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App\Entity\Article {#1094
  -id: 11643
  -title: "Anatomy of an Algo Stablecoin Apocalypse — TerraUSD"
  -slug: "anatomy-of-an-algo-stablecoin-apocalypse-terrausd"
  -introtext: "<p>The near-collapse of algorithmic stablecoin TerraUSD is just one more example of crypto-based financial alchemy doomed to failure and why DeFi returns are anything but “riskless.”</p>\r\n"
  -content: """
    \r\n
    <p id="e022" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc mb" data-selectable-paragraph><span class="l mc md me mf mg mh mi mj mk dq">T</span>here are no two more sexy words to an investor than “passive income,” except perhaps for “risk-free returns,” though technically the latter is three words (to be pedantic).</p>\r\n
    <p id="0cc7" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Which is why Luna, UST and Anchor Protocol rode a wave of speculation to become multi-billion dollar cryptocurrency projects with marquee backers.</p>\r\n
    <p id="459d" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Both “passive income”&nbsp;<em class="ml">and</em>&nbsp;“risk-free returns” were being touted by a combination of Terraform Labs, Anchor Protocol and TerraUSD, which were all “coincidentally” owned, created and run by the same people.</p>\r\n
    <p id="7555" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>To understand what’s been keeping the crypto-set up at night these past weeks, it’s first necessary to understand what stablecoins are and the role they play in the cryptocurrency industry.</p>\r\n
    <h2 id="646b" class="mm mn ja bn mo mp mq mr ms mt mu mv mw lo mx my mz ls na nb nc lw nd ne nf ng gc" data-selectable-paragraph>What’s so Stable about Making Coin?</h2>\r\n
    <p id="aefb" class="pw-post-body-paragraph lf lg ja lh b li nh kb lk ll ni ke ln lo nj lq lr ls nk lu lv lw nl ly lz ma it gc" data-selectable-paragraph>Early on in the development of cryptocurrencies, price volatility made it impractical for traders to hold on to them when waiting for fresh opportunities to re-enter the market.</p>\r\n
    <p id="4a11" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>At the time, there were few practical and expeditious fiat currency rails to enter and exit cryptocurrency trades easily, which is where the initial demand for stablecoins came about.</p>\r\n
    <p><img style="display: block; margin-left: auto; margin-right: auto;" src="/images/Stablecoins_Asset_Backed.png" alt="Stablecoins_Asset_Backed.png" width="800" height="450" /></p>\r\n
    <p style="text-align: center;"><em>All “asset backed” and “algorithmic” stablecoins are stablecoins, but “asset backed” and “algorithmic” stablecoins are mutually exclusive.</em></p>\r\n
    <p>&nbsp;</p>\r\n
    <p id="ede9" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>The first stablecoin ever created was Tether, or USDT, which became an overnight hit for traders looking for a respite from the volatility of cryptocurrencies.</p>\r\n
    <p id="c6e7" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>While it’s beyond the scope of this article to discuss the controversies surrounding Tether, of which there are plenty, in a nutshell, USDT promised to be backed 1-to-1 by dollars in a bank account.</p>\r\n
    <p id="dca0" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Anyone holding USDT could swap their USDT for “real” dollars whenever they wanted to, but in practice, would use it to buy more cryptocurrencies or sell the USDT to other cryptocurrency traders who wanted it.</p>\r\n
    <p id="e049" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>USDT falls under the category of stablecoins that are “asset backed” and the inverted commas is intentional, because it’s not at all clear that USDT is backed 100 cents in the dollar.</p>\r\n
    <p id="8439" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Other stablecoin issuers soon followed, including USDT’s main rival, USDC, which is run by Circle and has audited dollar deposits in a bank account.</p>\r\n
    <p id="82cd" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Without a digital dollar issued by the U.S. Federal Reserve, these “asset backed” stablecoins became the backbone of cryptocurrency trading, forming the most common trading pairs with other tokens.</p>\r\n
    <p id="516b" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>But “asset backed” stablecoins are anathema to blockchain purists, for whom decentralization is everything.</p>\r\n
    <p id="88ca" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Because “asset backed” stablecoins are usually issued by a centralized entity like a company or cryptocurrency exchange, they are thought to be more susceptible to interference, especially by government authorities.</p>\r\n
    <p id="7a78" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Enter the algorithmic stablecoin.</p>\r\n
