Today we talk to Dan Ashmore a Data Analyst at Invezz, combining quantitative skills and a macro background to compile analysis on a range of financial topics. He previously worked as an
investment analyst in the alternative investment arena of aviation finance in Ireland, as well as a sports arbitrage trader, where he predominantly exploited pricing inefficiencies of sportsbooks to
generate arbitrage trades. We sit down with Dan to talk about the Terra/Luna collapse to see how something like this can happen and if he thought it was an inside job…Hope you enjoy it.
Dan Ashmore Data Analysts at Invezz
Please, can you explain in full detail the causes of the UST collapse?
The conventional stablecoin is fully collateralized, which is intuitively simple – each unit is backed by $1 of fiat currency and the peg is hence stable. In the case of UST, however, the peg was maintained via an experimental mechanism of algorithmic arbitrage via the Luna token. You can look at it as being collateralized by Luna, but Luna itself was uncollateralized, which meant UST was uncollateralized.
Increased selling of UST amid the market pulldown was too much for the algorithmic peg to sustain – i.e. Luna could not absorb this amount of selling pressure – with the peg starting to dip to 99 cents, then 98 cents, then 97 cents. This caused more panic which led to more selling, and ultimately a total lack of confidence, causing yet more selling and yet more panic. Now you’ve got a vicious circle of panic and selling of an uncollateralized asset. In other words, a run on the bank.
That’s a high-level summary, if you want an in-depth breakdown from start to finish, this article explains the entire debacle.
Related: Will Terra Luna Rebound?
Does any evidence exist to prove that this attack was coordinated?
Lots of theories are circulating. The most compelling evidence for this is the fact the collapse occurred at a point when UST liquidity in the Curve pool was temporarily low, at $350 million (normally $3 billion) which would reduce the capital required to launch an attack substantially – i.e. a seller could have cleared it with a $350 million sell order and sparked the first bit of panic, which may have been all that was required.
My gut feel is that this may have been coordinated, but that’s just speculation really as nothing has been proven; I did my best to jump on-chain and find proof but no luck. I don’t want to venture too far into the world of conspiracy theories! Ultimately it doesn’t matter, to be honest – whether the run was instigated via an attack or organically, there was a vital flaw in the ecosystem that left it exposed to such an event.
What could have been done differently by the project team?
I could write a novel on this! But I’ll give a few big errors. The first was the very core of the concept – an uncollateralized stablecoin is by definition asking for trouble; you’re always going to be open to such an attack. Terra did try to collateralize it a bit, but they used Bitcoin to do so – the second grave mistake. Bitcoin is a very volatile asset and one that is also correlated to the very thing it’s meant to be collateralizing – another cryptocurrency.
A run on the bank, if it was to take place, was always going to happen on a very red day for the entire market; the correlation in the crypto markets is extremely high. Choosing bitcoin as a backup plan to assuage a selling attack was thus a fatal error – their collateral was melting in front of their eyes as they were trying to sell it, while the market was simultaneously dumping Bitcoin more, as it knew Terra was bound to sell it, leading to a vicious circle.
What are your thoughts on the recent mass delisting of Terra network blockchain tokens?
A lot of investors were getting duped, for example buying Luna without understanding the hyperinflation was essentially driving it down towards zero. Then again, in a free market, one should be free to buy and sell as one wishes. I probably would not have delisted the tokens, were I the CEO of an exchange.
What steps can be taken by project developers to prevent such scenarios?
The concept here was very flawed. I think that’s the main lesson really. If you’re looking for something to extrapolate to other projects, I think Do Kwon and the Terra community’s inability to constructively address criticism and doubts about the project presents a very poignant lesson.
Jump on to Do Kwon’s Twitter and search the keywords “idiot” or “poor” to see what I mean – he wasn’t exactly respectful with those who asked questions about the Terra model.
What is the effect of the UST collapse on the cryptocurrency markets?
Terra was a top 10 holder of Bitcoin, which was swiftly dumped in a last-ditch attempt to defend UST. This contributed to Bitcoin falling from $40K to $30K during that 48-hour period.
Luna was $42 billion at its peak; UST was $18 billion. That is a lot of wealth to disappear, and the selling pressure was definitely intensified as a result across the market, as there were contagion effects. Ultimately though, I think the main reason crypto is struggling at the moment are the macro headwinds – Fed hiking, inflation, the Russian war, etc. Look no further than the stock market, which is off to its worst start to a year since pre-WWII. If Terra never existed, crypto would still be heavily down right now.
How has the UST situation affected regulatory processes instituted by governments around the world?
Not yet, but I would expect that to come. You can’t have ordinary people losing that amount of money (especially those treating UST and Anchor as savings account) without turning the heads of regulators. It’s their job to try to draft a legal framework to prevent these things, really.
Related: Why did Terra Luna Collapse?
What are your thoughts on the recent tanking of cryptocurrency token prices?
