Happy Friday, dear readers. This is David Z. Morris, filling in for Michael Casey.
For the past six weeks, I've been keeping a wary eye on the TerraUST (UST) algorithmic stablecoin system, first writing about why it would collapse, and then watching it do just that. The human tragedy was immeasurable, and although Terra's inventor, Do Kwon, and his supporters want to dismiss the disaster as a mere stumbling block on the road to success, a series of civil and criminal cases suggest that fraud was involved. The line between fraud and failure is becoming increasingly thin, inviting comparisons between Kwon and Elizabeth Holmes of Theranos.
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But today I want to focus on the other side of the equation. I have seen repeated evidence that the UST has lost its stake due to an "attack," a "coordinated attack," or even a "contract killing." This framing often comes from those trying to defend the fundamental soundness of UST, despite years of warnings that algorithmic stablecoins are doomed to fail.
It is probably true that UST's decoupling was at least partly the result of an "attack," in the sense that capital was deployed strategically and in large quantities to bring down Terra-Peg. But there is a troubling misdirection just below this material level. One can see hints of it when the hypothetical attackers are described as immoral or as "more evil than Do Kwon" itself. The unfounded (and irresponsible) rumors that a major hedge fund company such as BlackRock (BLK) or Citadel was behind the attack are somewhat different.
The subtext of these defensive ticks goes something like this: "The collapse of UST wasn't really a failure because the big banks and Wall Street hate crypto and they sabotaged us because they hate us."
When you've spent a lot of time thinking about financial markets, this way of thinking is so foreign that it's not easy to point out all the ways it's wrong. So naturally I was angry and humbled when I came across a single tweet from an obscure, anonymous account that summed up the logical fallacies better than I did.
"There was no attack," wrote user @pitchbend 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 doesn't get much more correct than that. To elaborate on @pitchbend's bullseye: The thing about markets is that they don't know morality. In the words of Scott Galloway, professor of marketing at New York University, they know no mercy - but they also know no malice. The person acting against you doesn't care who you are, only what position you hold.
There are exceptions, such as the very personal dispute between activist investors Carl Icahn and Bill Ackman over Herbalife, a manufacturer of nutritional supplements. But in general, the only "attackers" in the financial world are people who see an opportunity to profit from someone else's mistake. They don't care if they are shorting a diamond mine with Congolese child laborers or an investment fund for widows and orphans. When they smell money, they strike.
To draw the most obvious parallel to the Terra collapse: Billionaire investor George Soros didn't attack the British pound in 1992 because he hated the United Kingdom. That may certainly have been the case, I have no idea, but it doesn't matter. Because it would have had nothing to do with his assessment of the financial condition of the pound, the profit potential of short selling, and the likelihood of victory.
In Terra's case, the profit potential was enormous. The final figures are not yet available, but a detailed analysis estimates the profit from the game at $800 million. You don't have to hate cryptocurrencies, Terra or Do Kwon personally to be after this kind of money.
That figure also roughly corresponds to the $682.5 million Jump Trading is said to have spent defending the UST peg, according to Igor Igamberdiev, The Block's head of research (though the numbers don't exactly match up). This spending also refutes the notion of a secret conspiracy by malicious attackers: if the attack on the peg was something devious, something that violated market rules, then why did Jump use market mechanisms to defend it?
Crypto meets reality. Reality wins
I see a couple of insights here. The first is a reminder of how poorly many people now speculating in cryptocurrencies understand financial markets. This has always been a troubling background problem with cryptocurrencies: Those who look closely know how experimental this technology and ecosystem are, and how often even well-valued projects fail or run themselves into the ground.
There's a natural impulse to protect people who may not understand these risks. At the same time, a big promise of cryptocurrency has been to open up the capital markets to people who would not qualify to participate in a traditional VC fund. This openness has helped many early crypto investors become wealthy, and they in turn have funded startups and projects that have further expanded the ecosystem. That would not be possible with the same kind of controls that apply in the equity markets. I don't know if there's a way to split this baby in half, and I've spent a lot of time thinking about that.
The second conclusion is equally complicated. Even if the rumors about BlackRock and Citadel are just rumors, it does seem very plausible that a large mainstream hedge fund was involved in the terra-depeg. That would be a very double-edged sword. On the one hand, it would mean that crypto is seen as a robust and trustworthy ecosystem, so the financial world is willing to take the risk of shorting it. The advent of more such short selling would also benefit the ecosystem in the long run by providing a profit motive for asking tough questions about projects.
But at the same time, it could also mark the end of what will, in retrospect, seem like a decade of happy innocence in the crypto world. The mainstream financial world has been happy to collect trading fees on cryptocurrencies and invest in startups. But if serious traders with large amounts of money are looking for ways to profit from cryptocurrencies' weaknesses, they could find an environment rich with targets.