Before the collapse of Terra USD and its sister cryptocurrency LUNA last week, many people on Reddit wondered if the Terraform Labs project was a scam or a Ponzi scheme.
Precisely in Redditseveral users saw a catastrophe coming around Terra USD, while others warned: “if you have doubts about a project after you have investigated it, it is most likely a scam”.
However, the Brazilian analyst and youtuber Caio Garé published a videoon March 25, in which predicted, a month and a half in advance, the fall of Terra USD (UST) and LUNA.
“Terra and LUNA are a great ponzi scheme and it can collapse,” Garé said in a video that today counts more than 47 thousand views. At the time, he warned that he was not the only one with such suspicions and mentioned Twitter user AlgodTrading, who called the project a scam.
Even Algod bet $1 million that the price of LUNA would collapse. The challenge was accepted by Do Kwon himself, co-founder and CEO of Terra.
Later, influencer Jordan Fish agreed to play the role of custodian and both Algod and Do Kwon transferred their bet amount to him. So, a year from now, exactly on March 14, 2023, if the price of LUNA is not higher than USD 88, then Algod will receive USD 2 millionotherwise the Terra CEO will be the winner.
Terra: data from a death foretold
The collapse of Terra USD and LUNA was announced on other occasions, as it was something that could be seen coming as soon as the design of their system was delved a little, at least, that is what several analysts pointed out.
In fact, Lyn Alden, a cryptocurrency market researcher and analyst, since April, He had been giving warnings about the irregularities he was observing on Terra.
Also the analyst Cory Klipstenhad been raising multiple red flags as a sign of danger around the project.
Before continuing, let us remember that UST is an algorithmic stablecoin that uses the LUNA cryptocurrency to maintain its parity with the price of the dollar American. But, it makes it very different from other stablecoins like Tether (USDT) or USDC which are supposedly backed by other assets.
Like other stablecoins, UST aims to maintain a 1:1 parity with the dollar, although it does not do so backed by a deposited value, rather its pegging occurs through algorithms that emulate the price of other assets.
Its mechanism has been detailed in other content published by CriptoNoticias, in which it is basically explained that its system stimulates the market to burn (destroy) or issue UST to increase or reduce its currency, as necessary. For each UST burned, the equivalent of 1 terra dollar (LUNA) is issued; and for each UST issued, the equivalent of 1 dollar of LUNA is burned.
In simpler words this means that a LUNA crypto asset is released when demand for Terra USD is low, and is burned when the demand for UST grows.
In the same way, this medium has offered detailed information to understand the reasons that led to its fall.
In any case, it should also be noted that the Terra debacle can be used for the industry to take stock and draw its conclusions about the events surrounding the implosion. This will offer the opportunity to learn from mistakes in order to avoid them in the future.
When the one at the top is the one who wins the most, without losses
As CriptoNoticias describes on its page on bitcoin and cryptocurrency scams, in a ponzi or pyramid scheme, a company that promotes a certain project Centralized fund raises funds from a large number of investors to favor those at the top, as in a pyramid.
It was precisely what youtuber Caio Garé observed when he said that he had previously noticed signs that something could go wrong with Terra USD and LUNA. The first hint detected had to do with the decentralized finance (DeFi) platform Anchor.
This is the lending and interest protocol managed by the Interchain Asset Association (IAA), an organization formed and co-chaired by Zaki Manian of Cosmos; Jack Platts of the Web3 Foundation; and Do Kwon from Terraform Labs. Although it was sold as decentralized, the truth is that it never was, and actually functions as a kind of central bank for the Terra ecosystem.
Anchor started by offering an annual interest rate of 20% for deposits in USTthe algorithmic stablecoin that was to maintain its 1:1 parity with the US dollar.
Attracted by the high profitability, hundreds of investors placed their UST deposits in the loan protocol with the promise of accruing annual interest as a reward.
It was assumed that the profitability of the deposits in Anchor would be guaranteed by the difference between the funds placed by the users and those borrowed, but be careful, not everything was as it was shown.
Borrowers also deposited other tokens such as bLuna (bonds in LUNA) or bETH (bonds in ethers) to Anchor as collateral to borrow UST from the lending protocol.
Although these borrowers had to pay interest on the amount borrowed, due to ongoing incentive programs, they received tokens from the lending protocol in parallel, so they were finally paid to borrow at UST.
