A&T Talk: What systemic risks will the Luna collapse bring?

Author: A&T Capital

How to View the LUNA Crash, Was It Inevitable?

@Jun_Yu:

The Luna project was initially invested in by OK. In 2018, I was responsible for investments at OK and met with the Luna team three times, twice in Seoul and once in New York. At that time, we learned that they had significant resources in Korea, with many large conglomerates involved. One of Luna's partners, Daniel, who was older, initially wanted to focus on digital payments and had not considered the concept of stablecoins. Later, perhaps due to market inspiration, they began to work on stablecoins.

Personally, I was not optimistic about their offline payment approach, which was akin to recreating China's Alipay in Korea or even globally. I thought it would be quite challenging, so I initially did not want to invest and passed on the project. However, there was a young lady on our investment team who was particularly fond of it, and in the end, OK did invest, which became the highest-return project in OK's investment history.

The principle of Luna's stablecoin is like stepping on one foot while standing on the other. We should consider where the profits come from; is it someone else's principal? If the money you earn is unknown in terms of whose it is, then your principal is someone else's money. This is a simple principle, akin to the herd effect, especially after experiencing last year's bull market, where people might think less about these issues.

So, I believe that in a certain sense, the LUNA crash was inevitable. Many people felt that Luna was a hidden risk and could likely explode, similar to Murphy's Law: if many people believe something might happen, it will eventually happen. And today, that has occurred; we have witnessed history.

Crypto has developed to a stage where it has caught the attention of mainstream finance on Wall Street, which has begun to participate. However, many in this industry have been too high-profile, too arrogant, even forgetting some of the basic jungle rules of finance. They have laid their cards completely on the table, waiting to be exposed. A crucial aspect of finance is not letting others know your bottom line. Knowing the bottom line makes it too easy to be attacked. Although people say that Luna's tie to Bitcoin would prevent such occurrences, when Citadel comes in, they don't care whether the money is from retail investors. As long as they can open a short position, they will target specific points for destruction. Do Kwon's actions are akin to carrying a bomb to the square, saying he wants to perish with everyone; who dares to snipe me? Citadel doesn't care how many people you blow up; they will snipe you openly.

Another point is that everyone should pay attention to how they earn their money and why the returns are so high. It's worth asking again, where do your returns actually come from?

@JinzeJIang0x0:

The speed at which Luna increased its supply was too fast. It took two years to build the ecosystem's foundation, and once the ecosystem improved, it skyrocketed from $100 million to $20 billion after Anchor came out. The minting of UST was too rapid, but did the price of LUNA minted through sales go down? The risks accumulated significantly through oracle minting; on one hand, it accumulated a lot of debt, and on the other hand, the assets minted should theoretically increase in price. The rapid minting and the method of oracle minting led to a continuous accumulation of risk, making it unsurprising that such situations arise when the market is not doing well.

Just now, LUNA made a foolish move by issuing an announcement, which I believe makes it very difficult to turn things around. The announcement stated that they would relax the minting of UST to LUNA. UST could run away through the minting of LUNA. On the surface, it gives UST holders confidence, but LUNA's depth is too shallow to support the $16 billion stock of UST. The circulating supply of LUNA may not even total a market cap of $1 billion, causing LUNA's market cap to shrink even more, leading to a rapid expansion of the UST/LUNA ratio, making recovery nearly impossible. A better measure would have been to adopt shock therapy, cutting off the minting channel to stabilize LUNA's market cap. Although UST could not be stabilized, people would still have confidence in LUNA's future recovery. Now, LUNA's market cap is certainly plummeting.

@Jun_Yu:

To comment on what Jinze just said, I personally feel that LUNA has been beyond saving since last night. I even think, why did it take a whole day to drop from 40? I find it particularly reminiscent of the 2008 subprime mortgage crisis, where Lehman Brothers went from hundreds of billions in market cap to zero in just a few minutes, almost instantaneously. In a mature capital market, everyone can quickly understand that it is a zeroing rhythm, leading to a stampede. The most rational choice for people is to escape. Perhaps there are too many retail investors in the crypto circle still holding onto some naive beliefs; even today, some are saying they want to buy the dip. Isn't that like picking up corpses in a pile of dead bodies? I think it could actually happen faster, directly going to zero.

@bitouq:

The entire process of the LUNA crash was seamless, completed through the outflow of funds from Anchor, likely a targeted attack. The entire industry underestimated the risks. DK mentioned a possibility of using LUNA to protect UST; there are many reasons to protect UST. Assuming that saving UST is valid, it is because UST is the foundation of the ecosystem, with all projects priced through UST. The collapse of UST is equivalent to a country's exchange rate imbalance, where all national assets cannot be priced using foreign exchange rates but must be priced using their own currency. Protecting UST is to safeguard the projects within the ecosystem, not the interests of users, to gain project support. Saving LUNA is about protecting community users; UST may not necessarily recover and might face legal risks. Saving UST is a matter of necessity to keep the ecosystem functioning.

