LUNA – A Wake Up Call

by | Jun 7, 2022 | Cryptocurrency

The past few weeks in the cryptosphere have been turbulent to say the least. For those that don’t know about the LUNA debacle, here is a quick run through of what exactly happened.

To understand this properly, we first need to understand how the Terra eco-system worked in relation to it’s so-called stablecoin UST and LUNA.

UST is an algorithmic stablecoin operated via computer code that helps maintain its price equilibrium. The process involves burning or minting LUNA and UST to maintain the price of the two tokens.

When a single UST was minted, $1 of Luna was burned and vice-versa. As UST threatened to go below its peg, holders will sell their UST (or burn it) for $1 of Luna, making a slight profit. This is until UST rises above $1, when the opposite encouragement happens. Simple huh? I mean what could possibly go wrong!

The code went wrong, that’s’ what. It did not cope with the environment it created in trader psychology.

Problems began on the 7th May, where we saw the beginnings of a sell-off in the greater cryptocurrency space, UST for the first time since its inception began to show signs of trouble and drop below $0.99.

In response, a large number of LUNA were minted to try to re-peg UST to the dollar. This in turn devalued LUNAs value as the circulating supply jumped excessively.

Traders began to panic, and began dumping LUNA, as well as UST and both assets rapidly fell into the burning depths of crypto hell, also known as near-zero.

LUNA prior to the UST collapse had roughly around 345 million tokens circulating, this number has increased to over 6 trillion.

Since the fall out, Do Kwon, Terra’s founder has proposed and implemented several actions to try and recover LUNA, but failed, miserably. Currently a vote is taking place to decide on whether the chain should fork into a new chain, renaming he original LUNA chain as LUNA classic and the new one LUNA Core.

The details of this proposal are not important, the other various attempts and their details are also, not important, what is important is the lessons learnt in this crypto catastrophe.

 

The Stable-Coin Unicorn

Repeat after me ‘There is no such thing as a Stablecoin, there is no such thing as a stablecoin, there is no such thing as a stablecoin, there is no such……’

To believe otherwise could be your downfall. This is not to say I am opposed to so-called stablecoins, they are a useful trading tool in the cryptospace, but they should never be treated as a safe-haven hedge against the collapse of crypto. They should be treated as a high risk trading tool to assist in short timeframe trades.

Whichever way you tackle an attempt to create a stablecoin, there are vulnerabilities you have to take on. LUNA tried to solve the centralization issue behind the issuance of Tether(USDT), however, their solution was their vulnerability. Tether simply burns and mints USDT based on its current pegged price to the dollar managed by a central point ensuring a relatively stable pegging, UST was reliant on another asset, LUNA and an automonous algorithm.

While Tether has a whole different set of problems, its ability to hold its peg to the dollar is far simpler, there are fewer variables and it has a centralised point of control to determine the minting and burning requirements of tokens, i.e Human Intervention.

Tether isn’t without its own vulnerabilities though, the biggest being the fact that we don’t really know what a USDT token is backed by. If there was an attempt to turn just half of the USDT into USD in a short time frame, tether would likely be unable to fulfil the request. This vulnerability is the price you pay for having a stablecoin that is more likely to remain stable. Tether have used the same formula as fractional reserve banking, they assume that there will be no more than around 10% of token holders wanting to redeem their tokens for dollars at any given time. But, just as when a nation goes on a bank run over fear of economic conditions and can cause banks to collapse and the cash to run dry, traders could lose confidence in the token and begin redeeming their USDT for USD only to find Tether can’t pay out. At which point USDT would begin to devalue pretty rapidly.

The very term stable-coin, contradicts how it works. A bitcoin is far more stable than UST or USDT could ever be, as a Bitcoin will always be worth a Bitcoin.

 

LUNA’s Centralization Exposed

I’ve seen few discuss this point yet, but for me, this has been the most important point everyone needs to learn from the LUNA incident.

When the unpegging of UST began to spiral out of control towards zero with LUNA following behind like a lost puppy, a decision was made within just a few hours to halt block production of both blockchains, and they did. Just like that, the ledger stopped, no more transactions were possible and the entire economy of LUNA and UST was halted.

Several hours later, block production began again. Now, tell me, does this sound like a decentralized autonomous system?

The very fact that this was possible at all should be a warning to Proof-of-Stake enthusiasts. While PoS consensus mechanisms can work, and they be decentralized better than LUNA’s setup, Proof-of-Work consensus is by far a more decentralized mechanism.

It took LUNAs 130 validators to stop block production, while it would take the consensus of the Worlds population to stop block production on the Bitcoin blockchain.

