[DEBRIEFING] Luna, Kwon and all things Terraform

Finance

Published: 19 May. 2022, 18:19 Updated: 19 May. 2022, 22:12

[DEBRIEFING] Luna, Kwon and all things Terraform

Terraform Labs CEO Do Kwon [SCREEN CAPTURE]

A coin that was once No. 8 globally in terms of market capitalization almost vanished overnight last week. After gaining a massive number of supporters, who were referred to as "Lunatics" by coin developer Do Kwon, the Luna cryptocurrency is now worth less than a cent, down from its $119.22 peak on April 5, just a month before the sudden collapse.

The value of TerraUSD, another cryptocurrency developed by Kwon, has also suffered a spectacular failure. The coin was designed to be pegged to the dollar. It was trading at around $0.08 on Thursday.

Luna and TerraUSD were developed by Terraform Labs, a company co-founded by Kwon and Daniel Shin. Stanford-educated Kwon remains CEO of the company, according to his Linkedin profile, while Shin currently does not hold any posts at the company, according to Chai Corporation, a payment firm Shin founded in 2018.

Below are some frequently asked questions about the crashes of the cryptocurrencies, and answers based on recent reporting by the Korea JoongAng Daily.

Q. What are the Luna and TerraUSD coins?

Luna and TerraUSD are tokens on the Terra network. Luna was designed to play an important role in maintaining the price of TerraUSD stablecoins and reduce market volatility so TerraUSD remained pegged to the dollar. Burning, or deleting, one dollar worth of Luna yields one TerraUSD. Burning one TerraUSD creates one dollar worth of Luna.

When TerraUSD fell below the target price of $1, users would turn them into Luna. When it traded above $1, users would create Terra from Luna. This arbitrage was supposed to maintain the peg.

What sparked the crash?

Before the collapse, TerraUSD's market capitalization was around $18 billion, while that of Luna was above $40 billion. TerraUSD's market cap now stands at $1.02 billion, down 94 percent, and Luna's is $999.13 million, down 98 percent, according to CoinGecko on Thursday.

TerraUSD started to lose its peg to the U.S. dollar on May 7 following a few massive withdrawals from Anchor, a Terra-based decentralized finance protocol that allows users to earn interest on TerraUSD deposits and take out loans against holdings. More than $2 billion worth of TerraUSD was taken out of the Anchor protocol.

The dramatic fall in the price of TerraUSD pulled down the price of Luna.

Reasons behind the sudden decline of TerraUSD remains a topic of debate — whether it was a malicious attack or just a response to higher interest rates.

Major global crypto exchanges, including Binance, halted the trading of Terra coins.

Was the Terra system built to fail?

TerraUSD did not have customer deposits backing the coins. Other pegged coins are backed by currency deposits. TerraUSD's peg was based on faith in its underlying algorithm.

"Algorithmic stablecoins are inherently fragile," said Dr. Ryan Clements, chair in Business Law and Regulation at the University of Calgary, in a report last year. "Algorithmic stablecoins require a support level of demand for the entire ecosystem to operate. If demand falls below a threshold level, the entire system will fail."

Another issue raised was the high yield offered to investors, which many critics describe as unsustainable. Terra's savings protocol, called Anchor, at times yielded 20 percent for people who bought TerraUSD and parked their coins in Anchor.

Terraform Labs CEO Do Kwon's Twitter post on May 14 following Luna's collapse. [SCREEN CAPTURE]

How did Kwon respond to the crash?

Following the crash, Kwon wrote on Twitter that he is "heartbroken about the pain my invention has brought on all of you." He stressed that neither he nor any institutions with which he is associated profited in any way from the incident, adding that he did not sell Luna or TerraUSD during the collapse.

He pitched a revival plan for the Terra system, saying that Terra is worth salvaging. The plan proposes forking the Terra chain into a new chain without the algorithmic stablecoin. Kwon says the network will begin coordinating the fork with validators before the end of May if Luna holders approve the plan.

What are investors doing?

Investors globally are furious. A group in Korea said it will file a class action lawsuit against Kwon. The movement is being prepared by members of an online community hosted on Naver and named Lunascam. More than 2,100 members have subscribed to the community since it was created on May 13.

They are blaming both Kwon and Shin, calling them "crooks" and the Luna coin a "Ponzi scheme."

On Thursday, LKB & Partners law submitted a complaint against Terraform Labs and its co-founders to the Seoul Southern District Prosecutors’ Office for fraud and securities law violations.

LKB & Partners attorneys speak to reporters at the Seoul Southern District Prosecutors' Office after filing a complaint against Terraform Labs and co-founders Do Kwon and Daniel Shin on Thursday. [YONHAP]

Can Kwon be charged with a crime?

Opinions vary. Fraud and misrepresentation have been mentioned as possible charges against Kwon by some Korean attorneys, though proving crimes or regulatory infractions may not be easy, argue others.

Terraform Labs "issued far more coins than it had promised in its initial whitepaper," said Park Po-jun, an attorney at the Kisung law firm. Park argues the Terra's initial whitepaper capped the distribution of Luna coins to 800 million, with 400 million in circulation. But more than 6 trillion Luna tokens were issued over the span of a few days in May.

The latest whitepaper does not state a cap for the issuance of new coins.

Cho Jung-hee, a managing partner at D.Code Law Group, said that Kwon may have committed fraud if Terra's anchor protocol is proved to be a Ponzi scheme.

"If it's proved that it only works if there are continuous buyers of Luna and TerraUSD coins, the system may be verified to be a Ponzi Scheme and that may prove Kwon's fraud," Cho said.

What are the regulators doing or saying?

Terraform Labs is a Singapore-incorporated company, which is still active, a branch in Busan, which has been dissolved, and a sub-branch in Seoul, also apparently shut.

The company is not a "notified entity" and that it had not registered under the Payment Services Act in Singapore. According to the Straits Times, a complaint has been filed with the police in Singapore, but the newspaper writes that the police are not investigating.

Korean financial regulators have so far been signaling a lack of legal justification to go after Kwon.

"It's difficult to take specific measures because there aren't laws on protecting investors" in cryptocurrencies, according to Koh Seung-beom, chairman of the Financial Services Commission on Tuesday. Koh said the financial authorities are closely observing the changes in price and transaction volume.

The U.S. Securities and Exchange Commission is investigating Kwon and the company on matters unrelated to the crash, and a U.S. court has agreed that Kwon must comply with a subpoena from the commission.

How will the Terra meltdown affect the cryptocurrency market in general?

Tether, the world's biggest stablecoin, temporarily fell below a dollar following the Terra incident. Bitcoin fell below the $30,000-mark to trade at around $29,000 on Thursday, though its correlation with the Terra meltdown is unclear.

"A cryptocurrency failed because it was designed inappropriately," said Kim Hyoung-joong, a professor of multimedia security at Korea University School of Cybersecurity.

"The incident happened because the sustainability of an algorithmic stablecoin was never verified as it's not under the inspection of any official organization," said Park Sung-jun, CEO at Andus, which operates the AndUsChain blockchain platform.

BYJINMIN-JI[jin.minji@joongang.co.kr]