Happy Friday, readers. David Z. Morris here, filling in for Michael Casey.
For the past six weeks, I’ve had an eagle eye on the terraUST (UST) algorithmic stablecoin system, first writing about why it would collapse, then watching as it did exactly that. The human tragedy has been immense, and while Terra creator Do Kwon and his supporters may want to label the disaster a mere speedbump on the way to success, a spate of civil and criminal proceedings suggest that many suspect it constituted fraud. That line between fraud and failure has become increasingly fine, inviting comparisons between Kwon and Theranos’ Elizabeth Holmes.
But today I want to focus on the other side of the equation. I’ve seen repeated references to the idea that UST lost its peg because of an “attack,” a “coordinated attack” and even “a hit job.” This framing often comes from those trying to defend UST’s fundamental soundness, despite many years’ worth of warnings that algorithmic stablecoins are doomed to fail.
It is likely true that the depegging of UST was at least partly the result of an “attack,” in the sense that capital was deployed strategically and in large amounts to bring down the Terra peg. But there is a troubling misdirection just beneath that material level. You can see hints of it in references to the hypothetical attackers as immoral or as “more malicious than Do Kwon” himself. It manifests just slightly differently in unfounded (and irresponsible) rumors that a huge hedge fund company like BlackRock (BLK) or Citadel was behind the attack.
The subtext of these defensive tics is something like this: “The collapse of UST wasn’t a real failure because the big banks and Wall Street hate crypto and they sabotaged us because they hate us.”
If you’ve spent a lot of time thinking about financial markets, this line of thinking is so foreign that it’s not easy to pinpoint all the ways in which it’s wrong. So I was naturally furious and humbled to come across a single tweet from an obscure, anonymous account that nailed the logical flaws better than I could.
“There was no attack,” user @pitchbend wrote in part. “If the design is flawed it deserves to collapse the sooner the better. What you call an attack was [a] stress test. And Terra failed it.”
It’s just business
It’s hard to be more correct. To expand on @pitchbend’s bullseye shot, the thing about markets is they don’t have any morality. To paraphrase New York University professor of marketing Scott Galloway, they have no mercy – but also no malice. The person trading against you doesn’t care who you are, just what your position is.
There are exceptions, as when activist investors Carl Icahn and Bill Ackman engaged in a very personal war over Herbalife, a maker of nutritional supplements. But, generally, the only “attackers” in finance are people who see an opportunity to profit from someone else’s mistake. They don’t care if they’re shorting a diamond mine staffed by Congolese child labor or an investment fund for widows and orphans. If they smell money, they strike.
To draw the most obvious parallel to the Terra collapse, billionaire investor George Soros didn’t attack the English pound in 1992 because he hated the United Kingdom. That certainly might have been how he felt, I have no idea, but it doesn’t matter. Because it still wouldn’t have had anything to do with his assessment of the financial condition of the pound, the profit potential of shorting it and his likelihood of victory.
In the case of Terra, the profit potential was huge. The definitive numbers are still emerging, but one detailed analysis estimated $800 million in profit from the play. You don’t have to hate crypto, Terra, or Do Kwon personally to pursue that kind of money.
That number is also roughly on par with the $682.5 million Jump Trading was estimated to have spent defending the UST peg, according to The Block’s research director, Igor Igamberdiev (though the numbers aren’t neatly related). That spending also puts the lie to the idea of a shadowy conspiracy of malicious attackers: If there was something underhanded about the attack on the peg, something that broke the rules of the market, why was Jump using market mechanisms to defend it?
When crypto meets real finance
I see a couple of takeaways here. The first is a reminder of just how poorly many people who are now speculating in crypto understand financial markets. This has always been a troubling background issue for crypto: those of watching closely know just how experimental this technology and ecosystem are, and how often even well-regarded projects fail or peter out.
There’s a natural impulse to want to protect people who might not understand those risks. At the same time, a major promise of crypto was opening up capital markets to people who wouldn’t qualify to contribute to a traditional VC fund. That openness has helped make a lot of early crypto investors wealthy, and they have, in turn, funded startups and projects that expanded the ecosystem further. That wouldn’t be possible with the same kind of controls in place in equity markets. I don’t know if there’s any way to cut that baby in half, and I’ve spent an awful lot of time thinking about it.
The second takeaway is equally complicated. Though rumors about BlackRock and Citadel are just that, it does seem very plausible that some large mainstream hedge fund was involved in the Terra depeg. That would be a major double-edged sword. On the one hand, it would mean crypto is regarded as a robust and trustworthy enough ecosystem that mainstream finance is willing to risk shorting it. The emergence of more such shorts would, furthermore, benefit the ecosystem long-term by providing a profit motive for asking hard questions about projects.
But at the same time it could mark the end of what will in retrospect seem like a decade of blissful innocence in crypto. Mainstream finance has been happy to collect trading fees on crypto and invest in startups. But when serious traders backed by big piles of money start looking for ways to profit by eating crypto’s weak and frail, they may find a target-rich environment.
