Nic Carter, general partner at Castle Island Venture, Eric Wall, former Chief Investment Officer of Arcane Assets, and Erik Voorhees, founder of ShapeShift, discuss what happened with the TerraUSD (UST) and LUNA fiasco, Do Kwon’s responsibility, the impact on the crypto ecosystem, and much more. Show highlights: 

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Previous Unchained Coverage of Terra

Hi, everyone. Welcome to Unchained, your no-hype resource for all things crypto. I’m your host, Laura Shin, author of The Cryptopians. I started covering crypto seven years ago, and as a senior editor at Forbes was the first mainstream media reporter to cover cryptocurrency full-time. This is the May 17, 2022, episode of Unchained.

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Today’s topic is what went down this week with TerraUSD and LUNA. Here to discuss are Nic Carter of Castle Island Ventures, Eric Wall, Chief Investment Officer at Arcane Assets, and Erik Voorhees of ShapeShift. Welcome, Eric, Erik, and Nic.

Eric Wall: Hello. Thank you very much.

Laura Shin: So, we’re doing something unusual. As I mentioned earlier, we’re livestreaming this podcast episode because events have been moving so quickly when it comes to Terra/LUNA that I felt the podcast might be somewhat outdated by the time it comes out on Tuesday. So, let’s just start with what opinion each of you had about the Terra/LUNA ecosystem, and I’m saying like before the depeg happened, or it could even be your opinion of algorithmic stablecoins in general. Why don’t we start with you, Erik Voorhees.

Erik Voorhees: I love experimentation, and I was an owner of LUNA before I got all wiped out, last week, with the rest of everyone. Though I certainly had a vested interest in it, I’d been following it for over a year, I’m a big fan of the Cosmos ecosystem, and as it was a Tendermint chain, I’d been watching it closely, I have to say, my original bias has been that algorithmic stablecoins probably can’t work. I used to think they were impossible, but I’ve had to open my mind, a little bit, and realized that like maybe it can be done.

So, I remain skeptical that they can work long-term, but I want to see people try, and I would much rather us learn that they can’t work from actual iteration in the market rather than from theory. I’m glad to see these kind of things getting built. It’s awful that this one got so big and then fell apart, which we’ll talk about, but yeah, you could say I was a skeptical and risk-understanding supporter before the collapse.

Laura Shin: Oh, that’s really fascinating. All right. Eric Wall, what about you?

Eric Wall: I’ve been frustrated for some time that we, so far, in this industry, haven’t really synthesized a good variant of a decentralized stablecoin. Like, I’ve been looking for that for a long time, and in that search, LUNA has been…like UST has been proposed as a good example of a decentralized stablecoin, and when I looked at it, originally, back in, I think it was June, last year, I recognized that this was yet another uncollateralized stablecoin.

The oracle mechanism was rather primitive, and the price was tied to the demand of basically a shitcoin. So, my perception was basically if you’ve seen that movie Speed, where Sandra Bullock is driving a bus and Keanu Reeves is on that bus, that’s sort of the analogy of the UST stablecoin that I saw, and it was, in my opinion, a matter of time, like, how far can they drive and how long can that journey go on for until it eventually collapses?

Laura Shin: And just to make sure I understand, so, it’s not necessarily that you think decentralized algorithmic stablecoins will never work. It’s just that you felt this particular one was not constructed well?

Eric Wall: Look, I won’t take credit and say that I’ve been convinced throughout this whole time that it is mathematically impossible that an algorithmic stablecoin cannot exist, but I think that we’ve seen a number of empiric examples that these examples do not work. There are historic examples even before crypto, that have tried this before, and now we have tried it in crypto.

Look, I mean, I think the intuition that has confused me a little bit is that, well, if you think about proof of stake, for example, proof of stake has the ability to secure a blockchain by using the native asset that it conjures, itself. If proof of stake works, then maybe you could make the assumption that, well, maybe we can stabilize the price of a stablecoin, also, inherently from the asset itself.

So, I didn’t exclude the probability of it happening, but I think that there’s enough empirical evidence to be at least extremely, extremely cautious and perhaps, you know, not be so inclined to assume that we have something that we should just push into the entire ecosystem, as people has been doing with LUNA.

Laura Shin: Yeah. Well, clearly, there was some merit to that thinking. Nic, what was your stance on algorithmic stablecoins as well as Terra/LUNA?

