South Korean entrepreneur Do Kwon hawked terraUSD as an innovation that would transform the industry. Stablecoins are supposed to be exactly what their name implies: stable. They’re pegged to the value of an existing currency, usually the dollar, so that buyers can always exchange them at a 1-to-1 rate. Traditionally, their value is backed by a reserve including more reliable assets such as cash and treasuries — themselves backed by the full faith and credit of the United States.
Not so for terraUSD. TerraUSD is backed instead by … wait for it … an algorithm.
Kooky as this concept sounds, in the end it’s rooted less in complicated computer science than in good, old finance. TerraUSD was tied to a newly minted cryptocurrency (but not stablecoin) also controlled by the Terraform Labs company, called luna. To put things much too simply, the tokens’ creators linked terraUSD to luna in such a way that, when high-frequency traders eager to earn an easy buck sold back and forth between the two, luna’s price would fluctuate while terraUSD’s value would hold more or less steady.
This is arbitrage theory, and it works as long as the traders keep trading. The problem is, the traders will only keep trading as long as they think there’s money to make. That means they had to think luna was actually worth something, which, thanks to an unfortunate confluence of factors, eventually they didn’t. And so the whole shebang crumbled to pieces.
TerraUSD operated, basically, on blind conviction. No sovereign state vouched for it, nor did a vault full of gold. People were simply asked to believe in terraUSD’s stability — and as soon as they didn’t believe in its stability, it became unstable. But cryptocurrencies and other digital assets that aren’t marketed as stablecoins depend essentially on the same thing: an always-churning hype machine that sucks in at least as much dough as leaves it.
The trouble is, the truest of true believers tend to be the ones who lose the most, because they stick around the longest — while the savvier (and somewhat more cynical) realize when to get in and when to get out. You can roll your eyes at basketball stars spending hundreds of millions of dollars on digital images of cartoon apes in human clothing, and you probably should. But look at tweets and Reddit postings from small-timers who put a year’s worth of paychecks into luna and encouraged their pals to do the same, or funneled their grandma’s retirement into ether. You might shed a tear instead.
Members of the cryptocurrency crowd, when accused of having been suckered into a Ponzi scheme of untold proportions, love to cry “community.” They claim they aren’t trusting merely in the monetary value of a token branded with a silly name and secured by “algorithm,” but rather that they’re trusting in the societal value of building a better system and a better world — and most important, the value of building it together. The real financial revolution, in other words, is the friends we’ve made along the way. Maybe so — but community has been key to plenty of historical pyramid plots. Why go to a Tupperware party but to meet like-minded housewives with whom to break bread and sell polyethylene plastic?
People will always be looking for community, and they’ll always be looking for money. Case in point: Luna 2.0 debuted last weekend to avenge its fallen predecessors. To draw investors in despite disgrace, Terraform Labs is conducting what’s known as an airdrop: putting free luna 2.0 into the wallets of original luna and terraUSD holders, to help them recoup their losses. Which they can only do, of course, if luna 2.0 becomes worth something. Better not sell just yet, then.