    <h2 id="3390" class="mm mn ja bn mo mp mq mr ms mt mu mv mw lo mx my mz ls na nb nc lw nd ne nf ng gc" data-selectable-paragraph>Algorithmic Angst</h2>\r\n
    <p id="4ea2" class="pw-post-body-paragraph lf lg ja lh b li nh kb lk ll ni ke ln lo nj lq lr ls nk lu lv lw nl ly lz ma it gc" data-selectable-paragraph>An algorithmic stablecoin works on the basis that instead of relying on a centralized intermediary to issue a stablecoin backed by assets, smart contracts can be used to achieve the same effect..</p>\r\n
    <p id="b042" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>The principle behind algorithmic stablecoins is simple.</p>\r\n
    <p id="9c3e" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>A decentralized blockchain protocol will issue an algorithmic stablecoin whose value is pegged 1-to-1 with something like the U.S. dollar, but underlying that algorithmic stablecoin will be another cryptocurrency or combination of cryptocurrencies.</p>\r\n
    <p id="653a" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>The other cryptocurrency will have a variable value and trade freely in the open market, except that smart contracts will automatically manage the supply and demand of that cryptocurrency to attempt to maintain the algorithmic stablecoin’s fixed peg.</p>\r\n
    <p id="ce89" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Trying to maintain a fixed peg with a floating underlying asset isn’t new — countries have been messing around with their national currencies for years to attempt to achieve very much the same thing.</p>\r\n
    <p id="4feb" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>During the 1997 Asian Financial Crisis, Thailand, Indonesia and South Korea, all of which were cesspools of crony capitalism at the time (and to some extent still are), maintained fixed exchange rates with the dollar, while nursing massive current account deficits.</p>\r\n
    <p id="3438" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>These fixed pegs encouraged Thai, Indonesian and South Korean borrowing, leading to excessive exposure to foreign exchange risk.</p>\r\n
    <p id="d3d7" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Because these pegs were artificially maintained, they were prime targets for an attack and hedge funds bet that the central banks of these countries didn’t have enough to keep supporting these fixed pegs.</p>\r\n
    <p id="83f7" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Basically, these central banks would borrow in dollars to buy back their own currencies to prop up the value of their currencies to maintain the peg.</p>\r\n
    <p id="731f" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Ultimately, the Thai baht, Indonesian rupiah and South Korean won all but collapsed in the wake of assaults on their currencies and the International Monetary Fund stepped in to initiate a US$40 billion program to stabilize these currencies.</p>\r\n
    <p id="1852" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>At its core, the value of a currency relative to another is a function of a multitude of factors, including that country’s interest rates, economic stock and political stability.</p>\r\n
    <p id="2513" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>By artificially maintaining a fixed peg with a currency like the dollar, Thailand, Indonesia and South Korea were effectively painting themselves into a corner, and these pegs would eventually break when their central banks ran out of other currencies to fix those pegs.</p>\r\n
    <p id="8417" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>History is replete with examples of countries artificially attempting to maintain fixed pegs with another currency, only to clean out their coffers in the process and not all of them were flaky emerging markets.</p>\r\n
    <p id="763a" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>In 1992, the United Kingdom maintained a fixed peg between the pound and Germany’s deutsche mark under the Exchange Rate Mechanism (ERM), even though the monetary policies needed by both countries was dramatically different.</p>\r\n
    <p id="021e" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>The U.K. was coming out of a recession and needed a loose monetary policy and low interest rates to stimulate growth, but these were artificially held high to maintain the pound’s peg as Germany, which was staving off high inflation, kept borrowing costs elevated.</p>\r\n
    <p id="7e49" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>By the spring of 1992, it became apparent to many currency traders that the U.K. didn’t have enough resources to keep the pound artificially high to and the massive selloff in pounds forced a painful devaluation.</p>\r\n
    <p id="e6ae" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Algorithmic stablecoins attempt to do what whole countries with their entire economic stock haven’t been able to — create a fixed peg with a floating underlying.</p>\r\n
