The Aftermath of Terra
The lessons from the UST Mania
In this post, we will talk about:
The UST Mania and Crash
Lessons from Terra and Luna
We have seen the biggest unwinding in all of crypto history in the past few days. Terra, which had nearly $29 billion in TVL at its peak, has given up almost all of its value. The native stablecoin UST continues to struggle in maintaining the peg to the dollar. The governance token Luna, which was trading at ~$130 just a few months ago, is trading near zero.
That’s right - zero.
The death of UST has major implications. The story was front-page news in the Wall Street Journal. The day after the de-pegging, Treasury Secretary Janet Yellen was in front of the House Financial Services Committee talking about the risk of stablecoins. When something in crypto leaves Telegram group chats and lands in the ears of politicians, you know something is wrong.
While we can make some guesses, the reality is that the exact aftermath of the UST bust is still unknown. Like any other successful ecosystem, Terra’s strength came from its composability. If you were a developer with an interesting idea, you could easily spin up a protocol on Terra and take advantage of their already-built user base.
This same composability became a weakness when things went south. The contagion from Terra quickly spread across multiple protocols, wiping out billions in value. Every protocol token felt the pain, and investors got to see an entire ecosystem being wiped out in front of their eyes.
If you remember from a previous post, the Anchor Protocol, in particular, was the Terra ecosystem’s demand engine. Known for paying out an absurdly high APR of ~20%, Anchor incentivized users to lock up their UST. At its peak, nearly 70% of all UST was locked up on Anchor.
When things were good, users celebrated Anchor for holding together the ecosystem. As soon as things turned bad, this same protocol became the culprit behind massive wealth destruction. If you locked your UST on Anchor, all you could do was sit and watch as your hard-earned money evaporated in front of your eyes.
The Lessons From Terra and Luna
Investing is a fascinating business that never fails to humble you. When Isaac Newton lost a fortune from the South Sea Stock Bubble of 1700, he famously said:
“I can calculate the motion of heavenly bodies, but not the madness of people.”
The reality is that there is no magic formula for investing - things are only obvious in the rearview mirror. In my experience, the best way to learn is to simply keep reflecting on your decisions until you have built a refined process.
So, when Terra collapsed, I went back to the drawing board to see what went wrong and what I had missed. Here are 6 of my takeaways:
A protocol’s biggest strengths can become weaknesses during downturns - composability and yield generation were two of the biggest demand drivers for UST. When the death spiral began, these were the same things that caused the ecosystem to collapse.
Decentralization has just as many disadvantages as advantages - At the core of crypto’s thesis is the ability to skip through intermediaries. Terra allowed anyone to become their own bank and mint their own stablecoins. However, this decentralized nature of Terra restricted their ability and efficiency in implementing solutions quickly. In the traditional finance system where things are centralized, you can count on institutions to come in and prevent bank runs. Individuals can rely on central authorities to protect their interests. In a decentralized world, none of these exist.
Stablecoin collateralization is critical - According to Gresham’s Law, the least collateralized currency tends to become the most circulated within an economy. However, Terra and every other stablecoin are way too early in the lifecycle. Proper collateralization is critical to making crypto successful.
Size does not ensure resiliency - Many people thought that UST was “too big to fail”. That phrase might be applicable in the traditional finance world, but it doesn’t apply to crypto today. In fact, Terra had de-pegged multiple times in the past. The system grew without adding resiliency. This time, Terra was actually too big to recover.
Integration without control is a disaster - Prior to February 2022, all UST redemptions happened on the Terra network itself. Once UST became integrated into Ethereum and CEXs, Terra’s parent company lost the ability to control the circulation of its token. This prevented the team from being able to act quickly.
Complicated does not mean good - Algorithmic stablecoins are incredibly complex. Starting from minting mechanisms to providing incentives to arbitragers, it requires a lot of talented people to combine their efforts. However, complicated does not mean good. In fact, I would argue one of the reasons why Bitcoin has stood the test of time is because it is simple to understand - it doesn’t try to be or do everything.
When I started writing this newsletter, I knew that most of the projects we talk about today will probably not exist in 20 years. I still went through with the idea because I wanted Uncommon Cents to be a history book of all the effort and innovation that went into building web3. Terra may not exist in the future, but the memories and lessons from Terra will continue to be relevant for many years to come.
As for myself, I was optimistic about the future of Terra. It had a daring mission, an evolving ecosystem, and many passionate supporters. I could not have possibly foreseen UST collapsing so soon and so fast. I think the most important lesson here is to not let one token paint your perception of the entire industry. Crypto will come back. For now, let’s continue to invest, build, learn, and educate others on why web3 is important. That is our way out.