Por 10 junio, 2022 No Comments

Continuing with our analysis over Terra situation, in this post we will attempt to analyze some insights of the attack on the Terra ecosystem and the consequences involved; in the next release, we will focus on the legal implications. What did cause the collapse of a cryptocurrency ranked eighth in market capitalization and the third-largest stablecoin? Can this crash spread to other projects? Should investors have been better informed? This article pretends to bring some light on the many issues involved. For those who prefer videos, we recommend this one posted by Coin Bureau with some insights on the issues here approached (except the legal implications).

Causes of the collapse

This article posted by medium.com can be helpful in trying to understand what happened as an introduction but for a deep analysis of the transactions, which lead to the collapse, the best post we found is this, by NGO Chainalysis. From our blog, we believe this matter is to be handled with caution and that it wouldn’t be wise to rush to conclusions but it is quite concerning that the price of the eighth-largest cryptocurrency fell 100% in a 6-days’ period. We’d like to highlight that the real fall is less (from 110 to 0.0001 dollar per token) but the rounding difference is for practical purposes. First of all, it is important to understand that LUNA, essential for contributing cash to the Terra ecosystem, was swept away by UST.

After having analyzed UST peg and how algorithmic stablecoins work (see article), we will focus on the cause of the collapse: the whole Terra ecosystem was the victim of a concerted market attack applying pressure in the right place and at the right time to achieve something “that was impossible to happen.” Amid multi-millionaire losses of money (some estimations report 45 billion dollars, equivalent to Lehman Brothers’ crash in 2008), some trades have profited largely (it is suspected that the “attackers” are concentrated in this group).

In a singular timeline, attackers started accumulating up to a billion UST, then obstructed temporarily the operation of the 4pool (that stabilizes and contributes liquidity), presumably took out loans in BTC, turmoil rumors spread away, rushed to sell aggressively and deprived the ecosystem of cash to maintain the peg. This “confirmed” the rumors (untrue at that moment) with wholesale and retail investors in panic selling in that gloomy market, leading to a deeper price drop of BTC, ETH and USDT (key currencies in the UST backing system), contributing to UST depeg and increasing market panic.

Some speculations were reported of investors selling under UST peg in Curve Finance in order to profit from shorting BTC (being aware that the LFG would be forced to sell large portions of its bitcoin reserve to maintain the peg with the subsequent price drop). Some people even state that those profits were used for further attacks on the Terra ecosystem. Other speculations reported that some outsider entities and traditional financial groups without crypto investments aiming to damage the overall crypto market’s value and reliability could be behind de attacks.

Panic spread quickly not only among retail investors but also among large investment funds, exchanges and other blockchains using UST and LUNA, rushing them to sell off their positions to avoid being dragged into the crash (in the first 48 hours, 9 out of 14 billion that were deposited in Anchor were withdrawn, for example). Regarding Anchor’s role in “speeding up” the collapse, I recommend this article from The Verge. Too critical, in my opinion, but with relevant data on this event.

Peg’s algorithmic system works like this: in order to make profits, UST holders (already worth 0.70 / 0.60) had to swap into LUNA (which price constantly dropped) and then sell off combined with   higher minting. The final crash stage took place when LUNA had a lower market cap than UST and this explains why LUNA’s collapse is deeper than UST’s collapse.

For a better comprehension of UST (and its collapse) it can be considered as a representation of the sale pressure over LUNA. So, when UST’s price is higher than LUNA’s price (what happened indeed), the sale pressure cannot be sustained and the value of both assets will come close to zero (due to the market’s lack of confidence).

Some comments report that, considering the proper time and type of attack, 350.000.000 dollars were enough to get UST and LUNA out of the game. We will release more information as available.

How did bleeding stop?

All market resources having been exhausted (more than 80,000 BTC were sold in an attempt to restore UST’s peg), the Luna Foundation Guard (“LGF”) was forced to take a drastic decision: the platform  restricted transactions for a bit more than 24 hours (the Terra blockchain was halted in two opportunities), a decision always rejected by crypto projects aiming to protect  their  reliability but, at that point,  harm was almost done, no recovery was possible and reserves and reputation were completely undermined.