    <h2 id="67e7" class="mm mn ja bn mo mp mq mr ms mt mu mv mw lo mx my mz ls na nb nc lw nd ne nf ng gc" data-selectable-paragraph>Très Terrable!</h2>\r\n
    <p id="bc63" class="pw-post-body-paragraph lf lg ja lh b li nh kb lk ll ni ke ln lo nj lq lr ls nk lu lv lw nl ly lz ma it gc" data-selectable-paragraph>The mechanics behind TerraUSD are similar to many other algorithmic stablecoins and nothing short of financial alchemy — the equivalent of smelting copper into gold.</p>\r\n
    <p id="9532" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>TerraUSD (UST) maintains its 1-to-1 peg with the dollar through an underlying cryptocurrency Luna, both of which are issued by Terraform Labs.</p>\r\n
    <p id="76e7" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>If UST falls below US$1, arbitrageurs (automated and human) are incentivized to swap UST for US$1 worth of Luna, which removes UST from circulation in an attempt to increase its price and recover the peg.</p>\r\n
    <p id="9afb" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Conversely, if the price of UST goes above US$1, these same arbitrageurs act in reverse, removing Luna tokens from circulation and swapping them to new units of UST.</p>\r\n
    <p><img src="/images/Luna_and_UST.png" alt="Luna_and_UST.png" width="600" height="336" /></p>\r\n
    <p id="8acc" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>But wait, there’s more.</p>\r\n
    <p id="2b56" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>To generate demand for UST, Anchor Protocol (which is also owned by Terraform Labs) offered ridiculous yields of almost 20% on UST deposits on its decentralized lending platform.</p>\r\n
    <p id="4106" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>By enticing investors with such high yields (typical dollar bank deposits provide less than 1% of interest) Anchor Protocol would stoke demand for UST, a stablecoin with over US$18 billion in market cap (at the time).</p>\r\n
    <p id="d716" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>For every new UST created, US$1 worth of Luna tokens would be taken out of circulation, or “burned” to use crypto parlance.</p>\r\n
    <p id="96bf" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>As demand for UST increases, more Luna would be taken out of circulation which would in theory help its price to increase because you can always redeem UST for Luna.</p>\r\n
    <p id="98eb" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>If Luna’s price is $50, then anyone can redeem it for 50 UST. Similarly, 50 UST can be redeemed for 1 Luna (Note: Not 50 Luna — Luna’s price is variable).</p>\r\n
    <p id="b4a0" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>How Anchor Protocol pays such high yields is by lending UST to borrowers, as well as through staking rewards on its collateral.</p>\r\n
    <p id="170f" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>But in March, it was noticed that Anchor Protocol was depleting its yield reserves at a faster pace to pay out its promised yields — demand exceeded the reserves available to pay out those yields.</p>\r\n
    <p id="8e46" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>In the same way that investors are drawn to a Ponzi scheme from the high regular payouts that eventually run out, depositors were drawn to Anchor Protocol to deposit UST, to earn those high yields.</p>\r\n
    <p id="d31d" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Remember, the blockchain is transparent, so investors can see what’s left in smart contracts to pay out yield and concerns that Anchor Protocol’s reserves would be depleted were soon met with a US$450 million injection of UST.</p>\r\n
    <p id="bc1a" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>But where did that UST come from?</p>\r\n
    <p id="e396" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>By Terraform Labs and its partners converting Luna to UST of course, in other words, taking from something that was “created” to pay off something that never existed (the yields).</p>\r\n
    <p id="fb3b" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Confused?</p>\r\n
    <ol class="">\r\n
    <li id="98d5" class="nt nu ja lh b li lj ll lm lo nv ls nw lw nx ma ny nz oa ob gc" data-selectable-paragraph>\r\n
    <p>Terraform Labs creates demand for UST through the Anchor Protocol, by offering high yields (almost 20%) on UST deposits.</p>\r\n
    </li>\r\n
    <li id="54f9" class="nt nu ja lh b li oc ll od lo oe ls of lw og ma ny nz oa ob gc" data-selectable-paragraph>\r\n
    <p>This demand for UST indirectly increases demand for Luna by reducing the amount of circulation of Luna because the more UST there is, the less Luna there is.</p>\r\n
    </li>\r\n
    <li id="b7b6" class="nt nu ja lh b li oc ll od lo oe ls of lw og ma ny nz oa ob gc" data-selectable-paragraph>\r\n
    <p>Enter the speculators.</p>\r\n
    </li>\r\n
