How the Anchor Protocol helped sink Terra
If Do Kwon didn’t exist, someone would have to invent him. For example, there are the bets he made – worth a total of $11 million and held in escrow by Crypto Twitter influencer Cobie – that his Luna token would be worth more in a year than it is. was in March 2022. Likes slurs such as “continue in poverty ser,” “are you still poor?,” and “I don’t debate poor people on Twitter“, Kwon is the loud and combative co-founder of Terraform Labs, best known for the ongoing disaster that is Terra/Luna.
As of this writing, Luna is worth less than a cent, and its sister token Terra, which was to be pegged to a dollar as a stablecoin, is worth 6 cents. An investor, who told Yonhap news agency reporters he lost 2-3 billion won (about $2.3 million), was arrested for trespassing after entering the apartment complex from Kwon, looking for the master of the stablecoin. Kwon’s wife asked for police protection after the incident.
At the Washington Nationals ballpark, Terra’s logo can be seen on the seats behind home plate – and the stadium’s luxury dining room is called Terra Club, according to CoinDesk. Terra paid $38.5 million for this ad, which appears to survive protocol.
This isn’t really Kwon’s first failed stablecoin. That would be Basis Cash, which was also supposedly worth $1, and also capsized. He also dodged two Securities and Exchange Commission subpoenas.
While Kwon’s obnoxious Twitter personality lured a number of retail investors into Luna, they weren’t the only ones who were enticed. Jump Crypto and Three Arrows Capital bought Luna; Coinbase Ventures, Lightspeed Venture Partners, Galaxy Digital, and Pantera Capital backed Terraform Labs. Mike Novogratz, the head of Galaxy Digital, even got a Luna tattoo, which he says will be “a constant reminder that investing requires humility.” Kwon will also have his own permanent reminder: he named his daughter Luna.
Kwon’s rise and fall has been quite rapid, even by cryptocurrency standards. Luna emerged as a bright spot in the markets in December and peaked in valuation, just above $116, in April; Luna was worth over $40 billion, all things considered. Meanwhile, a lot of crypto, including Bitcoin and Ethereum, was slipping. Luna’s popularity was due to a loan program, Anchor, which promised annual percentage returns (APY) of nearly 20%, which is obscene.
The Anchor protocol worked like this, according to its white paper:
Let’s say I wanted a higher rate of return than I could get in a regular savings account or by buying (say) government bonds. So I deposited $10,000 worth of Terra, the dollar pegged coin into the system. Anchor then turns around and lends my deposit to another investor, whom we’ll call Lars. But to make sure he’s good for the loan, he has to post some of his own assets as collateral. Part of the return on Lars’ guarantee goes to me, along with part of his interest. Above all, the deposits and the interest is in Terra.
It’s not particularly groundbreaking, and that’s also why I don’t understand the 20% interest rate since the borrowers were also be rewarded for borrowing. Where does the money come from? In January people were already warning that Anchor was not viable because there were not enough borrowers.
The most charitable thing you can say about that 20% rate is that it may have been a customer acquisition strategy, and the APY was going to be revised down later. . Other people said other things. For example, some said it looked like an obvious Ponzi scheme, where money from subsequent investors was paid out to previous investors as “interest”. I’m sympathetic to that argument since even Bernie Madoff didn’t always give his investors 20% interest rates.
Regardless, a large chunk of Terra was deposited at Anchor – up to 72% of Terra, according to Decrypt. Anchor created a request for Terra. Unlike stablecoins such as Tether and USDC, Terra was not directly backed by reserves. Instead, it was known as an “algorithmic stablecoin,” which attempts to stay at $1 through an arbitrage process with a sister token, Luna.
Arbitrage works like this: Let’s say I notice that Terra is trading at 99 cents. Oh damn, yes! I then burn my coins, take them out of circulation and convert them into Luna. By lowering Terra’s offer, I raise the price. Let’s say I got too excited, though, and the price is now at $1.01. Lars arrives and burns his Luna to get the equivalent amount of Terra, bringing the prize down to $1.
The problem with algorithmic stablecoins is that they fail. They fail because they rely on things they cannot control: investor demand; the people who will carry out the stabilizing arbitration; and reliable price information. In the specific case of Terra, it seems likely that a unusually large shrinkage unbalanced the system. After that, there was a death spiral – just like with Kwon’s other project, Basis. Similarly, non-Kwon algorithmic stablecoins like Iron and Neutrino have also fallen in the past. If there’s one thing I’ve learned about cryptocurrency over the years, it’s that nobody really cares about history, even very recent history.
Here’s how Anchor weighed on investors: People who had deposited their money couldn’t withdraw it when Terra failed.
The people who knew better — who saw the warning signs, even — did little to stop naïve investors. Sam Bankman-Fried, the founder of FTX, listed Luna and Terra on his exchange despite having a pretty good idea of what was to come. Here he is discussing it on the odd lots Podcast:
If you zoom out, okay, and say, “It’s a stablecoin, backed by volatile assets, what’s going to happen on a big market move?” To the right? Like, you know how it goes.
Unfortunately, many people did not know how it would turn out! Take, for example, investors who have been reckless enough to place money with Stablegains, a Y Combinator-backed startup that has promised to make “earning with DeFi simple and safe for consumers and businesses.” He promised a 15% return due to his relationship with Anchor in August 2021. Now that’s Tweeter“Users may continue to hold UST in Anchor through Stablegains. Please note that UST may lose further value and continued access is dependent on maintaining the Terra Blockchain and Anchor Protocol.
A lawsuit says Stablegains lost $44 million in investor money. Stablegains is not alone; investor Delphi Digital raised concerns about Luna but invested anyway. He lost $10 million. A South Korean venture capital fund has lost $3.5 billion, according to CoinDesk. Binance, another Terraform Labs investor, bought $3 million, and its holdings are now worth $3,000, according to The New York Times.
But there were winners, and those winners were insiders. Pantera Capital, for example, made $170 million on a $1.7 million investment, The New York Times reported. Another investor, Hack VC, pulled out of Luna in December. Venture capital firm CMCC Global was sold in March.
People are not wrong to be angry with Kwon. Kwon willingly took on the persona of a villain, because much like reality TV star Spencer Pratt, he understood that being the villain guaranteed you more attention. But as Pratt eventually discovered, once you’re the bad guy, it’s nearly impossible to break the cast. That means Kwon will pick up most of it, while Y Combinator, Stablegains, Bankman-Fried and others might walk away without a scratch.
“I am heartbroken by the pain my invention has caused you all,” Kwon tweeted on May 13 in what seemed like an abrupt change in tone. Since then, it is practically crawled. He wants to put the “ecosystem” back on its feet. He even came up with a new proposal to do so.
This proposal was rejected by the Lunatics community. I guess they weren’t mad about it.