Nothing cryptic about another ‘crypto’ disaster

Earlier this month, a cryptocurrency token called Luna crashed in price – an event that also brought down the value of bitcoin, became the biggest crash in cryptocurrency history thus far, earned the person or persons who (probably) orchestrated this fall nearly a billion dollars, and stuck a big-ass wrench in the machinations of the cryptocurrency community. Luna’s originated, a South Korean entrepreneur named Kwon Do-hyung, a.k.a. Do Kwon, has been charged with fraud. Stablegains, a cryptocurrency-based “yield generation project”, lost $44 million and may face a lawsuit from its investors for having misguided them about where the company was storing their wealth – in the “stablecoin” to which Luna was pegged. Money-making algorithms of the Venus Protocol, running on the BNB blockchain, lost $11 million due to Luna’s crash. There have been many more, and worse, repercussions.

While this fiasco is neither novel nor likely to be the last of its kind, it merits attention for those interested in (the opposition to) cryptocurrencies – for the sort of disaster that only a nascent piece of financial technology backed by the self-delusion of techbros could wreak. A few semi-helpful explainers on Twitter indicated that crash was a repeat in technique of the one George Soros orchestrated against the Bank of England in 1992, leading to the occasion known as ‘Black Wednesday’. Soros shorted the British pound shortly after the currency had become part of the European Rate Mechanism, which required the government to maintain the value of the pound within a fixed range with respect to the Deutsche mark. But Soros foresaw that thanks to inflation and higher interest rates, the pound would drop under this range against the mark and the Bank of England would be forced to buy back pounds on the open market. He eventually built up a short of $10 billion and made a profit of $1 billion. In this current case, replace the pound with the Luna or the bitcoin, as the case may be.

To put things very simply: Do Kwon, invented two cryptocurrency tokens called Luna and Terra. Terra was an algorithmic stablecoin, meaning a) 1 Terra would always be worth exactly $1 and b) algorithms running on the blockchain on which Terra traded would ensure that 1 Terra could be exchanged for $1’s worth of Luna and vice versa. The 1:1 pegging would be ensured through arbitrage trades. Luna, however, was not a stablecoin and its price could fluctuate. Do Kwon intended for Terra to protect Luna against market volatility. Bloomberg columnist Matt Levine pointed out that Do Kwon wrongly assumed that this financial system – of coins, pegs and algorithms – would remain stable as long as Luna maintained a non-zero value, i.e. that it wouldn’t crash. Or Do Kwon wasn’t wrong and knew that the system had another point of stability: when Luna’s value was zero. (He probably wasn’t wrong: a previous stablecoin experiment that failed to the tune of $54 million was run by two anonymous persons named “Rick” and “Morty”, and ex-Terra employees have alleged that “Rick” was really Do Kwon.)

On April 1, 2022, Luna had a value of $115. But in May, someone realised that while Terra’s value was pegged 1:1 to the US dollar through arbitrages, they could short Luna itself. (Here’s a simple explanation of how shorting works.) One possibility that some have floated (see here and here) is that the attacker bet in favour of Terra and against bitcoin. This arises because Do Kwon had setup a reserve of 39,897.98 bitcoins to back up Terra. First, the attacker bought a large quantity of Terra and then began to dump it, forcing Do Kwon to start selling bitcoin to keep Terra from becoming depegged from the US dollar. Then the attacker shorted bitcoin. Whether this individual(s) took the simpler route or the more involved one with bitcoins, Luna’s price crashed from $80.84 on May 1 to $0.000169 today. As David Rosenthal, from whose blog post on the topic I’ve benefitted immensely, put it, “By May 11th LUNA was under $1 and BTC was under $29K, down around 17% from before the attack, although it recovered to around $30K. By May 13th [Terra] had transitioned to … under $0.20 and LUNA was under $0.0001, having vanished $41B of “market cap”.”

On May 12, Terra ‘halted’ its blockchain; since Terra and Luna are/were tokens on the chain, they became worthless to their owners. But Do Kwon has already said that he plans to launch another blockchain.