You can make a lot of money by investing in crypto… but if you’re not smart about it, you can lose nearly everything in the blink of an eye.
Just ask the people who were heavily invested in the TerraLuna ecosystem. In a matter of hours, the value of their assets plummeted about 99%. In all, about $68 billion worth of investor value was vaporized.
That carnage encompassed the TerraUSD (UST) stablecoin, the LUNA token that was supposed to maintain UST’s peg to the dollar, and Anchor, a savings protocol on the Terra blockchain that promised an interest rate of 20%. In addition, the future of dozens of Terra-based crypto projects is now in doubt.
We’ll talk about what happened, because a lot of regular investors haven’t heard the full story – and they need to.
A Worst-Case Scenario for Terra Investors
On May 7, someone took $2 billion worth of UST out of the Anchor protocol and sold it. The sale broke UST’s peg to the U.S. dollar, driving it down to $0.91. The LUNA mechanism for maintaining the peg was overwhelmed.
Nervous traders started dumping UST, causing the peg to slip below $0.50. The stabilizing mechanism involved minting more LUNA to restore the peg. But the panic selling of UST caused the mechanism to go into overdrive.
LUNA minting increased exponentially, with total supply ballooning from 343 million to 6.53 trillion in just six days. The runaway inflation caused the price of LUNA tokens to plummet from $60 to a tiny fraction of a penny ($0.00013 as of this writing). The UST peg kept dropping, falling below $0.20 – making it useless as a stablecoin.
The implosion of the Terra ecosystem sent shock waves throughout the crypto markets. Bitcoin fell 21% over several days of turmoil as the Terra team tried in vain to prop up UST and LUNA by selling approximately 80,000 BTC held in reserve. Yes, 80,000 BTC, the equivalent of $3 billion.
That damage to the crypto markets spread the pain to just about every crypto investor.
But it was the “lunatics,” as TerraLuna enthusiasts call themselves, that got completely blown up. Some had invested everything they had in the Terra ecosystem. Or worse, they were highly leveraged.
The impact was devastating. Reports of suicides and attempted suicides started popping up on the TerraLuna subreddit. A list of suicide hotline numbers was pinned to the top of the page.
David Z. Morris of CoinDesk estimates that 1.7 million “lunatics” had their holdings wiped out, with the average investment being about $20,000.
I feel bad for all those who got caught up in this disaster. But the sad truth is that the worst outcomes were avoidable. People should not have lost everything.
All crypto investors can learn from this tragedy. It’s all too easy to fall into the traps that can lead to huge losses.
Today I’m going to share with you some rules every crypto investor should follow. Many are clichés, but the Terra disaster suggests an urgent need for a reminder.
7 Lessons from the TerraLuna Disaster
Here are the main takeaways.
- Not all stablecoins are created equalWhile all stablecoins attempt to maintain a peg to a fiat currency like the U.S. dollar, they don’t all do it the same way. For instance, when fully collateralized stablecoins like USDC and Tether create new units to meet demand, they acquire an equal amount of fiat currency to back it up. UST was an “algorithmic” stablecoin, which means that instead of collateral it relied on its relationship to LUNA to maintain its peg. Units of LUNA were either minted or burned to keep the peg stable at $1. But as I pointed out in April, extreme market activity to cause algorithmic stablecoins can lose their pegs and fail. That makes algorithmic stablecoins the riskiest type of stablecoin – something I’m not sure many of its investors realized.
- Don’t fall in love One of the things you learn as an investor in the stock market is to avoid falling in love with any one investment. That can lead to taking a dangerously large position and prevent an investor from selling when it would be prudent to do so. This phenomenon is worse in crypto, fed by online communities that focus only on the positive aspects of a project while hyping up huge potential price gains. Any critics get denounced and attacked. It’s common to see crypto investors “join a team” and root for one particular crypto over all others. But as we saw with TerraLuna, this emotional attachment blinds people to potential problems and often leads to people pouring way too much money into their favorite crypto.
