Why Terra Luna Collapsed with Jonathan Wu - WBD508

Jonathan Wu is head of growth at Aztec network. In this
interview, we pick over what happened when the stablecoin UST
crashed, how it linked to the Terra blockchain and Luna
governance token, the issues with recursive lending, and the need
for financial disclosure in the industry.


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Stablecoins have provided financial sovereignty for millions who
have been failed by their financial institutions and want
predictable value in a currency. So, the failure of a stablecoin
that had been financially backed by some of the biggest investors
in DeFi has been particularly traumatic for many investors.


Unlike some stablecoins, UST, native stablecoin of the Terra
Blockchain, was under collateralized i.e. it wasn’t backed by
another asset. Maintaining its peg to the dollar was
(theoretically) stabilized algorithmically: linkage of UST to a
governance token, Luna, and a complex dance of creation and
burning of both of these coins. In theory, this enabled UST to
remain decentralized.


In practice, there were some inherent weaknesses in the process.
Not only was the stablecoin designed to be a payments rail, but
the governance token, Luna, could be staked to derive yield. It
was accepted by lending protocols that allowed for recursive
lending (rehypothecation), an activity raised as a significant
risk to DeFi by many critics of yield farming (e.g. Allen
Farrington).


Then the house of cards started to crumble. Or, as Jonathan
describes it: the death spiral began. The result was a quick
unravelling of an asset, which had had a market cap of over $18
billion. An asset that many investors believed, wrongly, was
devoid of the risks associated with altcoins. An asset now with
an effective value of zero.


The story involves large profits being made by major investors, a
CEO who overplayed his hand and got some major calls wrong, some
shady characters in the DeFi lending ecosystem, complex
strategies not many understand, and a lot of people who could ill
afford to lose their investments getting seriously burned.


The critical issue is this again places Bitcoin in a bind. Its
price was directly affected, but its reputation suffers: retail
investors are warier to adopt, and regulators are more empowered
to pounce. There is a lot for the industry to learn, and learn
quickly. The stakes are currently stacked unfairly, and it’s the
same people who end up losing.