effects this had on the lending firms BlockFi and Genesis Trading. BlockFi took a significant loss to 3AC at the time of the crash, and was required to get a $250m revolving line of credit from FTX to be able to continue their operations.
Genesis required an injection of capital of around $140m from its parent company Digital Currency Group (DCG) to cover some of their losses in relation to 3AC.
Voyager Digital is a US based cryptocurrency brokerage company based in NYC. Founded in 2018, Voyager offered investors a secure way to trade over 100 crypto assets through their applications and earn rewards up to 12 percent on cryptocurrency loans.
In late June, it was reported that Voyager may be another victim of the DeFi contagion around the Terra, Celsius, and 3AC crashes. Voyager, it was reported, had lent out over $670m to Three Arrows Capital. Voyager also reported that Three Arrows Capital had failed to meet the necessary payments on its loans. This led to Voyager having to put a notice of default on Three Arrows Capital in early July. Crypto trading giant FTX and their venture firm Alameda Ventures offered a lifeline to Voyager, giving them a credit line of over $300m to help ease liquidity.
Currently, Voyager Digital is still facing the fallout of its bankruptcy filings around 3AC’s defaulted loan, and as of September 7th Voyager is at the auction block awaiting the selling off of its parts.
As stated earlier, the fallout from the Terra Luna implosion caused a massive shift in the broader market conditions for cryptocurrency trading and lending. As mentioned previously, the TVL in DeFi has dropped upwards of 59% from its pre-crash high of $205b earlier this year.
Similarly, the number of loans at the biggest CeFi platforms have dropped off significantly as well. Genesis, who had nearly $15b in active loans as of March 31st 2022, had just $4.9b in loans by June 30th of this year. Genesis, like most of the largest CeFi players, had been growing their loan books continually throughout their entire operations, having had a positive quarter-over-quarter growth for all but Q2 of 2021 in their past 2 years of operations before the Terra Luna crash. It is important to note that this is simply the data from the Genesis Quarterly Reports on their lending book as of Q3 2022 and does not take into account any of the current context around Genesis and their decision to freeze withdrawals in the wake of the FTX crisis.
Interestingly, while both TVL in DeFi and total assets in CeFi have seen significant drop offs from their all-time highs, stablecoin volume has not been observed to have the same affect. Stablecoin market caps have been relatively stable across all chains, with the total stablecoin market cap only dropping about 8.8%, from around $170b at the start of May to around $155b now.
Another interesting dynamic to observe over time will be the market capitalization of both USDC and USDT. USDT briefly saw its peg be lost earlier in 2022, and with many questioning where Tether’s reserves are currently being held, and there may be a potential reversal in their respective market capitalization wherein USDC would become the dominant stablecoin. It’s important to note, however, that this trend has reversed quite significantly since May. Currently, USDT’s market cap islin around $69b while USDC’s market is at $43b, and there has been several large moves from competittos trying to gain market share back from USDC and USDT.
Broader crypto markets have also taken a hit from the succession of market crashes that occurred. About a year ago, crypto markets reached their peak in market capitalization, when all crypto market capitalizations surpassed $3t in total value. Crypto markets also had significantly higher volumes earlier this year, with 24 hour trading volume across all exchanges reaching as high as $300b. These days, the market is substantially less profound, with a market capitalization under $1t and 24 hour volumes of around $40b.
When the UST crash happened, it resulted in the loss of funds for countless individuals, very few of whom have been reimbursed. Losses of these sizes with this much publicity around them have brought forward a new focus on implementing better and more robust regulations to an ecosystem that has up until this point remained largely unregulated.
Around the globe, lawmakers are forming new regulatory frameworks to have better oversight over the market, with many lawmakers specifically eyeing a way to better regulate the stablecoin market and the DeFi market. In the US, regulators from both the Federal Reserve and SEC have come forward about wanting to have better oversight on the ways that stablecoins are made going forward. Many believe that these products being issued by private organizations while not having any reserves to back up their holdings present massive risks to investors who may not be aware of their risks and treat the products like fiat currencies.
As a result of this, several stablecoins have voluntarily come forward to detail exactly where their reserves are, including Circle’s USDC and Paxos’ USDP, and Binance’s BUSD. These efforts by stablecoin issuers have been a way for them to combat against the negative press that the industry has received as well as to prove exactly what assets are backing their currencies.
No matter what happens moving forward, it’s clear that the market is now facing the consequences of using stablecoins that are not properly regulated or reserved in ways to protect users’ assets. Investors are now looking to use products that regulators have sanctioned as compliant to the relevant risks that may be apparent, where they can be assured that their assets are backed up by some tangible value.
By Marc Doucette and Jack McKay