Written by: "TIME"

Compilation: TechFlow Intern

As the cryptocurrency market entered free fall this month, the demise of TerraUSD (UST) brought even more misery to all, with critics already calling the $60 billion project a Ponzi scheme.

The TerraUSD (UST) project is a U.S. dollar-pegged stablecoin that its backers hope will disrupt traditional payment systems around the world. But it collapsed within days after panicked investors scrambled to withdraw their cash and unleashed a vicious, intensified bank run. Many investors were bankrupted by the crash, and the entire cryptocurrency market was wiped out, wiping out as much as $400 billion in value.

Jake Chervinsky, director of policy at the lobbying firm at the Blockchain Association's Washington headquarters, tweeted: "These have been some of the most painful weeks in cryptocurrency history, and one that will be on our minds for a long time to come."

Terra’s investors are certainly the worst victims, but its downfall could have all sorts of short- and long-term knock-on effects on cryptocurrencies and beyond, amid damage investigations by skeptical lawmakers and regulators Even more so. Sen. Elizabeth Warren of Massachusetts wrote in a statement to TIME magazine: "People have lost their life savings to cryptocurrency investments, and there are not enough protections in place to protect consumers from such risks. .We need stronger rules and enforcement to regulate this highly volatile industry."

The following describes the course of the crash and what happened after it.

What happened?

It seems difficult to succinctly explain Terra's meteoric rise and rapid decline without mentioning any blockchain expertise. In fact, there are many Terra proponents who argue against some of its apparent flaws by obfuscation and terminology. This article provides a simple explanation.

Similar to Bitcoin or Ethereum, Terra has its own blockchain, and its most important product is the US dollar-pegged UST stablecoin. Cryptocurrency traders use stablecoins as a safe haven in times of turmoil in the DeFi (decentralized finance) market - traders don't convert their relatively volatile assets into hard currencies, which can be expensive and raise tax issues , they will just exchange them for stablecoins.

Part of a stablecoin's value comes from being fully backed by its reserves. If investors decide to exit, the stablecoin fund should theoretically have enough cash to repay all investors at once. UST, on the other hand, is an algorithmic stablecoin that relies on code, constant market activity, and sheer faith to maintain its peg to the dollar. UST's peg is also theoretically based on its algorithmic connection to Terra's base currency, Luna.

Investors have been buying UST for the past six months. The main reason for their purchase is to profit from a lending platform called Anchor, which offers 20% to anyone who buys UST and lends it. Immediately after the announcement, many critics compared it to a Ponzi scheme, saying that it is mathematically impossible for Terra to give all investors such a high return. Terra team members even concede that's the case, but they refer to the high rate of return as a marketing spend on awareness, similar to how Uber and Lyft offered heavily discounted rides in their early days.

At the same time, some blockchain experts said that wealthy investors took a tactic last week. They borrowed a large amount of bitcoins to buy UST, intending to make huge profits when the value of UST fell. null".

This led to a depreciation of UST's peg to the US dollar. A bank run ensued, with investors earning interest on Anchor scrambling to get out, thinking it was too late. Their actions caused the pegged currency, Luna, to collapse as well, in what is known as a “death spiral.” As of now, UST is worth 12 cents, while Luna is worth a fraction of a cent today after being worth as much as $116 in April.

The life savings of numerous Terra and Luna investors were wiped out in a matter of days. The r/Terraluna subsite is littered with posts from many of the investors who have spoken openly about their mental health issues and contemplating suicide online. "I'm going through the darkest, worst mental pain of my life. I lost $180,000 and it doesn't seem real!" wrote one poster.

Terra dragged down Bitcoin and the entire cryptocurrency market

Even before Terra's debacle, cryptocurrencies were already in decline, partly due to the Fed raising interest rates. (They do this to prevent inflation, which causes people to consume less).

But the collapse of UST has brought another huge damage to the entire market, the most fundamental reason is that Do Kwon, the creator of Terra, bought billions worth of bitcoins as UST's security deposit. He and the Luna Foundation Guard deployed more than $3 billion to defend the dollar peg, creating downward pressure on the market that caused other large investors to dump bitcoin stocks. Bitcoin hit its lowest point since December 2020, and Kwon's attempt to save UST failed.

