The Weekly Roundup Special Edition: Terra's Collapse
Market Movers
The entire crypto market was rocked by the Terra U.S. Dollar (UST) stablecoin collapse, and the largest coins by market cap notched significant losses
The pump coin of the week was overcollateralized stablecoin loan issuer MakerDAO, whose governance token (MKR) skyrocketed following the UST instability
MakerDAO issues the DAI stablecoin and benefited heavily from the UST collapse and saw an increase of $80M of issuance of DAI
Other stablecoins like USDT and USDC also saw significant increases in market cap as liquidity moved away from UST
This week’s newsletter will be a bit different than our typical structure. The UST + LUNA cratering rocked markets, and we’d like to devote the majority of the newsletter towards breaking this down. The “First Sip” section will be at the bottom. We hope you enjoy. Stay bullish.
Table Talk Special Edition
UST CRASHES TAKING LUNA, CRYPTO W/ IT
Last week the “DeFi Download” discussed the de-pegging of UST from the U.S. Dollar. We mentioned that with $18.6B of market cap, it was unlikely that UST wouldn’t rebalance to its $1 stated value. Instead, the value crashed early this week and now sits at less than $0.20 at the time of this writing (via CoinMarketCap). Aftershocks from this collapse essentially zeroed out LUNA, UST issuer Terra’s coin.
UST is an algorithmic stablecoin. For a review of the different kinds of stablecoins, see our “First Sip” section from this newsletter. UST had a unique value structure that was pegged to the U.S. Dollar through their coin LUNA. Essentially, holders of LUNA/UST could take advantage of the arbitrage opportunities. If UST rose above the value of 1 U.S. Dollar by swapping $1 of LUNA for one UST allowed LUNA holders to bank the excess above $1 in the value of UST, and the value of UST would decrease because of the increase in issuance (via CoinDesk). The converse was also true, where holders of UST could convert it to LUNA and decrease the supply of UST at a 1:1 ratio (via CoinDesk). The most important piece of this is that the value of the UST stablecoin was not backed by assets at a 1:1 ratio but rather relied on “financial engineering” to maintain its peg to the U.S. Dollar (via WSJ). Without some sort of cash or cash equivalent asset collateralizing the entire issuance of the stablecoin, its reactions to large capital shifts require complicated procedures instead of simply selling-off the assets (via WSJ).
This past week, the value of UST dipped significantly below $1, and market forces did not rise to correct it.
On May 8th, the Luna Foundation Guard (LFG), which had approximately $3B in Bitcoin meant to safeguard the value of LUNA, responded to the slight de-pegging of $0.013 we discussed in last week’s newsletter. They announced $750M in Bitcoin loans to trading firms to stabilize the value of UST (via Twitter). Simultaneously, they issued a $750M UST loan to purchase BTC to further stabilize the algorithmic stablecoin by adding to the BTC collateral so that its value could now be maintained by an additional cash equivalent (via Twitter). As a result, the coin initially rallied back to within a cent of its $1 peg, but this did not last.
Several large withdrawals of approximately $2.8B UST from Terra’s Anchor Protocol, which were then liquidated into other stablecoins and cryptocurrencies, triggered a de-pegging event on May 9th where the value of UST slid to approximately $0.69 (via Fortune, WSJ, CoinMarketCap). Investors then began to flee the UST/LUNA, as well as the broader crypto ecosystem, in classic “bank run” fashion, mirroring the depression almost 100 years ago (via Forkast). May 9th alone saw nearly $800M of cryptocurrency liquidated following the UST + LUNA cratering (via Forkast). May 10th similarly saw massive LUNA and UST volume where UST was likely being converted to LUNA early in the day, which deceased LUNAs value, but ultimately, too many LUNA holders simply exited their positions by converting them to some other asset (via CoinMarketCap, CoinMarketCap).
May 11th featured a UST dead cat bounce as some investors re-entered their positions, believing the worst was over and there was an opportunity to claim some alpha. Instead, UST continued to slide further to the less than $0.20 range. LUNA’s fall from grace was much more dramatic as it collapsed from approximately $61 on May 9th to several hundredths of a cent at the time of this writing (via CoinMarketCap).
