One Year After the Terra Crash: The Market is Improving, but Still Struggling to Shake Off the Gloom

Author: ChainCatcher Editorial Team

On March 23, Do Kwon was arrested in Montenegro. In May of last year, it was reported that Do Kwon had attempted to flee South Korea before the Luna crash, but he consistently denied it. Until an Interpol red notice was issued, tracing him from Singapore to Serbia, Do Kwon continued to argue that he was not "evading" until the moment of his arrest in Montenegro.

Image source: Associated Press

When Do Kwon was arrested, his slightly bloated face appeared somewhat bewildered. During the subsequent investigation, he was accused of forging passports, and there were even rumors that he "swallowed a hardware wallet." The "suspect" before us now is a far cry from the young man who was once arrogant and overly confident just a year ago.

At the turn of 2021 and 2022, Do Kwon expressed hope for the new year on social media, writing: "Web3 is the key to the crypto industry in 2022" and "May the moon shine brighter this coming year."

He and the fervent Lunatics could never have imagined that this "new moon" would begin to fade after just over a quarter. In a market filled with high spirits, people often view confident and spirited young individuals with a different lens, including SBF at that time. Bloomberg once described Do Kwon as having built a "confident, combative, and occasionally childish" image on social media.

In March 2022, Terra and the UST algorithmic stablecoin faced frequent external scrutiny. Subsequently, Do Kwon chose a very aggressive way to respond to the doubts—betting with crypto KOL Sensei Algod on whether LUNA's price would exceed the current price of $88 a year later. The wager was for one million dollars, and a day later, Do Kwon increased the bet to ten million dollars. The bet was overseen by crypto KOL Cobie.

However, that lively wager seemed to have never happened, and by the time it was due in March this year, it had barely made a splash. Cobie, the overseer, remained silent on the matter that day, and after the collapse of the sponsor FTX, his crypto podcast Uponly also ceased updates, rarely mentioning the connection with FTX afterward.

Sensei Algod, who proposed the bet, referenced a tweet from a year ago, stating: "While looking back, we can easily judge that Luna would crash, but look at the comments under the tweet from a year ago, and you’ll know how I was ridiculed at that time. It's a good lesson to realize that the crowd often makes mistakes." After all, people only realize that "the moon has its phases" after suffering losses.

In fact, there was no shortage of whistleblowers during the Terra explosion and UST crash. When Terra first emerged, analysts noted the risk of the protocol triggering a "death spiral," and with the launch of the Anchor protocol offering a 20% APY UST deposit plan, more people began to predict the collapse of Terra, with some even warning that "Terra would destroy the entire crypto world."

But few could resist the temptation of such high yields, and everyone subconsciously believed they could exit before Terra's collapse. After all, even seasoned professionals like Jump Crypto, Hashed, and Delphi could not escape this disaster.

As Algod mentioned earlier, hindsight is easy. Those lacking experience and stop-loss strategies likely went through the shock and numbness of the heavy losses a year ago.

The Terra incident became the worst starting point of 2022, and thereafter, the fire ignited a series of heavyweight projects along a seemingly pre-laid fuse. Bitcoin's price fell from $34,038 and has not recovered a year later, despite the market steadily warming up, with Bitcoin's price peaking at $31,043 earlier this year. However, it is undeniable that the market is still shrouded in the aftermath of last year's chain explosions, and the risk of further explosions cannot be ruled out.

Do Kwon's arrest and the subsequent long trial and sanctions will not put an end to the entire incident. But in this year, what have we lost and gained after the Terra explosion?