@JinzeJiang0x0:

I think it might be because there is still a lot of liquidity on-chain, so there won't be an immediate withdrawal, and it can hold for a while.

@Jun_Yu:

The actions of the Terra Foundation are foolish. First, they exposed their financial situation; second, they panicked at the beginning and shot all their bullets, leaving themselves vulnerable.

What Will Happen to the Stablecoin Sector Next? Are There Other Opportunities?

@nake13: I think the answer to this question is already clear: algorithmic stablecoins without reserves are very difficult to succeed. When I first saw these concepts in 2018, they were quite interesting, but now it seems they are just mechanisms to solve liquidity issues. However, when you actually apply them in practice, you find they are very Ponzi-like and unstable.

@Jun_Yu:

I also feel that if Luna does not have a reserve backing it, it is hard to reassure people; without reserves, a crash is just a matter of time. This includes USDT, which is currently quite popular; of course, USDT does have reserves, but they may not be very transparent and have gone through a lot of historical sedimentation. If we really want to use a 1:1 ratio, the best option right now is still USDC. At the same time, these stablecoins must also consider regulatory issues; since they are all dollar-pegged stablecoins, U.S. regulations cannot be ignored. The best advantage of USDT now is that it has gained people's trust as a stablecoin, and they have become accustomed to using it for pricing. As for algorithmic stablecoins, no matter how good the mechanism is, once it reaches a certain point, it becomes more like a financial derivative.

@nake13:

We see that the development of stablecoins in 2020 has gradually shifted from uncollateralized to collateralized; this trend is also present in DeFi 2.0. Personally, I still prefer algorithmic stablecoins, which do not necessarily have to be dollar-pegged; what people actually need is a product with relatively stable purchasing power.

@Jun_Yu:

In fact, BTC and ETH are also seen as stablecoins by some people; their volatility may also decrease in the future.

@bitouq:

Yes, I have been paying attention to some ETH-based stablecoin products; however, their scale is still quite small, and the current focus is not on this area.

@JinzeJiang0x0:

I think the perspective on USDT is quite good. We have previously discussed the issue of transparency and opacity; excessive transparency can actually hinder the circulation and trading of products. Products on platforms like Curve exist in a state of information asymmetry; the token price comparisons between different pools do not directly affect the outside price. If everything were completely transparent, there should be a discount, but in reality, people do not engage in rigorous pricing; instead, it is based on trust and consensus. For example, BUSD is more like a corporate liability and should have a discount, but everyone believes it should be 1. Even UST, if it develops slowly, could have opportunities, but the recent strategies have been too aggressive, leading to the collapse of its ecosystem.

How Do You View Terra's Official Response to This Crisis?

@forgivenever:

I think this round of collapse was targeted by Wall Street OGs; a few years ago, they looked down on it, but now they feel the entry cost is too high, so they used a targeted attack to acquire low-cost chips. They first used institutions like DCG to fool Terra into buying BTC at high prices above $40k. Once Terra built up its position, they began to act. Originally, a Ponzi like Terra had no issues with inflows and outflows during a bull market, but now, in this bear market, there are certain risks; because of this, they needed to try to create a 4-pool in Curve to hedge against risks, but during this offensive process, their liquidity was affected.

Afterward, Wall Street borrowed nearly $3-4 billion in BTC and began to sell off, causing panic. Many celebrities and capital began to flee from Anchor; during this process, Terra's backers like Jump were still selling ETH to buy in, but selling ETH only further exacerbated market panic and catalyzed the exit of large holders. This gradually formed a death spiral. Meanwhile, the yields on Anchor may have been an expectation during the bull market, but now they have formed a hard peg, further reinforcing this positive feedback loop.

At the same time, I believe DK's rescue plan was very poorly executed; the act of abandoning LUNA to save UST essentially handed money to those arbitraging users, while users who supported LUNA and Terra bore the cost.

@JinzeJiang0x0:

He should not have allowed the market to arbitrage; he should have closed the minting channel or filled the quota himself every day to keep the money within the foundation.

@forgivenever:

The correct solution would have been to burn 95% of UST directly after the airdrop to holders.

@Jun_Yu:

In the end, LUNA will become fertilizer for the industry, remaining in the industry as nutrients for the next bull market. So what will happen to the industry in the coming period? How significantly will it be affected by this event? What specific manifestations will there be?