We stress the fact that LUNA’s holdings are not only an economic representation, its holders are granted voting rights over the project (with a software development, companies and foundations involved). At such a low price, it would have been pretty cheap to take hold of the overall Terra ecosystem. This is the result of the “Proof of Stake” consensus mechanism where a node could have taken over the whole blockchain, compromising safety and decentralization of the overall network.

Are other projects likely to be attacked?

On the week following LUNA’s fall, a similar attack attempted to hit USDT (the largest stablecoin with the highest market capitalization). Although some days closes below US$1, it has never traded below 0.99, falling above 0.97 in its darkest days. The positive impact on Tether (the company behind USDT) was reflected in higher transparency in terms of value reserves to maintain the peg. For further information, we recommend this article posted by iProUp.

The risk of collapse for other stablecoins still exists but there are two pillars to consider: stablecoins depending only on algorithms are very few and the UST-LUNA deep connection cannot be found in other projects. Unfortunately, this event destroyed the ecosystem confidence on most decentralized stablecoins.

Besides, for a better evaluation of the risks involved, it is essential to understand how each stablecoin works. This article published by The Defiant can be helpful for a better understanding  of algorithmic stablecoins’ risks: they generate more opportunities but (up to now) they always end up in big losses for many people.

There are two main categories of stablecoins, namely: those issued by a company (centralized) and the company declaring  to have enough reserves for the tokens in circulation (like USDT or USDC) and decentralized stablecoins (like DAI or UST in the past). Should DAI lose its peg, holders would be able to buy other cryptoassets working as collateral backing assets. Unfortunately, Terra’s collapse had a negative impact on decentralized finance, undermining its reliability.

Other beneficial factor contributing to safety in crypto projects, besides backing assets, is the flow of transactions. With higher market cap and daily transactions to maintain the peg, the more stable they will remain.

What will happen to LUNA and UST holders? Did they lose everything and that’s all?

Nobody really knows. Several proposals are under analysis by the community (even some of them were submitted for analysis by the community itself). The same applies to every Terra’s blockchain project and UST’s projects as well. Some people reported that Terra’s reserves would be addressed to compensate those investors who supported the project till the end (indeed those reserves were used to recover the peg) and /or for rescue purposes (see this article posted by Bloomberg), but both alternatives seem to have been disregarded.

As mentioned before, LUNA’s holders are not only entitled to their tokens’ trade price but also to voting rights over the future of the project. Some community members proposed to let LUNA “die” and “to dollarize” UST as any other stablecoin, restoring value to UST holders. But the ecosystem lacks the required funds and would lose functionality since the network transactional token is precisely LUNA.

One of the most viable alternatives has been proposed by Do Kwon, CEO and co-founder of Terra platform. The current blockchain could be forked into two branches, maintaining the collapsed token as “LUNA CLASSIC” (LUNC) and restarting the network with a new LUNA token. Such new token would be distributed among developers and LUNA/UST holders. Further information available in this article posted by Bolsa Mania. Even though Do Kwon’s proposals had negative voting results, the fork proposed seems to be the only possible solution, pending the definition of tokens issuance, their distribution among the aggrieved investors and other technical details.

What changes can emerge in the crypto ecosystem?

I recommend this interview to Binance CEO by Crypto News. There are lessons to be learned. For instance, any asset having collaterals shares the collaterals’ risks. Higher moderation is expected in general together with a good planning when market goes down and a reduction of excessively attractive yields.

In general, the overall ecosystem turned to a more modest scheme by both developers and investors and projects under development will require to be handled with caution. Definitely, there is a new vision for altcoins investment.

Finally, all projects that survived this catastrophe, especially those closely connected to the Terra ecosystem, showed resilience and are likely to attract new investments in the short term. The crypto industry is required to focus on recovering confidence after such an unfortunate event like the Terra fallout.

Diego J. Nunes


Estudio Nunes & Asoc.