As I said above, it’s mainly due to the microclimate, which is incredibly bearish. These are high beta assets that were always going to sell off once sentiment turns – we have seen altcoins dropping 99% in previous markets, and we will see it again.
The reality is a lot of tokens in the space are worthless. Once the tide turns (which it appears to have done already), everybody wants out. Correlations go to 1 in a crisis.
How can the average Joe/Jane make the best rational decisions when it comes to investing in cryptocurrencies?
Nothing fancy, but it comes down to portfolio allocation, diversification, and risk tolerance.
For example, don’t ape into Bitcoin if you plan on putting a down payment on a house next month. Don’t buy a load of Ethereum if you already have a big bag of Solana, as they’re highly correlated. Always make decisions based on the context of your overall portfolio.
Additionally, block out the noise such as Twitter screenshots of 100Xs, paid promoters, and all the rest of the frothy hysteria – it’s rarely as it appears on the Internet, and anybody with a smartphone can tweet. Finally, the market is cyclical and humbles you, don’t forget how brutal bear markets can be so prepare yourself accordingly.
What measures can cryptocurrency developers take to mitigate the volatility risks associated with cryptocurrency tokens?
I don’t think that’s a job for developers, really. Eventually, a decoupling may occur and the ultra-high correlation and extreme volatility may come down, but we are a long way off that right now. Any altcoin will remain highly volatile for the foreseeable.
What do you think the fallout will be for cryptocurrency token crashes?
A lot of coins will go to zero, as we have seen in previous down cycles. The memes and non-utility projects will be among those struggling. The solid projects will survive, but will take a serious beating (as we are already seeing).
What do you think the effect of cryptocurrency crashes will be on adoption rates?
I think it’s the other way round. These crashes and intense volatility will only stop when adoption increases and the size of the market becomes substantially bigger.
Do you think there is a future for uncollateralized stablecoins?
No. These things run on trust. Terra collapsing in such a high-profile manner makes it unlikely that another one will succeed. You can’t put the genie back in the bottle.
What would your answer be to industry critics who think stablecoins are just a fad?
Uncollaterised stablecoins are done, in my opinion. Collateralized stablecoins, however, are far from a fad. They’re vital for a host of reasons – onboarding from fiat to crypto, DeFi will run through them, a way to hold crypto and enjoy the benefits while not taking price risk, etc, etc. The list is endless.
Anyone who thinks stables are a fad is really saying crypto as a whole is a fad. And I believe the world has shown by now that it needs an alternative to the trad-fi system.
What is your favorite investment strategy for your personal crypto portfolio?
Keep my portfolio allocation to a level I’m comfortable with and maintain diversification. I don’t drive myself mad by trying to predict the market – I hold projects long-term that I believe in (which are very few). All the silliness on the side can be fun to play around with – NFTs, memes, etc, but you’re playing with fire in my eyes if you hinge your financial future on it.
I hold other investments too and that factors into my treatment of crypto – every decision you make should be based on your overall portfolio return, risk and goals.
What advice can you give to first-timers in the cryptocurrency space?
Stick to Bitcoin to start. Take time to study and understand it. Avoid random altcoins because most are worthless.
Follow smart people, and block out anonymous accounts who have ulterior motives, such as clout-chasing, paid promotions, or flexing. It’s difficult to make money – maybe there used to be a day where one could buy any crypto and wait for a 10X, but that day is gone.
Be careful and ensure you understand what you’re purchasing, as well as the risks involved before you do. Only invest what you can afford to lose.
How will incoming regulations affect the growth of the cryptocurrency space and the development of projects?
I think regulation is necessary and inevitable. Laws will catch up with the technology and growth in space, and hopefully, we will reach a nice equilibrium. There may be bumps along the way, but I’m not too worried about regulation as a whole.
What role can cryptocurrency insurance play in risk minimization?
That would depend on the insurance.
For example, you could have insured Luna’s holdings by opening relatively cheap short bets on UST. You’d sacrifice the interest rate on borrowings (the short won’t lose money as UST will never go above $1), but in the case of the recent meltdown, your Luna losses would have been offset by the gains on the UST short as UST went to zero.
Like any insurance, if used wisely it can minimize risk. Of course that comes with the trade-off of sacrificing return, so it would need to be analyzed on a case-by-case basis.
How far do you think project developers should go in ensuring codebase stability?
As far as is necessary. Sounds like a curt answer, but that’s sort of the point. Codebase stability is vital. A house can’t be built on shaky foundations, so do whatever is necessary to ensure it’s solid.
Do you have any takes on what the summer holds for the cryptocurrency space?
I think the macroclimate is so brutal that there could be further pain ahead. The Fed will need to continue hiking; it’s necessary for demand to contract to rein in inflation. Crypto is high beta and likely won’t fare well in a sustained downturn (as we are already seeing).
Then again, what do I know? I don’t have a crystal ball. Let’s hope I’m wrong and Bitcoin has flipped the US dollar by the time this publishes:)