October 5, 2022

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How the TerraUSD crash made savings vanish and dreams disappear

TerraUSD was touted as a blue-chip cryptocurrency. Now its investors are reeling from painful losses and asking if it was all a get-rich-quick scheme.

A surgeon in Massachusetts can’t stop thinking about how he lost his family’s nest egg. A young Ukrainian considered suicide after losing 90% of his savings. Other investors have given up dreams of starting new businesses or quitting their day jobs.

All of them were swept up in the mania for TerraUSD, whose total value swelled to $18bn before collapsing earlier this month. The coin’s sudden downfall is a reminder that crypto — which enjoyed a huge bull market last year — is often little more than a casino, with weak regulation and few means of recourse for the losers.

The crash caught many investors off guard because TerraUSD was a stablecoin, designed to maintain its value of $1 per coin. Unlike bitcoin, which has crashed repeatedly in its short history, TerraUSD was pitched as a harbor from volatility. It slipped below $1 earlier this month and was trading around 8 cents on 26 May.

Investors piled into TerraUSD because of the opportunity to make money in Anchor Protocol, a sort of crypto bank that offered annual yields of nearly 20% on deposits of the coin. Critics questioned whether Anchor’s yields were sustainable. But such eye-popping interest rates are common in decentralised finance, or DeFi, a sort of parallel financial system for crypto with its own version of banks and lending.

READ Bitcoin plunges as Terra’s meltdown drags cryptos lower

As often happens in unregulated, untested parts of the markets, the pitch was too good to be true. Now, the TerraUSD implosion has fueled calls for greater government oversight of stablecoins.

Some investors who lost money in the crash say they didn’t understand exactly what they were getting into. One of the key risks that many failed to appreciate was the design of the stablecoin itself. TerraUSD was prone to collapse because it was an “algorithmic” stablecoin not backed by real assets. Other stablecoins, such as USD Coin, say that they hold $1 of cash, Treasury bills or other traditional financial assets for each unit of digital currency, allowing them to maintain their peg to the dollar.

A spokesman for Terraform Labs, the Singapore-based company behind TerraUSD and Anchor Protocol, said it had been clear about the risks of both initiatives. “As with virtually everything else in life, each individual must decide for themselves what risks they are willing to undertake,” the spokesman said.

“We worked hard to put in place measures we believed would help maintain and protect the future of Terra, a future we believed in from the beginning,” he added.

Keith Baldwin, a 44-year-old surgeon who lives outside New Bedford, Massachusetts, saved $177,000 during the past decade. Last year he took his savings and bought USD Coin, putting it in a crypto account that paid a 9% annual yield.

In April, he moved it into a pseudo-savings account powered by TerraUSD that offered 15%. More than 90% of his savings vanished in a few days when TerraUSD lost its peg to the dollar. Dr. Baldwin said he didn’t know that Stablegains, the startup that managed the account, was converting his USD Coin holdings into TerraUSD. (USD Coin has kept its $1 peg.)

Dr. Baldwin doesn’t consider himself a crypto enthusiast. He had hoped to spend the money on a house. Now he has been cutting back on expenses so he can still save for his children’s education. “I don’t want to punish our kids for the mistake I made,” he said.

TerraUSD slipped below $1 on 7 May. Over the next week, it kept falling and rebounding, as the team behind the stablecoin — led by South Korean crypto developer and Terraform Labs founder Do Kwon — burned through a $3bn reserve fund in an unsuccessful bid to defend TerraUSD’s value.

When Dr. Baldwin learned that TerraUSD’s troubles were threatening his nest egg, he scrambled to withdraw his funds from Stablegains. Hours ticked by as the site processed the transfer. By the time they landed at Dr. Baldwin’s newly created account at the Kraken crypto exchange, the coin was trading at just 14 cents.

Stablegains said last weekend it was winding down, and its founders said they were “deeply sorry and devastated.” In an emailed statement, Stablegains said it had disclosed the risks of DeFi online and in its terms of use. The startup has said it had nearly 5,000 customers.

The meltdown has reverberated around the world. In France, Thomas Blanc had hoped to use his profits from crypto investing to organise free electronic-music festivals, do charitable projects and help his parents retire early. Instead he ended up losing nearly $400,000.

In Australia, Ben Thompson endured sleepless nights before deciding he would sell his TerraUSD if the coin recovered to 65 cents. He woke up the next morning to find it trading around 10 cents.

In Ukraine, a 30-year-old man who used to work in insurance thought a stablecoin would be safer than a bank in his war-torn country. He fell into a depression, he said, after losing most of his savings.

READ Meet the 24-year-old who quit hedge fund Citadel to get rich at Terra

Dr. Baldwin, Blanc and Thompson and the Ukrainian man are all part of a more than 4,000-person group on the chat platform Discord devoted to seeking restitution for their losses.

In a 13 May tweet, Kwon voiced regret to those who lost money in the TerraUSD collapse, writing: “I am heartbroken about the pain my invention has brought on all of you.”

In the coming days, investors burned by the crash may receive funds in a new cryptocurrency, partly compensating their losses. Kwon and his fellow developers have said they are creating the new cryptocurrency as part of a reboot of the Terra blockchain network.

It is unclear how many investors were affected by TerraUSD’s collapse, but it is likely in the thousands.

Until the crash, about 265,000 cryptocurrency addresses had deposited TerraUSD to Anchor Protocol, according to blockchain analytics provider Nansen. That might not correspond to the total number of investors, though, since one person can have multiple addresses. And in some cases, multiple people pooled their assets and deposited them on Anchor from one address.

Unlike asset-backed stablecoins, TerraUSD was effectively backed by Luna, a volatile cryptocurrency, also created by Kwon. A built-in mechanism was designed to restore TerraUSD’s dollar peg if its price ever deviated from $1.

Here is how it was supposed to work: If TerraUSD fell below $1, traders could buy the coin and convert it into $1 of Luna, earning arbitrage profits. That would dry up supply of TerraUSD and push its price back to $1. But the mechanism only worked if traders saw value in Luna. When TerraUSD started wobbling this month, Luna went into free fall.

Some investors said they didn’t know TerraUSD had such a vulnerability. Brian Anderson, a 45-year-old former teacher in Utah, took out a $95,000 loan against his home in December 2020 and put the money in Anchor Protocol in March, encouraged by an online investing course. He had planned to use the interest payments and other gains to attend a US-accredited medical school in the Caribbean and become a doctor.

“I thought it wasn’t risky,” Anderson said, “being in a stablecoin.”

Write to Alexander Osipovich at [email protected] and Caitlin Ostroff at [email protected]

This article was published by Dow Jones Newswires, a fellow Dow Jones Group service