“These algorithmic stablecoins are designed in such a way that they have an upward force during bull markets, which is why they are so popular. But this force can have the opposite effect in bear markets, exposing their fundamental flaws. Therefore, That’s what ultimately triggered (the crash),” said Sam MacPherson, an engineer at MakerDAO and co-founder of software design firm Bellwood Studios.

Its ripple effects were felt throughout the cryptocurrency ecosystem. The company sold about $30,000 of its own ether in order to defend UST's peg to the U.S. dollar, sending ether plummeting below $2,000 for the first time since July 2021. The number of investors trying to cash out their ethereum-based stablecoins sent transaction fees on ethereum skyrocketing, sparking an even worse run.

Shares of Coinbase, one of the largest and most mainstream companies in the cryptocurrency world, slumped 35% last week. According to Cryptoslam, the entire NFT ecosystem has plummeted 50% in sales volume over the past seven days.

The cumulative result is hundreds of billions of dollars lost across the ecosystem. Many fear that Terra's debacle is just the first domino to fall that will spark a long-rumored "crypto winter." "Crypto winter" means mainstream investors lose interest and values ​​remain depressed for months. Bloomberg's Edward Harrison wrote: "I suspect that some cryptocurrencies will become worthless. Capital investment in this space will slow down as investors choose to conserve energy, repeating what happened in the dot-com bubble."

So what might this debacle lead to next?

Regulatory form could be tighter

Stablecoins have long attracted scrutiny from regulators. Congress held a weighing hearing in December, and also in December, President Biden’s task force called for “urgent” action to regulate stablecoins.

Terra’s debacle provides further evidence in favor of regulators who believe the space needs to be controlled by governments. On May 12, Treasury Secretary Janet Yellen called for "comprehensive" regulation of stablecoins, saying that while the current crash is too small to threaten the entire financial system, stablecoins are growing rapidly. They pose the same risks as the "bank run" risks we've known for hundreds of years.

Hilary Allen, a professor at the American University Washington School of Law, testified at a congressional hearing on the risks of stablecoins in December. She said the aftermath of Terra's collapse shed light on the potential for unregulated cryptocurrencies to go mainstream. Condition. "In a few years time, similar events will have a much wider pipeline and cause more widespread damage. If the banks continue to move closer to this area, it will be more serious. I think it is crucial that regulators and policymakers take this into account. Take this event as an opportunity to build a firewall between the traditional financial system and DeFi.”

Massachusetts Rep. Jake Auchincloss told TIME that he is preparing draft legislation that would require stablecoins to be subject to federal audits. Jake Auchincloss believes that stablecoins can play a role in "maintaining the US dollar as the world's reserve currency", so he has no intention of banning stablecoins. However, he wants to bring stablecoins under the purview of federal agencies such as the Office of the Comptroller of the Currency: ensure stablecoin issuers can prove they have 90-day liquid reserves, and explore imposing mandatory requirements for customer insurance. "We will let private sector actors make their own 'risk versus reward' decisions, empowering the federal government to take action to ensure that the sector does not pose systemic risk," he said. "

Senator Warren, a long-time public denigrator of cryptocurrencies, took Terra's debacle as evidence that regulators need to "clamp down" on stablecoins and DeFi before it's "too late." Across the Atlantic, the European Commission is considering imposing a hard cap on the daily activity of large stablecoins, Coindesk reported.

At the same time, most in the cryptocurrency world already seem resigned to the impending regulatory reality.

MacPherson said: "The lives of many people have been destroyed. The rest of the cryptocurrency ecosystem needs to be open to working with regulators on this issue, so that we can prevent similar situations from happening again." MacPherson said.

The boundary-pushing phase of stablecoins may be over

Over the years, countless ambitious blockchain developers have wanted to create a functional and secure algorithmic stablecoin, in the hope that they might be more inflation-resistant and less susceptible to inflation than reserve-backed stablecoins. Government supervision and seizure. But such products all eventually lost their peg to fiat currency and failed. In the news for the past few months, UST was the most successful example in this field, and now it has become the most tragic failure.

Its fiasco will cast a long-term shadow on the next developers who try this approach, and venture capital firms and investors may take a more cautious approach to adopting a similar model. Frax and magic internet money (MIM) are two other boundary-pushing stablecoin projects in the market that, while maintaining their peg to the U.S. dollar, have seen sharp declines in market capitalization over the last week.