In addition to the bankruptcy of leading crypto firms like Three Arrows Capital, Voyager, Celsius, and FTX, hundreds of projects have declared death or gone silent in the rapidly cooling market; investors have begun to reassess their judgment criteria for crypto projects, and the hot money from traditional finance has rarely flowed into crypto and Web3; regulatory policies in multiple countries led by the United States have tightened, with banks cutting ties with crypto-related businesses, and market makers choosing to exit. Under multiple pressures, crypto firms like Coinbase, Kraken, and Tether have begun to seek global markets, while crypto firms and Web3 entrepreneurs have been migrating from the U.S. to Singapore, Dubai, and Hong Kong in search of the most suitable "crypto sanctuaries"…

This article will quickly review and (incompletely) summarize the significant events and impacts one year after the Terra explosion.

I. Review of the Chain Explosion Events

1. Terra Collapse

On May 8, 2022, Terra withdrew $150 million of UST liquidity from the existing UST-3Crv (UST/USDC/USDT/DAI) liquidity pool to establish a new funding pool for UST on Curve, the 4Crv Pool (UST/FRAX/USDC/USDT), causing the UST price to begin to slightly de-peg.

To hedge against risks, some institutions and users began to sell UST on a large scale, with 2 billion UST flowing out from the lending platform Anchor that day, increasing the pressure on UST's price peg. The sudden influx of UST in the market further exacerbated the price drop, leading many to exchange their UST for its underlying asset LUNA, which also increased the supply of LUNA and caused its price to plummet. The prices of LUNA and UST entered a death spiral, nearing zero.

On May 11, Do Kwon announced that he could not save the market.

On May 13, numerous exchanges delisted Luna and suspended trading, and the Terra blockchain ceased operations.

In less than a week, the Terra ecosystem, with a market cap exceeding $40 billion, collapsed. The explosion of LUNA/UST affected many crypto institutions and projects. The price of BTC fell from $34,038 to $31,328, with a weekly decline of 7.6%.

2. Three Arrows Capital Declares Bankruptcy

The first to publicly announce being affected by the LUNA/UST collapse was Three Arrows Capital, one of Terra's largest investors, which found itself in a liquidity crisis due to the collapse.

During the LUNA/UST collapse, Three Arrows Capital invested an additional $200 million. According to liquidation firm Teneo, the LUNA/UST collapse exposed Three Arrows Capital to risks amounting to approximately $600 million.

In addition to direct financial losses, the collapse of LUNA/UST affected market sentiment, causing the price of BTC to drop from $30,000 to $20,000, leading to a large-scale credit contraction in the crypto market.

Three Arrows Capital had used a significant amount of leveraged funds, but due to the illiquidity of its substantial assets (such as the $1 billion GBTC it held), it could not sell them or provide additional margin, resulting in a drastic shrinkage of its assets. Meanwhile, creditors demanded compensation due to its inability to repay borrowed funds.

3. Voyager Bankruptcy

The collapse of Three Arrows Capital triggered further failures of lending platforms. Three Arrows Capital had outstanding loans involving approximately $666 million (including 15,250 BTC and $350 million worth of USDC stablecoins).

On July 6, 2022, the crypto lending platform Voyager announced it was filing for bankruptcy protection and suspended trading, deposits, and withdrawals.

On July 11, 2023, Three Arrows Capital filed for bankruptcy protection in a New York court. According to Teneo's liquidation report, Three Arrows Capital owed approximately $3.5 billion to 27 cryptocurrency companies, and these creditors have since filed lawsuits against Three Arrows Capital.

Among them, the largest creditor is the crypto lending platform Genesis, a subsidiary of Digital Currency Group (DCG), which provided Three Arrows Capital with a $2.3 billion loan. Part of this debt was borne by its parent company DCG, as Three Arrows Capital held $1 billion worth of GBTC trusts issued by DCG. Therefore, Genesis ultimately filed a claim of $1.2 billion against Three Arrows Capital.

Additionally, the crypto lending platform BlockFi stated that Three Arrows Capital was one of its largest borrowing clients, and the company's collapse resulted in a loss of approximately $80 million.

4. Celsius Bankruptcy

On July 13, 2022, the crypto lending platform Celsius announced it was filing for bankruptcy, with Three Arrows Capital owing $75 million in USDC loans.

