The dark side of the moon

Under the spell of the moon

(La Luna, Belinda Carlisle, 1991)

Last week, doomsday news shifted its focus from Ukrainian battle-fronts to the financial metaverse. Instead of headlines of crimes allegedly committed on civilians, headlines were dominated by an atrocity of another kind: the US$1 trillion ($1.39 trillion) wipeout of crypto assets after the collapse of Terra Luna.

Wait, Terra what? Some have barely grasped that Bitcoin is not the smaller and smaller change that you get after paying the rising price of kopiO in the coffeeshop. And isn’t the Bored Ape a close relative of the primates in the Mandai Zoo? Why are they instead highly-priced NFTs (non-fungible tokens) in the metaverse (a little less after last week’s debacle)? What is this alien universe anyway?

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In this “alien” universe, “staking” isn’t about driving something into the heart of a vampire. Rather, it means locking up crypto holdings in order to obtain rewards or earn interest. Instead of planting crops of food, yield farmers use decentralised exchanges to lend, borrow or stake coins to earn interest and speculate on price swings.

If one didn’t understand anything about the preceding three paragraphs, it is probably a good thing as well, for you’ve probably avoided being hit amid the US$1 trillion crypto meltdown. Unfortunately, with the eclipse of this obscure Terra Luna, there were the inevitable spillovers into traditional financial assets and the economy.

Folks who had been promised 20% yields were hurt. On May 12, I came across friends who took a punt on Terra after it fell 99% from the peak of US$120 last month to just over US$1. Yet, they promptly lost 99% of it when Terra collapsed to close to zero. Even those who bought its sister coin, Luna, at a “cheap” three cents saw their money wiped out in a couple of days. They used to say a week is a very long time in politics. In the darkest corners of the metaverse, it is a lifetime of savings lost for some, without them even knowing why.

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The sideswipe to mainstream crypto coins like Bitcoin and Ethereum saw seesaw moves of more than 30%. The more obscure the asset is, the higher is the volatility. Among high net-worth individuals (HNWIs) and millennials who spent their life minting and gaming, some have had to sell conventional assets, including stocks and bonds, to cover margin calls. The Nasdaq continued its annus horribilis, plummeting to new 2022 lows. Perhaps one positive for some of these HNWIs here is that the surging rents of GCBs (Good Class Bungalows) in Singapore may reach a temporary pause.

Fortunately, one of the largest stablecoins, Tether (aka USDT), held. It dipped 2%, but was able to still function and maintain its peg to the US dollar. If it had suffered the confidence loss the way Terra Luna did, or it was not able to sell assets to raise sufficient US-dollar cash for redemptions in time, the contagion might have been far more widespread and the consequences dire.

Given all that has transpired, I am surprised that there is still argument against some amount of sensible regulation that is required to ensure that innovation as an end in itself does not result in financial Armageddon and a return to the Stone Age.

Mooncakes and Moonies

Few know this, but the fact is Terraform Labs, which is behind TerraUSD or UST, is incorporated in Singapore and run by South Korean Do Kwon, who is rumoured to be based here. Apparently his wife had to call for police protection when unknown folks came to her apartment in Seoul looking for him. Putting aside this gossipy titbit, let’s first figure out how Luna’s eclipse came about and what we can learn from it.

First, “stablecoins” are pegged to a currency like the US dollar. Being less volatile than other cryptos in theory, they are used as a means of exchange for cross-chain transactions. To the decentralised finance world, the fact that they are generally not regulated (versus central-bank digital currencies which are being developed by the US Federal Reserve, the People’s Bank of China and the Monetary Authority of Singapore) had always been a plus-point.

TerraUSD is even better, in this sense. An algorithmically designed stablecoin, it maintains its US-dollar peg using a complex mechanism with Luna. Both were created by Terraform Labs. To maintain the price of Terra, the Luna supply pool adds and subtracts from Terra’s supply. Users then burn (sell) Luna to mint Terra and may burn Terra to mint Luna. Theoretically, within the developer’s algorithm, there is no human intervention. Perfect right?

