Capitalism at Work

We look at what recent price performance implies for the future of BTC, and explain the Luna and Terra collapse.

Capitalism at Work


Capitalism at Work

You’ve probably noticed, but if not, the YTD performance across crypto assets has been poor, to say the least. BTC and ETH are down c. 60% from their all-time highs set last November, and altcoins are down, on average, by 80%. In part, this is explained by the extremely challenging macro set-up (hawkish Fed and high inflation) that is currently driving the S&P 500 to its worst start to a year since 1939 and the NASDAQ down more than 25%.

Besides macro, crypto-native stories have also been adding stress to the sector. The overarching concern about crypto being nothing more than a liquidity bubble / Ponzi scheme tends to increase when large endogenous events take place. So, it’s no surprise that sentiment is down as we just saw $50 billion of value, held within projects backed by the human and investment capital of some of the smartest investors in the industry, evaporate in a matter of days (more on UST/LUNA below).

Worrying about these events is both fair and healthy, and it helps us (1) remain grounded and humble and (2) learn what works and what doesn’t.

There are some thoughts that have been going through my mind lately that I think matter within the context of the price action of all asset classes recently, but especially crypto:

I don’t know where that bottom is, and for now, it does seem that investors have been eager to sell. From NYDIG on May 19th:

What’s most important to stress, however, in my opinion, is that when there is no Central Bank to backstop the market, the “bust” part of cycles always ends up happening, and as we’ve said, for a good reason. Additionally, in markets like crypto, we have daily prices for venture capital like projects, which is why cycles tend to be so brutal, both on the upside as well as the downside (can you imagine if start-ups were quoted in the stock market? How wild would their share price movements be? Well, that’s basically crypto).

That was a long-winded way of saying that these corrections not only need to happen but also represent what capitalism is supposed to do - bad hands get flushed out, good hands get a gut punch but will recover and likely come back stronger. Regardless of the sector, corrections are painful, and they have the tendency to feed off of themselves until a true bottom is found… so it’s important to take a step back, understand your risk tolerance, and act accordingly.

Terra and Luna's Legacy

The meltdown of both TerraUSD (UST) and Terra (LUNA) has been widely covered but we thought that an easy to understand explanation of cause and effect could be useful to those who didn’t follow the drama by the hour.

As a reminder:

Why did it fail?

Whilst the exact catalyst is not super clear (although reliable sources point to the $150 million worth of UST being withdrawn from the Curve Wormhole pool followed by a $350 million sale of UST for USDC on Curve [Tim’s note: don’t worry, I also have no idea what the Curve Wormhole is and I’m not even going to ask Diego to explain further.]), what matters and followed was nothing short of a classic Tarantino shootout scene:

What matters most is that we’ve seen a project collapse on the back of unsustainable high rewards (in this case, the Anchor yield) being offered in order to drive adoption (in this case, demand for UST) and could only be temporary. Once they were forecasted to change, and coupled with some other more technical events, this led to a loss of demand for UST and a capitulation of trust within the protocol.

Fear spread out to other stablecoins as well, with c. $5.5 billion worth of outflows following the event (and a brief de-pegging of Tether as well). Whilst notable, that outflow only represents less than 4% of total stablecoin assets.

Another consequence of this has been a small rotation from Tether (who’s been opaque about the reserve assets that actually back its stablecoin) to USD Coin (pegged to the USD).

UST was nowhere near Tether in terms of importance for the crypto universe ($500 million of daily trading volume for UST vs $62 billion for Tether), and as such its collapse has not posed a systemic risk. There are important lessons to learn from this, but the fact that there was no central institution to backstop the fallout of a fragile project should be, in part, celebrated as allowing for capitalism to ensure that only the most resilient projects survive across cycles. This should help us, in the long run, have a more sustainable and efficient crypto infrastructure.

Three Important Charts

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Backyard. | Crystal Lagoon, Malta
Published in: Markets
Diego Tremiterra

Co-founder and Editor-in-Chief. Covers Markets, Business, and Thematic Oversight. Currently a hedge fund Jr. PM, ex-Goldman Sachs capital markets and startup COO.

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