In addition to the impact from Three Arrows Capital, Celsius was also affected by the LUNA/UST collapse, as it was the largest holder of stETH (Ethereum staking tokens on Lido). The market sentiment affected by the UST de-pegging caused stETH to de-peg from ETH. As the value of stETH fell and liquidity issues on the platform worsened, users severely withdrew funds, forcing the platform to sell stETH at low prices to meet redemption demands. Ultimately, it declared bankruptcy due to severe insolvency.

5. FTX Collapse

On November 11, 2022, the cryptocurrency exchange FTX, including its affiliates, filed for bankruptcy protection in the U.S. for over a hundred entities.

The collapse of FTX originated from a document disclosed by CoinDesk. On November 2, 2022, CoinDesk revealed that Alameda Research might already be insolvent.

On November 6, 2022, Zhao Changpeng publicly expressed concerns about FTX's solvency, and Binance decided to liquidate all remaining FTT on its books. This triggered a withdrawal rush from users for FTX and Alameda, with billions of dollars in assets flowing out from FTX and Alameda's related wallet addresses.

On the evening of November 8, FTX suspended user withdrawals. The funding gap for FTX reached as high as $8 billion.

On November 11, the cryptocurrency exchange FTX filed for bankruptcy protection.

With the release of FTX's bankruptcy documents, it became clear that FTX and Alameda had long been in crisis. Data showed that Alameda had liquidity issues as early as May due to the Terra collapse and the bankruptcy of Three Arrows Capital. At that time, FTX allegedly used FTT tokens as collateral to lend to Alameda to rescue it from the Voyager and Three Arrows Capital bankruptcy turmoil. This also became the primary trigger for FTX's subsequent liquidity shortage.

The price of BTC fell from $20,905 to $15,500, with a weekly decline of 21%.

6. BlockFi Bankruptcy

On November 28, 2022, the cryptocurrency lender BlockFi announced it was filing for bankruptcy protection.

In court documents, it stated that its liabilities to creditors ranged between $1 billion and $10 billion, with over 100,000 creditors. Among them, FTX ranked second with a debt of $275 million.

7. Genesis Bankruptcy

On January 20, the crypto lending platform Genesis filed for bankruptcy protection.

After the FTX collapse, Genesis had $175 million in derivatives stuck in FTX. Prior to this, due to the collapse of Three Arrows Capital, Genesis suffered losses amounting to $2.36 billion. The company halted withdrawals and new loan issuance from its lending subsidiary on November 16. Bitcoin prices remained around $21,000.

II. Chain Reaction: The Decline of Algorithmic Stablecoins and the Exploration of Stablecoin Regulation

After the collapse of Terra and the algorithmic stablecoin UST, it not only triggered a series of related project collapses but also directly drew attention to stablecoins in the market.

First, after the collapse of Terra, people attempted to protect their rights through legal channels but found it impossible to locate corresponding regulatory laws. Until April 19, 2023, when the U.S. House Financial Services Committee released a 73-page "Stablecoin Bill Discussion Draft," which explicitly mentioned the handling of algorithmic stablecoins: those that cannot guarantee a one-to-one asset reserve and do not directly or indirectly hold dollars must be banned.

Although this draft does not represent the final bill, stablecoins have already attracted significant attention from regulatory agencies. Compared to discussions about "whether crypto assets are securities," the regulatory demand for stablecoins appears more urgent.

Secondly, algorithmic stablecoins rapidly declined after the Terra incident. According to data from Defillma, from May 8 to 15, 2022, the market shares of USDC and USDT increased by about 3%, while the market share of algorithmic stablecoins was eroded.

USDN is an algorithmic stablecoin launched by the WAVES protocol, using a mechanism very similar to that of UST/LUNA. USDN began to de-peg almost simultaneously with UST. At the beginning of 2023, USDN transitioned from a stablecoin to a Waves ecosystem index token, no longer pegging to the dollar at a 1:1 ratio, essentially abandoning the algorithmic stablecoin track.