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However, what happened was the fine balancing act between both of these keeping parity of sorts broke down. Investors hold Terra because of the “anchor protocol”, which is kind of like your bank account, except that you are promised 20% interest to stake your Terra there — a lot more than banks would sensibly pay for.

A rumour that started over the first weekend of May that Terra was changing its 20% fixed rate to a floating one and observed large transactions of TerraUSD being withdrawn caused a liquidity flight.

Holders started exchanging Terra for other stablecoins, with the bulk swapping for Luna. With the supply of Luna spiking, its price fell. As confidence evaporated, the exchange mechanism and algorithm crashed, and the Terra blockchain was halted.

In the process, according to a Bloomberg report on May 15, the Luna Foundation Guard (LFG), set up by developers, bought US$3.5 billion worth of Bitcoin to use to buy Tera and maintain the peg. The problem was that Bitcoin also crashed to US$24,500 from US$33,000, and there are now allegations that Bitcoin was transferred out from LFG wallets via Gemini (another crypto exchange).

Aside from cries of Ponzi, police reports have been filed in Singapore against Do Kwon, according to Reddit, on behalf of UST and Luna investors. Unfortunately for the Moonie-like believers — 1,000 Singaporean investors who were said to be affected — they are unlikely to get their money back to buy mooncakes for the Mid-Autumn Festival.

Cry wolf

In the heat of the Luna eclipse, rumours spread about BlackRock and Citadel jointly borrowing 100,000 Bitcoins (worth US$3 billion) from crypto exchange Gemini to purchase UST and dump it. This is akin to the “short-sellers profiting” allegation each time a market in a conventional asset of stock collapses. BlackRock and Citadel issued statements denying that they were even trading UST, and Gemini denied lending this amount of Bitcoin to any large institutional counter-parties.

One message that was re-tweeted and further embellished was “this was pure market manipulation”. Another Reddit comment went, “I’m vested in crypto year, this is silly. When times are good the cult-like crypto fanbois smugly dump on fiat and brag how good decentralised and unregulated currency is. Now they are crying for help. Lmao.”

When Elon Musk tweets and Dogecoin (which started as a joke) soars, it’s good. It’s the decentralised bros against the boomers who want regulated control. No one complains when assets with no intrinsic value melt up to the stratosphere, so long as they are on the right side of the trade. But on the way down, we see cries for protection.

Ah, la luna, la luna

The light that will bring me back to you

US Treasury Secretary Janet Yellen pointed out that there are risks of financial instability and a need for a regulatory framework on stablecoins after the de-pegging of TerraUSD. And the Fed last week warned that stablecoins are vulnerable to runs. Really? As we postulated in this column last year, not all stablecoins are stable. While TerraUSD offered staking yields of 20% — quite a bit more modest than the 60% offered by Ng Yu Zhi’s nickel Ponzi scam in Singapore last year — one only has to ask the question of how such returns are generated. And if one doesn’t understand an investment proposition, it’s always better to stay aside than be carried away with FOMO (fear of missing out).

Where does that leave Luna and the fanatics? Unlike overly excited Enron shareholders some 20 years ago, they don’t even have a piece of paper scrip to put on the wall to remind them of their folly. Well, there is always hope and prayer. There are proposals going through the community titled Terra Ecosystem Revival Plan, which among other things would distribute one billion new Luna tokens to UST and Luna holders. Given most exchanges have pulled the once-fourth largest cryptocurrency in the world from trading — and it’s now trading close to zero — how that will be distributed is anyone’s guess.

Will the revival take the form of other meme coins issued at 16 decimal points so that they draw speculators back as they inflate by 1,000s of per cent by moving to one decimal point in price, and a new tribe of believers get converted? It might. Or it might not. But with the correction in conventional asset prices on the local stock market with global risk off and investors selling in May, I am shopping again.

Chew Sutat retired from Singapore Exchange after 14 years as a member of its executive management team. During his watch, the exchange transformed from an Asian gateway into a global multi-asset exchange and he was awarded FOW’s lifetime achievement award