    <li id="1f02" class="nt nu ja lh b li oc ll od lo oe ls of lw og ma ny nz oa ob gc" data-selectable-paragraph>\r\n
    <p>Since 1 UST will always buy you $1&nbsp;<em class="ml">worth</em>&nbsp;of Luna, speculators are betting that as demand for UST increases, the amount of Luna available decreases, which ought to increase its price.</p>\r\n
    </li>\r\n
    <li id="3161" class="nt nu ja lh b li oc ll od lo oe ls of lw og ma ny nz oa ob gc" data-selectable-paragraph>\r\n
    <p>The problem of course is when Terraform Labs and its partners uses some of that Luna to swap into UST or buy other cryptocurrencies to shore up reserves in Anchor Protocol.</p>\r\n
    </li>\r\n
    <li id="e9d0" class="nt nu ja lh b li oc ll od lo oe ls of lw og ma ny nz oa ob gc" data-selectable-paragraph>\r\n
    <p>Swapping Luna for UST or using it to buy Bitcoin to pay off the yields of Anchor Protocol is exactly what it sounds like — a Ponzi scheme.</p>\r\n
    </li>\r\n
    </ol>\r\n
    <p id="647e" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Even Do Kwon, the man behind Terraform Labs alluded to Luna and UST’s “Ponzi-esque” qualities.</p>\r\n
    <p id="a5de" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Speaking with Bloomberg, Kwon noted,</p>\r\n
    <p id="25d0" class="lf lg ml lh b li lj kb lk ll lm ke ln ok lp lq lr ol lt lu lv om lx ly lz ma it gc" style="padding-left: 30px;" data-selectable-paragraph>“If UST were to keep growing, LUNA price has to higher than now.”</p>\r\n
    <p id="4037" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Which begs the question, “why?”</p>\r\n
    <p id="da2d" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Why does Luna’s price need to be higher?</p>\r\n
    <p id="4435" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>To support demand for UST of course.</p>\r\n
    <p id="4558" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>The higher Luna’s price, the less is needed to swap for UST to pay out those insane yields on Anchor Protocol out of the Anchor Protocol Reserve.</p>\r\n
    <p id="4f7b" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Because if Anchor Protocol lowers its yields on UST deposits, demand for UST would fall (there is hardly any organic demand for UST outside of earning unrealistic yields on Anchor) and if demand for UST falls, it could slip its peg.</p>\r\n
    <p id="2c20" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>If UST slips its peg, the price of Luna would then fall, because arbitrageurs would swap UST for Luna and then sell Luna to realize the arbitrage — a self-perpetuating downwards spiral.</p>\r\n
    <p id="c926" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>And if all of this sounds like a Ponzi scheme, that’s because it was structured as one from the very beginning (hopefully unintentionally).</p>\r\n
    <p id="82eb" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>In mid-March, a US$1 billion Luna token sale was undertaken to acquire Bitcoin for UST’s reserves, on top of indications that those reserves could grow to include US$10 billion worth of Bitcoin.</p>\r\n
    <p id="df2c" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>But why would an algorithmic stablecoin need reserves when it’s not an “asset backed” stablecoin?</p>\r\n
    <p id="90c0" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Kwon himself proffered an explanation to Bloomberg,</p>\r\n
    <p id="da1e" class="lf lg ml lh b li lj kb lk ll lm ke ln ok lp lq lr ol lt lu lv om lx ly lz ma it gc" style="padding-left: 30px;" data-selectable-paragraph>“Having third party reserve assets to meet short-term demand in redemption of UST can be quite valuable.”</p>\r\n
    <p id="2892" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Why the need for third party assets?</p>\r\n
    <p id="c087" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Because there’s only so much Luna that can be conjured out of thin air to buy other more valuable cryptocurrencies before uncomfortable questions about Luna’s inherent value (there is none) start being raised.</p>\r\n
    <p id="e9d8" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Legendary investor Warren Buffett once famously said,</p>\r\n
    <p id="5b6c" class="lf lg ml lh b li lj kb lk ll lm ke ln ok lp lq lr ol lt lu lv om lx ly lz ma it gc" style="padding-left: 30px;" data-selectable-paragraph>“Only when the tide goes out do you discover who’s been swimming naked.”</p>\r\n
    <p id="55d5" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>The same way that the 2008 Financial Crisis exposed Bernard Madoff’s US$65 billion Ponzi scheme, the past few weeks have done the same for UST, Anchor Protocol and Luna, culminating over the last weekend.</p>\r\n
    <p id="067a" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>As financial markets got roiled, cryptocurrencies were hit hard and as Luna slid in value, a classic run on UST was all but inevitable and the algorithmic “stablecoin” (parenthesis mine) lost its dollar peg.</p>\r\n