The USN launched by the Near protocol began using USDT to mint USN after the UST collapse. However, due to double minting, a "gap of $40 million in collateral" emerged, and the project ultimately failed.

Additionally, decentralized stablecoin projects were also affected. The DAI launched by the MakerDAO protocol fell from over $8 billion to $4.8 billion in market cap and has yet to recover; in February 2023, Frax announced it would set its target collateralization ratio (CR) to 100%, removing algorithmic support, thus making FRAX a fully collateralized stablecoin.

Despite this year, some DeFi giants have begun to develop stablecoin businesses, such as the over-collateralized stablecoin crvUSD issued by CRV and the upcoming over-collateralized stablecoin GHO from Aave. These stablecoins are entirely different from UST, adopting a more conservative mechanism.

III. Incentives Behind the Chain Explosion

1. Over-concentration of Ecosystem

Taking Terra as an example, the 20% APY helped Terra rapidly absorb over $10 billion in market cap in a short period, developing quickly. The algorithmic stablecoin system appeared flexible but was, in fact, extremely fragile. The main issue was that the Terra ecosystem was overly concentrated and singular; according to data from April 2022, the locked amount in Terra exceeded $30 billion, with Anchor accounting for 51.15%, over $15 billion. The Terra ecosystem essentially lacked any DeFi protocols capable of absorbing UST, and when the demand for UST's application in Anchor significantly declined, it inevitably led to the comprehensive collapse of UST and LUNA.

Moreover, the collapse of FTX also stemmed from the mistake of putting too many eggs in one basket, as most of FTX's assets were directly related to FTT.

2. Excessive Leverage

The infinite layering and excessive leverage became the direct cause of Three Arrows Capital's bankruptcy: Three Arrows invested in a derivative with anchored value through leverage, staked the derivative to obtain high liquidity collateral, and then sold the collateral for arbitrage. However, when the derivative became unpegged from the underlying asset, the price and liquidity of the derivative plummeted, and Three Arrows could not sell the derivative in time to cope with creditor withdrawals, ultimately leading to bankruptcy.

Excessive leverage and high leverage ratios have always been one of the biggest systemic risks in the crypto market. While the interlocking model can generate a positive feedback loop for the crypto industry during stable market conditions, it also leads to a snowball effect during market downturns.

3. Lack of Regulation and Transparency in CeFi

Since the inception of the crypto industry, it has lived in the shadow of unclear regulation. The crypto industry lacks effective regulation of institutional behavior, and CeFi projects like Three Arrows and FTX wielded excessively concentrated and unmonitored power, leading to chaotic capital expansion.

Even after the chain explosions, exchanges like Binance took the lead in disclosing reserve proof Merkle trees, but still lack the endorsement and supervision of authoritative third-party institutions, and the lack of a commitment to a punitive mechanism does not possess high credibility. The industry still needs to explore better on-chain custody methods and auditing mechanisms.

4. The Crypto Community's Obsession with "Cult of Personality"

The rapid rise of Do Kwon, Su Zhu, and SBF, as well as the projects they founded, was a conspiracy of the mass market, media, and capital.

5. Human Nature Remains the Same

Finally, there is an old saying: speculation is as ancient as mountains, and there is nothing new on Wall Street. Speculators build high towers with greed, while short-sellers profit from panic. The repetition of history is not due to inherent social laws but more about eternal human nature.

IV. Seriously Examining the "Elephant in the Room"

Every coin has two sides. Although the series of explosion events like Terra and FTX dealt a heavy blow to the industry, they also sharply punctured the massive bubble created by the last bull market, prompting the industry to begin re-examining the "elephant in the room." The industry's value standards, safety mechanisms, and regulations are all moving towards a new level.