@forgivenever:

The Cosmos ecosystem has basically been halved because UST has invaded the Cosmos ecosystem too much. If the Luna ecosystem does not regain confidence and does not resolve the panic, it is essentially finished. Many exchanges that bought in on UST have also suffered losses, with Binance and KuCoin being the most severely affected, as these two were early and heavily supportive of UST, while others supported it later and in smaller amounts. The market landscape has changed, and Wall Street will enter more quickly afterward. The first step of crypto capitalism is the entry of Silicon Valley VCs, such as a16z, but once quantitative funds come in, the competition will increasingly link with traditional markets. In the future, the correlation between the crypto world and traditional markets will increase. Whether a public chain is strong or not will no longer depend on its technology and paradigm but rather on the strength of the Wall Street or Silicon Valley capital behind it, as well as the volume of voices shouting on Twitter, which is quite sad. Because the original intention of our industry is to advocate for decentralization and the iteration and innovation of technological paradigms, rather than the current capital-driven development of Solana. Therefore, the current situation is even more tragic for Chinese entrepreneurs; with Wall Street entering, Ponzi schemes are everywhere, but Ponzi itself is also an important means of developing Web3.

Will the Next Decentralized Stablecoin Have a Different Outcome?

@forgivenever:

This is not a matter of slow or fast; its development needs to consider its path or applicable scenarios. For example, if you launch a stablecoin today and follow the user base of Stepn, that would be great because Stepn has over 600,000 users, which is very dispersed. If the stablecoin develops very quickly and has a large issuance, the boundaries of inflow and outflow are actually very small. If the holders of the stablecoin are all whales, and the whales can exchange for a large amount of liquidity, then it becomes a game between large holders, and retail investors can only be forced to protect themselves. Therefore, it is essential for the holders to be sufficiently dispersed and for the information asymmetry to be high, rather than relying on the development of large holders. Relying on large holders for fast development also leads to fast destruction.

What Systematic Impact Will the LUNA Crash Have on the Entire Industry?

@Jun_Yu:

I don't know how much penetration Luna's ecosystem assets have in the crypto industry, but I generally feel it should be less than the impact of subprime mortgages during the 2008 financial crisis. In the short term, there will be a blow to confidence, and other projects that extend similar models will be affected. However, as Yuan mentioned earlier, the entry of mainstream institutions from Wall Street presents a challenge to crypto-native individuals, but on the other hand, could it be a good thing for the crypto industry? It may lead to some reflections on the valuation methods of the entire industry, returning to rationality and supporting more projects that can deliver results. About a month ago, a well-known project in the market attracted more and more attention, and I have been pouring cold water on it, advising everyone not to just look at the high yields while packaging it with an X-to-earn facade and telling grand stories. It is essential to ask where the returns actually come from; there is no perpetual motion machine in the market, and these projects need to be questioned. But this does not mean negating Web3; Ponzi is a neutral term. The early ecological construction requires some future overdraft, but the crucial point is whether this debt can be repaid in the future. A significant reason for the LUNA crash is that it owed too much and could not repay.

@JinzeJiang0x0:

I think this is very similar to the 2008 financial crisis, where financial companies crazily printed money in disguise and lent it out, absorbing a lot of toxic assets. When the tide truly recedes, they find they cannot sell and are insolvent. However, one advantage is that much of its liquidity is locked on-chain, which will quickly clear the risks. For a project, it may die, but the ripples it creates will quickly clear the risks in the on-chain liquidity. Therefore, it will not have long-lasting aftershocks like a traditional financial crisis. So I have always felt that leveraging in DeFi is not as frightening as leveraging in the traditional world because, although its high volatility is not ideal, conversely, its risks clear quickly, allowing everyone to start over.

@Jun_Yu:

It's like a boil being lanced, exposing the risks.

@bitouq:

For stablecoins like UST, which are among the top in market cap, surpassing DAI and BUSD, their decoupling will undoubtedly have a significant impact on similar uncollateralized stablecoins in the future, and market confidence will also be greatly affected. However, in the end, everyone still hopes for a decentralized stablecoin that can serve as a safe-haven asset, but this requires a developmental process.

Reflecting on the LUNA Crash, How Should Users Set Risk Isolation When Managing Assets?

@bitouq:

Currently, the blue-chip DeFi projects have an investment cycle; the quality of the products is a basis for investment, but it is also essential to pay attention to the timing of entry. For instance, Luna rose significantly last year; its rate of increase was too fast, and the bubble was substantial. Currently, there are still very few DeFi products that can escape the Ponzi scheme; most profitable products are still Ponzi schemes, so it is crucial to pay attention to the investment cycle and not blindly chase high prices.