However, as Garé revealed, nothing was sustainable over time, since Anchor’s income was less than its expenses, so the protocol had to draw on its reserves to make up the deficit and continue to pay high interest rates on UST.
In fact, your management team had to increase their reserves twice in order to continue with its growth strategy, offering high interest rates subsidized by UST.
In his video, Garé recalled that, previously, two rescue injections had been performed on Anchor. One for USD 50 million in 2021 and another for USD 500 million in 2022.
Garé’s observation was also featured for Lyn Alden, who called the Terra system a trapwhere “the huge demand for UST is driven almost entirely by unsustainable high-yield cultivation.”
If the return opportunity for investors dries up, demand for UST will likely decline. If demand for UST declines, it could cause a negative feedback loop and liquidity problems for both UST and LUNA. This is known as a “death spiral” where tons of capital is withdrawn from the Terra ecosystem, which will crash the LUNA price and then eventually break the UST parity. If that happens, it is functionally very similar to an emerging market currency crisis.
Lyb Alden, Cryptocurrency Market Analyst.
For Caio Garé it was clearly visible that, at any moment, Anchor would not have the capacity to pay the high interest rates promised, given that around 70% of the UST that was in circulation was deposited in the loan protocolwith the idea of generating interest.
“When people buy UST they don’t realize that they help increase the price of LUNA, and in this way they contribute to filling the vaults of Terraform Labs, the entity that controls this ecosystem,” said Garé.
From your point of view, the more people used their UST with the idea of earning interest in Anchor, the more they helped LUNA increase its valuewhich allowed Terraform Labs to generate the necessary funds to continue financing the Anchor platform.
So, for Garé there is no doubt that Terra is a ponzi scheme, since it bears in mind several elements that define a fraudulent project. Among them, two stand out, such as the promise of high yield regardless of the scenario that occurs in the market, and at the same time, dependence on new investors to enter to sustain it.
Everything seemed to work perfectly, until the death spiral appeared. This happened when users rushed to liquidate their crypto assets faster than the “algorithmic” stabilizer could take effect. The price of the “brother” token [LUNA] It fell from about 86 dollars at the beginning of last week and plunged to 0.003 cents on the dollar last Friday, May 13.
Terra USD and other algorithmic stablecoins, or failed math?
As CriptoNoticias Criptopedia explains, stablecoins are tokens issued on the blockchain whose value is linked to an external asset, such as national currencies or precious minerals.
These are assets that function as digital representations of the dollar, the euro and even gold and were born as a solution to the intrinsic volatility of native cryptocurrencies.
As we pointed out earlier in this article, the Terra was to maintain a link through dynamic control of supply and demand for its stablecoin to preserve its parity with the dollar, but it failed, dragging down users who believed its promises.
However, Terra USD is not the first algorithmic stablecoin to crashthere are also others like, for example, Empty Set Dollar, or ESD.
Launched in 2020, Empty Set Dollar described itself as a stablecoin that would act as a reserve currency for the DeFi sector. It tried to build on the design of another project called Basis, and was released by an anonymous team to minimize the threat posed by regulatory intervention.
The protocol sought to maintain its parity by issuing additional tokens when their price rose above $1 to increase supply and dilute the value of tokens already in circulation. Rather, it would incentivize users to burn their tokens in exchange for debt coupons when the price fell below $1, to create scarcity.
Although the price of ESD hovered near $1 for much of the fourth quarter of 2020, the token entered a death cycle at the end of December of that year and never again had parity with the US dollar.
There were also other failed algorithmic stablecoins, including Basecoin, BasicCash (BAC), ampleforth (WIDE) and USD Neutrinojust to mention a few.
all these projects They have several elements in common. But the one that we could highlight the most is the point that distances them the most from bitcoin (BTC) that it does not have an authority or control entity that is responsible for its emission or decision-making regarding its movements.
While, Terra and other algorithmic stablecoin development teams, as well as other ecosystem projects, have been called into question by the decisions that arise from its central entities. These, in turn, are led by founders, directors, employees and others, who are dedicated to promoting and developing their proposals, even if they have design errors or are not sustainable over time.
Based on this, Lyn Alden’s words seem reasonable when she comments that, after all her studies, the only investable asset in the entire digital asset ecosystem is bitcoin.
“Everything else in the industry is something I classify as speculation, whenever I look at it (at best), or basically a ponzi scheme (at worst), depending on the specific asset in question,” Alden said. .