Disclosures
I am writing on behalf of people who are holders of both LUNA and UST, and have held both tokens for longer than 12 months.
I am friends with equity holders in Terraform Labs (who have invested in funding rounds totaling more than $100M), but they have neither read nor endorsed any of these views. I have mutual friendships with people who own and operate large crypto exchanges that make markets in LUNA and UST but do not have any direct business relationships with any of them. I do not have any relationship with TFL management or with the validator community. I have an ongoing relationship with other DeFi organizations, and I have an interest in developing my own blockchains and ecosystems.
Overview
As a participant in the DeFi and crypto market ecosystems, I see the current situation facing the people in the Terra community as existential for the industry as a whole â thus, after observing the ongoing absence of âadults in the room,â I have taken it upon myself to provide this community with as much informed insight as possible. Regardless of where we all fit into the crypto ecosystem, the consequences of what does or doesnât happen to the Terra project will affect us all, for years to come. A lot of you seem to be quite young or otherwise inexperienced with the world of distressed finance; it is clear, based on the posts on this forum, that the people in this community are woefully unaware of three major points:
- Terraform Labs, UST and LUNA are now distressed assets.
- As holders of distressed assets, you have specific rights.
What follows is meant to be âfood for thoughtâ to help all of you in understanding what to do with your rights, should you choose to exercise them. A lot of people â particularly Terraform Labs management â seem to want you to think that you donât have rights, which is understandable given the position in which they will find themselves if this community bands together and starts asserting itself; beyond my personal interest as an ecosystem participant, I also have some deeply painful experiences in which people worked to prevent me from understanding the rights I should have exercised, until it was too late, which gives me further incentive to ensure all of you donât make the same mistakes.
Remember, kids â the rights you donât use, often end up taken away from you! Just because this is a âdecentralized economyâ doesnât mean that the Monetary Authority of Singapore, or South Korea, or whatever, isnât going to do something about this fiasco. And, for all of us interested in the health of the ecosystem, itâs far better if this community is actively involved in that dialogue, and in crafting the final resolution, than if a bunch of regulators and politicians speak on your behalf to âprotect you.â Youâll end up with less money (if any), and the crypto ecosystem will end up in a worse position.
Consequences
Letâs lay out the situation for the key stakeholders, in terms of the economics of these assets. Based upon my understanding of how things work (yâall are the experts â feel free to correct me!), these are the key variables in our equation:
- Terraform Labs equity holders
- UST stablecoin holders
- LUNA governance token holders
- Validators
- Exchanges
- Terraform Labs management
Now that UST has de-pegged and LUNA has crashed, I consider the overall Terra ecosystem to be a distressed asset; I donât think anyone here would argue that everything is healthy and able to recover on its own (if you feel that way, then the rest of this post will be total nonsense to you). If we agree on this as a fact, letâs go through what it means for the various entities outlined above.
Equity Holders
First, we start with the equity holders in TFL. What should be interesting to those observing this situation is how very little weâve heard from the investors in TFL. These are people and organizations have have put hundreds of millions of dollars into an entity that has completely imploded overnight â and yet, you donât hear them calling for anyoneâs head, or asking for their money back. In fact, having been in direct communication with some of these equity holders, I can tell you that theyâre being extremely level-headed about this situation, and focused more on the ecosystem fallout than the impact to their own portfolios. That being said, there isnât much they can do; as an equity participant in a distressed asset, theyâre the most junior debt holder in the layer-cake of obligations (meaning, theyâre the lowest layer in that cake). They could sue the team for fraudulent misrepresentation or something, but thatâs a long ways off.
UST Holders
Those of you who own UST are in a very interesting, and very powerful, position, which you clearly do not recognize. Unlike the equity holders and the LUNA governance holders (whom weâll get to in a minute), you are holding an asset for which TFL made specific, ongoing representations as being redeemable for $1. They marketed these dollar equivalents using fancy graphics meant to attract retail holders, and they did little to disclose the risk factors through which you would not, in fact, be able to redeem them for the $1 rate at which they were advertised.
Yes, I understand that the mechanics behind this redemption were available, and that people who looked into it might realize itâs super-complicated and risky, but nobody was asked to do this before being sold these assets. Moreover, it wasnât just TFL that was doing this â the exchanges were selling you these assets in the same way, and would categorize them similarly to collateral-backed stable coins with far lower redemption risk. The fact that UST and USDT and USDC were often listed next to each other, and with the only difference seeming to be that âthis one is needed if you want to stake in this protocol,â made it easy for people to get duped. And, if you went on TFL websites or communicated with TFL management on Twitter, they would tell you were an idiot or that youâd âcontinue in povertyâ if you didnât understand that there was little chance that UST wouldnât return $1.