    <p id="5bef" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>The death spiral looked something like this:</p>\r\n
    <ol class="">\r\n
    <li id="fb0c" class="nt nu ja lh b li lj ll lm lo nv ls nw lw nx ma ny nz oa ob gc" data-selectable-paragraph>\r\n
    <p>A broader bear market lead to a selloff in Luna.</p>\r\n
    </li>\r\n
    <li id="a8fb" class="nt nu ja lh b li oc ll od lo oe ls of lw og ma ny nz oa ob gc" data-selectable-paragraph>\r\n
    <p>UST holders fear a peg break, regardless of Anchor Protocol’s yields and so they start to sell their UST, forcing the algorithms to mint more Luna at a time when the market is already bearish.</p>\r\n
    </li>\r\n
    <li id="99ca" class="nt nu ja lh b li oc ll od lo oe ls of lw og ma ny nz oa ob gc" data-selectable-paragraph>\r\n
    <p>Too many sellers find too few buyers and Luna loses its value.</p>\r\n
    </li>\r\n
    <li id="96a2" class="nt nu ja lh b li oc ll od lo oe ls of lw og ma ny nz oa ob gc" data-selectable-paragraph>\r\n
    <p>Because UST derives its value from Luna, it loses its peg even further, forcing more Luna to be minted.</p>\r\n
    </li>\r\n
    <li id="9943" class="nt nu ja lh b li oc ll od lo oe ls of lw og ma ny nz oa ob gc" data-selectable-paragraph>\r\n
    <p><em class="ml">Ad infinitum</em>&nbsp;until both UST and Luna go to zero except for the Luna Foundation Guard.</p>\r\n
    </li>\r\n
    </ol>\r\n
    <p id="8652" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>As Luna fell and UST slipped its peg, Kwon and the Luna Foundation Guard (because only something that sounds like a Marvel franchise will save Luna now), a consortium of the biggest cryptocurrency players including Jump Crypto, Three Arrows and Defiance, intervened to shore up Luna and UST.</p>\r\n
    <p><img src="/images/Anchor_Protocol.png" alt="Anchor_Protocol.png" width="740" height="416" /></p>\r\n
    <p id="4cf6" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Instead of being required to mint Luna to arbitrage UST’s price, there was now the option to swap UST to Bitcoin instead, but that just adds fuel to the fire.</p>\r\n
    <p id="a290" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Bitcoin itself is volatile and adding it to the reserves to prop up UST would just take the rest of the cryptocurrency market down with Luna, UST and Anchor Protocol.</p>\r\n
    <p id="c563" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Because that gives the impression that the yields at Anchor Protocol are sustainable (they are not) and more UST chases more unsustainable yields, which needs Terraform Labs to raise more investment to prop up the scheme.</p>\r\n
    <p id="deef" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>At its lowest point this past week, UST, the supposed “stablecoin,” was trading at US$0.225.</p>\r\n
    <p id="21a0" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>In a nutshell, UST is an algorithmic stablecoin backed by Luna, but Luna itself is backed by nothing other than speculation that demand for this token will exceed supply.</p>\r\n
    <p id="bc8b" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>The goal of Terraform Labs of course was that UST would take off as a widely used stablecoin well before the Luna Foundation Guard or other superheroes of the cryptoverse ran out of money to support it.</p>\r\n
    <p id="099e" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Luna and UST are being propped up by Bitcoin and other cryptocurrencies which Terraform Lab’s founders and closest associates purchased with the Luna that they printed out of thin air, paid for by Luna speculators.</p>\r\n
    <p id="9bc2" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>In other words, using new investor monies to pay off other investor’s returns by way of Anchor Protocol’s yields.</p>\r\n
    <p id="386b" class="pw-post-body-paragraph lf lg ja lh b li lj kb lk ll lm ke ln lo lp lq lr ls lt lu lv lw lx ly lz ma it gc" data-selectable-paragraph>Yeah, probably not a Ponzi scheme.</p>\r\n
    <p>&nbsp;</p>\r\n
    <p><span class="s1"><i>Disclaimer: This article is for informational purposes only and does not constitute a recommendation or investment advice. You should not construe any such information or other material as legal, tax, investment, trading, financial, or other advice. Please seek a professional financial advisor before making any investment decision. We are not&nbsp;responsible for and do not endorse or accept any responsibility for the availability, contents, products, services or use of any third party website as stated in our&nbsp;</i><a href="support/privacy-policy" target="_blank"><span class="s2"><i>privacy policy</i></span></a><i>.</i></span>&nbsp;</p>
    """
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  -metakey: "Anatomy of an Algo Stablecoin Apocalypse — TerraUSD"
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