Proof-of-Work is the ultimate defense against centralization, I don’t care what ridiculous environmental arguments people spring up, or what ‘transaction throughput’ arguments people have, PoW is a far more superior consensus mechanism to PoS, or at least any PoS setup we’ve seen so far.

Though, those interested in this topic may want to look into Tezos’ Liquid Proof-of-Stake Mechanism (LPoS), it is far superior than any other PoS out there right now.

 

LUNA – Moving Forward

While I don’t believe LUNA can ever return to its former glory in the marketcap charts, they are still nevertheless pushing through new proposals in an attempt to revive the project. The current proposal is to Fork the original LUNA chain. The new chain will be the official LUNA chain, the old chain will become LUNA Classic (LUNC) – Sound familiar?

Once again, this is proving just how centralized the whole LUNA project is, one man and his dog has made the proposal, validators vote, proposal goes through if enough votes go in favour. It is democratic to a point, but not exactly a revolutionary move forward from the decrepit legacy financial systems we all despise so much.

The proposed new forked chain will be capped at 1 billion tokens, and there is a distribution laid out in an attempt to compensate token holders of LUNA and UST prior to the May 7th depegging.

The latest proposal details can be found here, but here is a quick run down on the token distribution for the new chain:

  • Pre-attack Luna holders distribution – for all holders with a snapshot balance of 10k Luna or less, 30% unlocked at genesis; 70% vested over 2 years thereafter with 6 month cliff. This is to ensure that small Luna holders have similar initial liquidity profiles. This would cover 99.81% of Luna wallets while only representing 6.45% of total Luna at the Pre-attack snapshot.
  • Post-attack UST holders distribution – 20% 15%. This is to ensure that depeg related allocation is on par with the original stakeholder (pre-attack Luna) allocation. The 5% saved goes to the community pool.

Of course, you cannot please all the people, all of the time. There are many who would like Terra to just commit to burning the excess LUNA tokens in the current chain and thus returning its supply to somewhere close to is original amount. But of course, this is not as simple as many people think. For one, most of these 6 trillion tokens now have an owner, with traders buying them up at fractions of a cent on exchanges. So, to burn the excess token supply would be to destroy the purchased asset of the thousands of traders who ‘bought the dip’ following the May 7th collapse.

 

The Blame Game

Following the May 7th LUNA apocalypse, Terra and Terra founders Do Kwon’s twitter has been bombarded with distraught, angry and in many cases suicidal tweets from LUNA and UST holders. They want answers, they want compensation, they want justice and they believe all of this is their god-given right – “it’s all Do Kwon’s fault”, “He scammed us!”, right? Wrong!

While it is true, the LUNA project was ultimately flawed, the algorithm failed at the cost of all its token holders, but if you are relying on that which you invest in to take full responsibility of any catastrophes that may occur down the road, then you shouldn’t be investing, particularly not in the crypospace. This is unregulated finance, or at least that’s what we want it to be, don’t jump into the wild west if you are not prepared to be gunned down.

I won’t share any of the hundreds of tweets screaming for justice, the suicide notes or the stories of how people sold there homes to invest, made a 100 million then lost it all because I refuse to assist in the further loss of these individuals dignity, but really, you invested everything? You made 100 million and lost it ALL?

Firstly, you don’t sell your home to invest it all in a single asset, and certainly not cryptocurrency and most double certainly not in something like LUNA. Secondly, if you made 100 million and didn’t take profits you have only yourself to blame. That isn’t trading or investing, that’s plain old stupidity.

I had absolutely zero invested in LUNA, not because I believed the project would die quite so catastrophically as it did, but because it was so clearly overvalued and largely un-battle tested. It was on my shopping list to buy, if a reasonable pull back occurred, but only 2 -5% of my crypto-portfolio, not the entirety of my wealth.

Those that lost everything only have themselves to blame, and the best advice I can give to these people is to learn the important lesson offered to you here. Start to rebuild anew. You will build back yourself and your wealth far stronger than it could have ever been before. And, remember this, the very fact that you lost everything because of your naivety and ignorance to educate yourself about what your invested in, and how best to manage profits would suggest, even if $100 million was dropped into your account prior to the collapse, you would have lost it all anyway.

Wealth in many ways can be compared to the power of magic described in fantasy novels, or the special powers given to superheros, used correctly it can be a power for good and prosperity, but when placed into the wrong hands it can corrupt and destroy everything you loved.

‘With great power, comes great responsibility’

But, I feel, I’m preaching to the choir, our readers I’m sure know all the above, after all, that is why you are here reading this instead of some spending your time in some pump and dump telegram group.

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