Weâve had stable coins, and weâve had de-pegs, but we have never had a situation quite like whatâs just happened to you. The chair of the US Federal Reserve didnât need to release a statement when Basis Cash imploded, or regarding their opinion on Iron Finance. Therefore, youâre in a very unique position in which your actions will define stable coin policy â you are basically as powerful as the regulators in the countries in which you live, as whatever lawsuits etc you file will define years of case law on stable coin regulation. With that in mind â and I say this with no economic interest in whatever happens to UST â I think you should assert yourselves as the most senior creditors in TFL, as you were provided with an implicit guarantee of repayment at a rate of $1 per UST token.
What does this mean? Well, instead of begging Do Kwon and TFL for answers, UST holders should actually contact the courts in Singapore, and South Korea, and wherever else, and immediately assert their rights as debt holders demanding repayment of their funds. You can and should establish a precedent that the issuers of stable coins have an obligation to repay the holders; itâs actually the only way we can continue to operate things like algorithmic stables, as the equity value of the company ends up becoming an emergency backstop allowing well-capitalized firms to provide those sort of financial instruments without having to leave tons of cash sitting in a bank account (which, anyone who has tried to create a fully-collateralized stable coin, as I have, will tell you is a complete disaster and would kill off most next-gen DeFi). If you can get an emergency order issued to this effect â and I doubt Singaporeâs MAS would argue in favor of a management team that tells people to âstay in povertyâ over you â well, congratulations, youâre now the most senior debt holder in the layer-cake of obligations for Terraform Labs. And, since TFL canât repay its obligations to you, it is likely that you can petition for TFL to be declared bankrupt (not familiar with the Singapore laws, so hopefully someone from that jurisdiction can opine, but this would work in the US).
Hereâs where things start to get fun. If TFL et al are declared bankrupt, and if youâre the most senior credit holder, well, congratulations, kids â now YOU control Terra. You will have a choice to make: to allow TFL management to remain in control, in whatâs known as âdebtor in possessionâ (DIP), or to ask the courts to appoint an administrator. Based on TFL managementâs communications to UST holders, it seems you might be better off having an administrator appointed.
Thereâs probably some of you reading this and thinking, âoh no â if that happens, we are well and truly hosed, because thereâs no way we will get our money back,â but past experiences tells us that this is not always true. For example, the creditors of Lehman Brothers (Alvarez & Marsal, if I remember their name correctly) decided that the management needed to step aside and leave things in the hands of an experienced administrator, who then successfully made the creditors of the firm nearly completely whole (much to the surprise of everyone who sold their debt positions for pennies on the dollar in early-stage panic selling â sound familiar?). In addition to figuring out how to maximize the assets that remained in the entity, the administrator in the Lehman case made it clear to management and directors that there was a high chance they would sue them directly for âdisgorgement,â in which case they would be held personally liable for the companyâs collapse and forced to return any money they made from salaries, stock sales, and so on. Having worked with former Lehman Brothers management after the collapse of the firm, I can tell you for a fact that the fear of this action weighed on them for years .
While the threat of disgorgement turned out to be mostly theoretical in the case of Lehman, as the administrator magically made everyone whole, it is highly likely that TFL management would not be so lucky; thus, in effect, the UST holders could ensure Do Kwon and his colleagues âcontinue in povertyâ until theyâve fully compensated the holders of UST.
In addition to TFL and pushing for bankruptcy, the UST holders have to figure out what to do about the exchanges. They happily listed these dollar equivalent assets and sold them to you; they made tons of money off of their fees on the way into them, and on your way out of them. I know there is a perception that some of these exchange operators are benevolent elder statesmen of crypto, but this is a carefully crafted image to help them avoid the responsibility of these exact sorts of situations. Once again, dear UST holders, you have way more power than you realize â once youâre done wringing TFL and its management for every dollar theyâve got, this is the next place to turn.
A combination of these actions â TFL bankruptcy, disgorgement of profits from Do Kwon et al, and litigation against the exchanges â would likely return $1 for every UST token. Itâs up to all of you to decide just how aggressive you want to be about this; personally, if I was a complete jerk, I would buy up as much UST as possible from people whoâve given up on getting their money back, and play hardball with these entities to do exactly this sort of thing. Please look up what Paul Singer did to the government of Argentina, to get an idea for how extreme these things can get, for creditors that want to make a point. Based on how scared the exchanges are about regulators killing their game â and how much money theyâre spending on lobbyists and political friends all over the world â most of you will get paid off very quickly, if this turns into an actual thing.