"I think it has sufficiently destroyed all confidence in the algorithmic stablecoin model. There is a good chance that after Terra we may never see them again...although I never use 'never' when talking about cryptocurrencies This argument. said Allen.

Over the past week, many leading figures within the cryptocurrency community have scrambled to disassociate themselves from other types of stablecoins and UST, arguing that the reserve-backed stablecoin is relatively safe and should be allowed to continue to thrive with minimal oversight. develop. The Blockchain Association's Chervinsky wrote on Twitter that UST is "in a class by itself" compared to other "very stable and reliable" models. Matt Maximo, a researcher at cryptocurrency investor Grayscale Investments, wrote in an email that the collapse of UST could boost demand for dollar-backed or over-collateralized stablecoins.

However, Allen believes there are still risks in reserve-backed stablecoins. “The funds most similar to these reserve stablecoins are the money market mutual funds whose collapse fueled and triggered the 2008 financial crisis. They caused runs and were bailed out.” (Economic reporter Jacob Goldstein in 10 The same analogy was drawn on this issue in the month's "The Future of Money" issue of Time magazine).

Venture capital may stop investing in cryptocurrencies

Over the past few years, venture capital firms have poured massive amounts of money into the cryptocurrency space, perhaps most notably Andreessen Horowitz. Terra itself is also the beneficiary of a group of brand investors, including Pantera Capital and Delphi Digital.

The collapse of UST may cause mistrust on both sides. "Many institutions investing in this space are likely to see large losses in the short term, leading to a slowdown in venture capital investment," Maximo wrote in a letter to TIME. Chris McCann and Edith Yeung, general partners at cryptocurrency-focused venture capital firm Race Capital, told Bloomberg this week they've heard of deals falling apart, repricings and founders being "dumped" by potential investors.

MacPherson, on the other hand, blamed part of Terra's debacle on venture capital firms that lent their institutional credits to dangerous projects. He said: "I think they should bear some responsibility because they ruined some ordinary people who invested in UST without knowing the risk of decoupling. Some 'companies' made a lot of money off of this, and I think they should compensate those who have been affected. Lost people."

Now, Terra's main investors are being forced to face a choice: bail out the project or run away. Many of them have been silent for the past week. Michael Novogratz, the billionaire founder and chief executive of Galaxy Digital, showed off a giant luna shoulder tattoo online in January, but hasn't tweeted since May 8.

A representative of Lightspeed Venture Partners, a large cryptocurrency-focused firm that invested $250,000 in Luna tokens, wrote that they will remain focused on the space. “Lightspeed Venture Partners has been investing in the blockchain space for over 8 years. We see this as a computing paradigm shift that is more important than the short-term price ups and downs of Bitcoin. We are doubling down, especially in infrastructure, DeFi and Emerging use cases,” they wrote.

The Decentralized Finance Hype May Be Slowing

Much of the promise of cryptocurrencies lies in their decentralized nature, meaning that their value comes not from manipulative controlling institutions like banks or governments, but from cleverly designed code and network effects. Some cryptocurrency enthusiasts this week saw Terra's debacle as a successful stress test of that assumption: Bitcoin's persistence in the face of such a massive sell-off proved its durability.

But Terra's debacle did reveal many centralized pressure points in the ecosystem. If not broken, these stress points are at least sharply bent. While cryptocurrencies don’t have a CEO, Do Kwon, the charismatic founder, single-handedly created Terra as a project. After hundreds of billions of dollars in market cap evaporated, he used his position of power to defend his token like the Fed and in turn smash the entire market (we wrote to Do Kwon for comment on this but have yet to hear back) .

The attack showed the vulnerability of decentralized exchange Curve pools, whose prices can change rapidly as whales enter and exit. At the same time, Binance, the world's largest cryptocurrency exchange, has also exposed the weakness of insufficient liquidity, which makes it difficult to deal with a large number of UST entering circulation.

In fact, Terra's legendary deeds show that the decentralized nature of the blockchain dictates that bad actors can have a huge impact on the system. But many enthusiasts say such incidents actually help weed out those who try to abuse the system, fostering a stronger and more educated user base going forward. "The permissionless nature of blockchain means we can't stop it, but I think we should do a better job of informing the public about the risks," MacPherson said.

Might Fewer People Fall for Ponzi Schemes...Maybe

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