- Pride comes before a fall Any time an investor has some success they tend to overestimate their true abilities. In crypto, it’s easy to confuse luck with ability. But that overconfidence encourages investors to ignore risk. In TerraLuna’s case, that includes several big players who thought they were too clever to get burned. That includes boutique investing firm Delphi Digital, which lost $10 million, and South Korean venture fund Hashed, which is estimated to have lost $3.5 billion. Then there’s Galaxy Digital CEO Mike Novogratz, who in January tweeted a picture of himself with a fresh Luna-themed tattoo. Galaxy is thought to have lost $300 million to the TerraLuna collapse. But the person with the reddest face is TerraForm Labs founder Do Kwon, who had a reputation for ridiculing TerraLuna critics as being “poor.” Kwon is now desperately trying to salvage his platform while fending off a growing number of lawsuits.
- No crypto is 100% safe – even popular onesMost crypto veterans know to avoid obscure cryptocurrencies because they’re much more likely to fail than a top-ranked crypto. But TerraLuna was well-regarded by many (though it did have its share of vocal critics). As noted above, several prominent investors had sunk millions into the project. As late as May 1, LUNA was ranked 8th on Coin Market Cap, while UST was ranked 10th. And yet the project collapsed spectacularly. While crypto can deliver huge gains, it is indisputably risky – even Bitcoin. This needs to factor into every crypto investing decision you make.
- If it sounds too good to be true, it probably is One of the biggest attractions in the Terra ecosystem was the Anchor protocol’s promised 20% returns on UST deposits. In a world where decent yields are tough to come by, a 20% return looks temptingly juicy. But it was unsustainably high, as many critics pointed out. And Anchor proved to be the weak spot that led to the implosion of the whole TerraLuna ecosystem. This is another axiom that everyone knows, but often gets ignored when greed overwhelms common sense.
- Don’t put all your eggs in one basketThis one seems like such common sense you’d think no one would be foolish enough to do it. But many investors put most, if not all, of their money into LUNA or TerraLuna projects. Some put their life savings into it. And they’ve lost everything. No matter how much you believe in something, you should never go “all-in” on any one investment. It’s often the path to ruin.
- Don’t invest more than you can afford to loseI’ve repeated this chestnut more times than I can remember in stories I’ve written about crypto. I’ve always advised people to limit their crypto investing to 5% or less of their total investable capital. But when prices are rising people start thinking they need to put more and more money in to maximize their gains. Some go even further and use leverage – borrowing money to invest in crypto. All these folks are doing is maximizing their risk. When crypto crashes, such people get crushed. Invest responsibly. Keep your exposure to crypto at a level where a crash won’t wipe you out.
So, What Happens Now?
The question now is what happens to TerraLuna and all the investors who suffered heavy losses?
CEO Do Kwon is seeking to reconstitute TerraLuna at least, if not UST. He has proposed forking the existing blockchain to create a new Terra, designating the old, dead blockchain as Terra Classic. People who previously held LUNA, UST, and UST on Anchor would receive an airdrop of the new token.
How much would depend on what you owned previously and whether you scooped up tokens on the cheap after the crash. The formula is skewed to favor small token holders who owned before the crash.
Because the airdrop will be in new LUNA tokens, there’s no way to determine how much wealth investors would recover. I’m personally skeptical that the market will have much of an appetite for a crypto that had such a colossal meltdown.
Do Kwon says his plan to revive TerraLuna is akin to when Ethereum forked after the disastrous DAO in 2016.
But I’m inclined to see it more as a Lehman Bros. situation. Much trust has been lost in the TerraLuna’s project.
While I’m sure those who lost money are rooting for a revival, it’s unclear if developers who had built on the Terra platform will stick around. Both Binance and Polygon have already offered to help Terra developers migrate their projects to their respective platforms.
Then there’s Kwon himself.
In addition to a wave of lawsuits, there’s now evidence Kwon liquidated the Terraform Labs Korea Corporation just days before the crypto collapsed. Terraform Lab’s legal team resigned.
In my view – given all these obstacles – the odds are stacked against a successful revival of TerraLuna.
Follow me on Twitter @DavidGZeiler.