Now to the interesting part: some have speculated that the events surrounding UST were a concerted effort to profit from a BTC short position by causing UST to crash (via Twitter). The idea comes from LFG announcing on March 22nd that they would begin buying BTC to create a rainy-day fund for the Terra protocols (via Twitter). It then followed up with an announcement that Terra would be creating a stablecoin “4pool” on Curve and ended up withdrawing capital on May 8th (via Terra, Twitter). This gave a “capital efficient” way for the attack to be carried out as the attacker amassed a $1B UST position while waiting for the 4pool UST withdrawal (via Twitter).
The two contributions totaling $250M UST were taken out within a few hours and combined with a $350M selloff of UST; this caused the first shift in UST down to the value we discussed last week, and as desired, LFG sells BTC in order to maintain the peg and drives BTC value down (via Twitter). Several hours later, an additional $650M of UST was offloaded (via Twitter). This triggered the massive withdrawals from Anchor that created the downward spiral of the whole ecosystem (via Twitter).
Rumors are speculating about the identity of the attacker. Some have speculated that Citadel or Black Rock orchestrated the play, but these claims are unsubstantiated (via Fortune). If so, though, this would represent a systematic dismantling of a platform that caused crypto markets to hemorrhage for a highly profit—a clear example of market manipulation.
Terra paused operations of their chain and are evaluating future steps. We’ll learn more as the facts emerge, but remember, crypto is risky and is very much a dark forest. Invest wisely.
First Sip
In a downturn like the one we are currently experiencing, we would like to highlight a strategy that mitigates your exposure to extreme volatility in the long term.
DOLLAR-COST AVERAGING INVESTING
Dollar-cost averaging (DCA) is the process of dividing up your total investment into small increments and then investing them in the market regularly over a predetermined time frame (via NextAdvisor).
Say for instance, you want to invest $10K into Bitcoin for an entire year but are unsure of the best time to buy-in and/or you want to minimize risk. Instead of pulling your hair out and checking the price of Bitcoin every day, internally debating the best price point to enter, you could instead invest $192.3 dollars once a week for the whole year ($192.3 x 52 weeks = $10K). With DCA, you can set up any amount of capital over any time frame; however, the amount of money must be divided up equally to ensure you are investing in the same amount, at the same time point, for the entire predetermined duration. If you choose to DCA, set a schedule that you can follow and then follow it.
There are two main reasons for DCA instead of trying to time the market: it lessens the risk + takes some of the emotions out of investing.
If you DCA, you eliminate the risk of potentially spending all your capital on a cryptocurrency at a peak price point. Per Investopedia: “For example, suppose that as part of a DCA plan you invest $1,000 each month for four months. If the prices at each month's end were $45, $35, $35, $40, your average cost would be $38.75. If you had invested the whole amount at the start of the investment, your cost would have been $45 per share.” Crypto is already inherently risky; you cannot have great returns without its extreme volatility. DCA, like its name suggests, averages out that volatility.
On the emotions front, simply investing a predetermined amount at a predetermined time point minimizes erratic selling/buying. Think of yourself as a robot while using DCA, you buy at x time y amount, zero emotion.
In the end, DCA is known as being a great method for beginners as you can allocate a preferred amount of your portfolio to a crypto or two that you believe in long term without trying to become a technical analysis wizard.
Yes, someone who times the market perfectly will make more money than someone who uses DCA. However, DCA may allow someone to manage their money in a way that helps them sleep at night. Do your own research and implement the best strategy that works for you.
Meme of the Week (via Reddit)
“If you are in crypto for the lambos, you must also be ready for the Ramen”
Keep your head up. Together we will rise.
Pat + Ari ✌️
Disclaimer: None of this is investment advice, financial advice, or trading advice. CRYPTOPONG does not endorse any of the cryptocurrencies, DeFi applications, or NFT collections mentioned in this article. Perform your own due diligence and/or consult a financial advisor before investing.