In terms of industry value standards, the so-called "leaders" are being demystified. Terra, FTX, and others were crypto giants with market caps in the billions, backed by top investors like Temasek, Sequoia Capital, and Grayscale, yet their collapse happened in an instant. This made the industry realize that "too big to fail" is not an ironclad rule, and authority can also lose credibility. When the speed of hot money entering does not keep up with value creation, it often lays the groundwork for the biggest pitfalls.

After the explosion events, the valuations or prices of most primary and secondary projects gradually adjusted, moving towards a healthier direction. Investment institutions led by Temasek have also begun to initiate reviews and improvements to their investment processes. Meanwhile, some crypto users may no longer be easily deceived by financing backgrounds and dream stories.

According to RootData, in April 2023, financing in the crypto sector amounted to $814 million, a decrease of approximately 77.6% from $3.623 billion in April 2022. Additionally, the number of financing rounds dropped from 186 to 106, a year-on-year decline of about 43.1%.

At the same time, the transparency of the crypto industry is also increasing. Leading centralized exchanges like Binance, Kraken, OKX, and Huobi have disclosed reserve proofs and accepted industry supervision after the FTX incident, although they still lack the endorsement of authoritative third-party auditing institutions at this stage. After the collapse of FTX, companies and individuals have invested more in financial management and compliance, and projects related to crypto accounting and on-chain asset custody are on the rise.

Moreover, the continuous explosions have also forced crypto regulation to accelerate, finding a balance between innovative development and orderly regulation in the crypto industry. Currently, countries or regions and organizations led by the United States, Hong Kong, South Korea, Japan, Singapore, and the European Union are formulating industry regulatory standards. By the end of 2022, over 42 sovereign countries and regions worldwide had implemented 105 regulatory measures and guidelines for the crypto industry, excluding mainland China. Among them, the U.S. had 22 measures, including crypto trading, regulatory guidance, judicial rulings, and stablecoins; the EU had 9 measures, involving regulatory guidance on crypto, stablecoins, anti-money laundering, etc.; South Korea had 8 measures, mainly in judicial rulings, stablecoins, and regulatory guidance on crypto.

Although the progress of crypto regulation varies among countries or regions, and there are significant differences in attitudes, crypto regulation still shows trends of globalization and refinement.

V. "East Rising, West Falling": The Evolution of Crypto Regions Under Regulatory Trends

The U.S. is one of the largest crypto markets globally and also has one of the most complex regulatory environments. The U.S. does not have a unified crypto regulatory agency; instead, multiple federal and state agencies are responsible for different areas of regulation. After the Terra incident, U.S. Treasury Secretary Janet Yellen called for regulation of stablecoins by the end of 2022 to protect consumers and financial stability. She also urged Congress to pass legislation granting the Treasury the authority to regulate stablecoins and other digital assets.

After the collapse of FTX at the end of last year, the U.S. SEC further strengthened its regulatory stance towards the crypto industry, beginning to review and prosecute some crypto projects that may involve violations of securities laws, including leading crypto firms like Binance, Coinbase, and Kraken. Currently, due to the continuous pressure from U.S. authorities on the crypto industry, some projects have chosen to "escape" the U.S. and expand their global business. Well-known crypto market makers like Jane Street and Jump Trading are also planning to exit their crypto trading businesses in the U.S. Although the U.S. has strict regulations on the crypto industry, it does not completely reject it, recognizing the innovative potential and social value of the crypto industry.

South Korean authorities have launched an urgent investigation into the Terra case and its founder Do Kwon and related personnel, who may have violated fraud, money laundering, or tax evasion laws. The South Korean Financial Services Commission (FSC) has also announced plans to strengthen regulation of cryptocurrency exchanges and platforms, requiring them to register with the government and comply with anti-money laundering and consumer protection regulations. Even though the government is still dealing with the aftermath of "Terra," South Korea is not as aggressive as the U.S. government. Recently, the South Korean government has drafted some regulations, and the central bank plans to introduce separate regulations for stablecoins to ensure the crypto industry can continue to develop in South Korea.

