Thoughts on Terra's Collapse
UST collapsed three days ago. The algorithmic stablecoin depegged from $1, the ensuing redemptions hyperinflated the Luna supply, which crashed both of their prices and evaporated nearly $17.2 billion from the market.
The entire collapse took less than two days.
Luna’s all-time high price was $119.18 on 4/5/22. It fell to a current price of $0.00044927. UST depegged from $1 and is currently trading at $0.21.
Below is an explanation from Jack Niewold on the background and mechanics of the collapse.
What follows are my thoughts about how this collapse will affect DeFi and the surrounding crypto ecosystem. It is clear that the shockwave from the crash will cast outward and effect much more than DeFi alone. The downfall of Terra may end up being the harbinger the SEC needs to move on regulation of stablecoins.
From Hester Pierce directly:
I expect the aftermath of UST/LUNA will put a temporary chill over the entire space. The market needs time to digest. People have become skittish as a sense of doubt and uncertainty pervades the space. Those with the vision will remain steady, but casual participants will likely experience doubt and uncertainty.
People looked to the major coins for a sense of stability. USDC and Tether held their $1 pegs throughout the crash—a sign of strength when it was needed most.
In time, money will start moving again and new protocols will emerge.
Regulation is inevitable. We will have to do our best to take it in stride. The most strategic participants will learn to work with regulators to push for sensible regulation. It’s a fool’s game to pretend that crypto will not be regulated in the U.S. The priority is for the most essential aspects of the crypto space to remain intact.
Of the many essential aspects, the most fundamental is the self-custody of wallets. Regulation that would require third-party custody (as is done with equities/brokerage accounts) would destroy the space as it’s known today. It is crucial that crypto remain open and free. Individuals have the right to custody their own assets, even with the risk of theft and loss.
Third-party custodians provide a fine service to the market. At full adoption, most will choose to custody their assets with a third-party—willing to trade off sovereignty for convenience. This is a good trade for most people.
A small percentage will continue to take the responsibility of custody onto themselves, as many do now. This is a critical component of a thriving, global crypto ecosystem. The right to self-custody acts as a check on the concentration of economic power in the hands of the institutions. If you have the ability to withdraw your assets into your own custody, the check exists. If you must interact with a third party to engage with your assets, the check does not exist. The best a retail investor can do today is move their equities and related assets from broker to broker.
The right to self-custody is woven into the fabric of crypto. It must not be regulated away.
If there is a silver lining to the financial devastation of Terra’s demise, it is that people have learned what happens when a large financial structure implodes. It is a painful lesson, but a powerful one. Things that may have once been seen as “too big to fail” are now understood to be things that can fail. We have a shared and visceral understanding of what collapse looks like in a decentralized market.
The destruction of Terra carves a permanent reminder into the blockchain of the pitfalls of hubris, ego, greed, and poor design. Hopefully, this will become the cautionary tale that drives the ecosystem in a better direction and keeps it away from these pitfalls in the future.
Terra’s collapse will embolden the critics. They are already beginning to speak up. If the crash brings the entire space into a prolonged bear market, the critics will use take the opportunity to attack—as they did in 2018 and 2019. Prepare for loud criticism in the short term. The noise will die down as the critics lose interest and move on to other things. The core of the space will survive and continue to talk, build, and participate.
Critics will attempt to parlay vulnerabilities in DeFi into an indictment of all crypto technologies, including NFTs, GameFi, and more. This is nothing new— it’s simply an extension of dug-in opposition to crypto finding a new vector for criticism. Anyone in and around the space can separate the projects that get criticized most heavily in the corporate media from the innovative things happening deeper within the space. But communication fails because the loudest critics and the smartest people in the space are talking past each other.
Many of the NFT projects that became popular during the last bull market may fade away, but NFTs as a technology have a bright future. They will broaden into different applications as they are adopted by more industries. This is possibly the end for the profile picture (PFP) boom that brought projects like the Bored Ape Yacht Club to the mainstream. Now, NFT concepts with specific applications are rising in popularity—such as music NFTs that can share an artist’s royalties with fans.
We can’t forget that many people lost everything in the collapse.
It’s a terrible day when this much wealth vanishes nearly overnight. It also gives us an opportunity to explore ways to keep this from happening in the future. A common saying in crypto is, “don’t invest what you can’t afford to lose.” This takes the inherent volatility of the crypto markets into account in helping people to understand the importance of risk tolerance. A person must know how much risk they can afford to take. They must also remain skeptical of investments that proclaim to be low-risk, especially if they cannot explain how the investment works. No asset, currency, or protocol is “risk-free” in crypto. Everything has a risk profile. This becomes most obvious when taking the investment horizon into account. The shorter your investment horizon is, the lower your risk tolerance should be.
This is a difficult moment for crypto. But it is still early, and the space will continue to iterate and grow over time. As with any macro technology trend, it will take years (if not decades) for crypto to reach its full potential. We must keep a long-term focus, and not worry about short-term price movements. We must also tune out much of the hype as possible. Every investment must be understood, the same as it has ever been in all other markets and asset classes. We must focus on the best projects with the most potential, while also keeping an eye on new projects without giving into a frenzy and becoming blind to risk.
Most of all, we must remember that economies and markets have always been cyclical. Patience and conviction will be rewarded over time.