LUNA Holders
First, letâs be clear on something: if you hold a LUNA token, you do NOT own equity in TFL, or in the Terra ecosystem. You have purchased a governance token, with governance rights. That is all. There seems to be quite a few people in this community who act as though LUNA is an equity token, when that is precisely what it isnât; if people were to assert this as a matter of fact in court, and if it was accepted, it would basically blow up the entire governance-token-issuance game, which would affect the entire crypto ecosystem in all sorts of unforeseen ways. And, no, hiding behind a VPN and sticking to DEXs wonât solve that problem, as anyone handling funds from an unregistered, illegal securities offering is exposing themselves to a LOT of liability (see: the rights of your friends who own UST, as above).
So, if we focus on your rights as holders in the LUNA governance token, there are some major questions regarding what happened to the token in the last few days, and who is responsible for it. To save myself from having to draw lots of flow charts and give a long-winded explanation, Iâll get to the point: it seems to me that you got screwed over by a combination of TFL and validator activity that went completely around the governance functions that were supposed to be in place for LUNA (please correct me if I am wrong, as I am not super well-versed in the governance mechanisms of this project). It seems to me that the hyper-inflation of LUNA, which led to the insane collapse in its price, was performed through an off-chain consensus between TFL and the validators, as a poorly thought-out way to salvage UST. If this is the case â and I donât know for sure, because maybe this was actually something programmed into the smart contracts which none of us knew about, but it doesnât seem to be â then there is a question of what TFL sold you here. If the governance tokens werenât able to govern â if they couldnât even govern against hyper-inflation of their own token â then there are a variety of legal claims that could be made against TFL; and, if the validators acted in concert with TFL to damage the rights of governance token holders, they could also be held liable.
In analyzing the situation facing the LUNA holders, and in my basic understanding of what the validators did in the final days of this token, itâs become clear to me that the role of being a validator in a stake-based project might be way more risky, in terms of liability, than any of us have understood. The actions of the validators and the effect it has had on LUNA is going to be really, really important for LUNA holders, to determine who might be able to chased for damages; any entity with deep pockets that served as a validator and allowed those block changes to go through should probably call a lawyer immediately. The LUNA holders are still going to have a difficult time with a case â similar to the TFL equity holders, you were never promised any price stability or expectation of value whatsoever â but I think it would be a net positive to the crypto ecosystem if people who sold governance tokens, and people who were tasked with enforcing governance-based token operations, could be held liable when they violated the very basic act of following their own governance procedures.
Again, I could be completely off here. Maybe the LUNA tokenomics performed as planned, and everyone just failed to read the fine print. Maybe the validators and TFL didnât get into a chatroom and do a bunch of stuff without adequate disclosure and voting. Whatever happened there, though, is your best chance for getting back some cash â other than that, youâre pretty much left to the mercy of the markets.
There is a chance that LUNA could somehow merge its ecosystem and value into another blockchain, in some sort of token âexchange offeringâ â for an idea of what that might look like, take a look at Lehman Brothersâ sale of a large portion of its operations to Nomura. However, these matters are complicated by the fact that UST holders remain the senior debt holders in this entity, so any economic value from that transaction might be theirs to keep.
Validators
As stated above, the validators for the Terra blockchain need to think carefully about their actions. If TFL pressured them into making changes that went outside of the scope of the stated governance structure of the Terra blockchain, they could be held liable for damages in the value of LUNA resulting from these changes. I have no direct understanding of what happened here, but it is clear that these validators need to change the way they deal with this community, and with UST/LUNA holders, as these token holders decide whether the validators spend the next several years dealing with litigation. If you think you can simply bail to another blockchain and declare yourself free of the problems of TFL and the Terra ecosystem, well⌠Itâs worth a shot, I guess?
Exchanges
Everything I wrote about the validators applies 10x more to the exchanges. If I were operating an exchange, I would immediately offer a $1 for 1 token redemption plan for all UST within my ecosystem, to turn myself into a net creditor and eliminate my exposure to this toxic mess. And, I would implement policies to make determinations regarding current and future token listings based upon potential for systemic risk. There was a time when you could paint a house with lead paint; similarly, there was a time when you could offer a stable coin on an exchange that had a risk of complete meltdown.
Terraform Labs management
The right thing to do is to start over, from scratch. Hand over all of your earnings from this project, and your operations, to a trustee. Donât make statements about the value of UST and LUNA, and donât do things that affect the value of these assets in terms of the ability to make sure UST holders can get repaid and LUNA holders can perform their own governance actions to determine the future of the blockchain and its ecosystem. It is time for you to move on, and accept that this ecosystem can only survive without you. You have led this ecosystem into distressed territory â please act accordingly.
Next steps
Okay, enough writing for now; itâs dinner time. I hope this was helpful to some of you. Feel free to reply here with your feedback; if there is any interest, I am happy to provide more of my thoughts on this matter. I sincerely hope as many of you recoup value in this as possible. I can assure you that all of your thoughts here are not being tossed into void â you should assume that there are several laser printers in several offices creating large piles of paper containing everything being posted in these forums, in preparation for the inevitable legal and regulatory fallout.