In the context of uneven regulatory developments across countries and regions, crypto innovation has shown new regional trends, with some viewpoints summarizing this trend as "East Rising, West Falling." Crypto firms and Web3 entrepreneurs have been migrating from the U.S. to Singapore, Dubai, and Hong Kong in search of the most suitable "crypto sanctuaries."

The Singaporean government, with the slogan of "encouraging innovative development," has opened its arms to Web3. Singapore is one of the major centers for crypto innovation in Asia, hosting numerous crypto projects and companies, including Terraform Labs, and has already issued multiple payment institution licenses. Singapore has a comprehensive regulatory framework for cryptocurrencies called the Payment Services Act (PSA), which requires cryptocurrency service providers to obtain licenses and comply with anti-money laundering and counter-terrorism financing rules, while the government has also adopted a relatively friendly and flexible regulatory approach. A series of measures have revitalized the Web3 industry in Singapore. In the second half of 2022, various Web3 conferences held in Singapore successfully ignited the passion of Chinese Web3 entrepreneurs, further pushing the "Eastern Web3 Power" and Chinese projects into the global crypto market.

Hong Kong, as a leading international financial center, is closely following Singapore's footsteps but is committed to achieving the status of a global Web3 center.

In December last year, Southern Eastern Asset Management launched Asia's first virtual asset ETFs, including Bitcoin ETF and Ethereum ETF, in Hong Kong. Although many crypto projects gathered in Hong Kong in April this year, the Hong Kong government's current requirements for the crypto industry are actually stricter. The regulatory framework proposed by the Hong Kong Monetary Authority (HKMA) requires all institutions providing cryptocurrency trading platform services to apply for licenses and comply with anti-money laundering and counter-terrorism financing regulations. Additionally, only professional investors meeting certain conditions can trade through these platforms, while retail investors are excluded. The HKMA stated that this is to protect investor interests, prevent financial stability risks, and maintain Hong Kong's reputation as an international financial center.

Previously, HKMA President Eddie Yue stated that virtual assets would be developed sustainably and that there would be no "softness" in digital asset regulation. Overall, Hong Kong adopts a more stringent and prudent attitude in supporting and accepting the development of the crypto industry in the region.

In Dubai, after the Terra incident, the government still maintains a relatively open and supportive stance towards crypto innovation. The government has launched several initiatives to promote the development of blockchain and crypto in the region, such as the Dubai Blockchain Strategy, Dubai Future Foundation, and Dubai International Financial Centre (DIFC). Dubai also provides a flexible regulatory framework for cryptocurrency companies, allowing them to operate under a sandbox system or obtain licenses from DIFC or the Abu Dhabi Global Market (ADGM). Currently, due to the subsequent collapse of FTX, Dubai is re-evaluating the risks of the crypto industry, and the Dubai Virtual Assets Regulatory Authority (VARA) has strengthened its scrutiny of projects applying for crypto licenses.

Other countries are also continuously monitoring the Terra incident and its impact on cryptocurrency regulation. For example, Japan has strengthened oversight of cryptocurrency exchanges and platforms, requiring them to report suspicious transactions and enhance cybersecurity measures. India has proposed a bill to ban all private cryptocurrencies (except those issued by the central bank). Recently, the EU passed comprehensive cryptocurrency regulations called "Markets in Crypto-Assets" (MiCA), aimed at making the rules more consistent among member states and ensuring consumer protection and financial stability.

In summary, the Terra incident highlights the necessity for more effective and coordinated regulation of crypto assets, especially algorithmic stablecoins, which pose significant challenges to consumer protection and financial stability. Different countries have different approaches and priorities regarding cryptocurrency regulation, and global dialogue and cooperation among regulatory agencies, policymakers, industry participants, and civil society are crucial for promoting innovation and trust in the crypto space.