Nic Carter: Yeah. So, I’ve been, you know, a stablecoin enthusiast for a long time. I support the institution of stablecoins, you know, defended Tether on a number of occasions, right? So, I think the fiat-backed model is great. The fully-convertible model works and provides a great service and you know is a great complement to Bitcoin. You know I don’t think it’s incompatible with Bitcoin in any way. The algorithmic model, I first thought deeply about it when I indulged in SPACEs, SpaceCoin, back in the day, looked at that investment, developed a variety of attacks on it, and thought it would be impossible, that it wouldn’t work. 2020, I looked into Terra, I wrote a whitepaper on stablecoins. I looked at a whole bunch of different models and wrote Terra off.

I thought it wouldn’t work, and then I was shocked when it swelled to such a significant scale. I wasn’t as critical as Eric was because I don’t really have the appetite to go toe-to-toe with people in crypto like that. I don’t have the stomach for it, frankly, but I had been critical of LUNA/Terra, and I didn’t think it would work, and I think, you know, there are a variety of mechanics which made it get as large as it did, which were irresponsible, but yeah, my current stance is it would be great if there was a crypto-backed stablecoin that was, you know, credibly decentralized and could resist seizure the way that fiat-backed stablecoins can’t. That has to be over-collateralized, in my opinion.

I don’t believe you can do it in the under-collateralized way. I think we have abundant examples in crypto, in the history of stablecoins, history of seigniorage share stablecoins. We have abundant examples from financial history, monetary history, and so, for a while now, I’ve been convinced that seigniorage share stablecoins cannot work.

Laura Shin: So, let’s talk about what actually happened this week. There’s been a lot of speculation on Twitter and elsewhere that this was a deliberate attack on Terra. Do you think that that was the case, and you know, explain why or why not?

Nic Carter: I can start. I don’t think it was coordinated. I think it is a form of coping in order to think that you’ve been victimized by a single entity as opposed to just investing in something that is unstable. We don’t need a catalyst, actually, for a bank run to occur. You don’t strictly need an attack to occur for a fundamentally unstable system. All you need is, you know, a few sellers to get spooked, and then it catalyzes more and more, and then it’s a rush to the exits, and the exit’s too small.

So, that’s what we saw. Like, certainly, the rumors of BlackRock or Citadel doing this are completely fallacious, you know? You didn’t need a single malicious entity, and I think people are trying to reapportion blame to some fictitious presumed entity which, you know, brought this whole thing down, and it’s a way of avoiding the reality of the situation, which is that it was unstable.

Laura Shin: Yeah. I just need to comment on that. When BlackRock posted an article about how, you know, they had this denial, the comments back to them were just people wanting to believe that it was them and accusing them anyway. I mean it was, you know, I was shaking my head, reading it, but anyway, Erik, you wanted to add something, Erik Voorhees?

Erik Voorhees: Yeah. Yeah. I agree mostly with what Nic said. I think, more importantly, it doesn’t matter if there are attackers out there. Like, these systems need to be able to exist and thrive and survive in an adversarial environment. So, I don’t really care if like one entity did a kill shot on this or if it was, you know, a million market participants acting in their own interests, which is, I think, what the default position should be. If it is one attacker, I think that changes the conversation and distracts from it.

Like, the mechanism needs to be able to withstand a single attacker, and if it can’t, then it needs to die and go away. So, yeah, I mean, certainly, it’d be very interesting and scandalous if it was, but I’ve seen no strong evidence to support that, and I think people should assume that this is the vagaries of how markets work.

Eric Wall: Yeah. I’ve just got to add something to that. I think that the timing of the event was kind of suspicious, in some sense, if you know about the 3pool on Curve and the 4pool that they were moving their liquidity to, the destabilization of the peg happened at that exact moment. If it had happened a couple of hours later, then there would’ve been billions in liquidity to cushion the fall of the UST.

So, it seems like, I’m not excluding, like, I agree completely with what Erik Voorhees said that it doesn’t matter if it was an attack or not because we didn’t have these artificial pools of liquidity for LUNA before, and it was just that we were moving liquidity from one pool to the other, these systems should be resilient to that, but I cannot exclude the possibility that there was something related to the timing of liquidity being moved from one pool in Curve into another pool because that decreased the threshold that an attacker would need to mount against Terra in order to be successful.

So, I think that it’s definitely possible. I don’t have any evidence. I don’t have any evidence of that, but I don’t think that it’s at all unlikely to assume that someone saw that, in this exact moment, there is less liquidity that would cushion the fall of UST. So, if I attack now, I’m going to have a higher success rate. So, the timing of the depegging seems to be related to the moving of liquidity on Curve, in my opinion.

Laura Shin: Yeah. I agree that the timing is suspicion. Kevin Zhou of Galois Capital, who has been sounding an alarm about what he felt was a risky structure of UST for a long time. I was DMing with him, and he said that he felt that someone could’ve accidentally kicked it off when they saw the liquidity was low. If they didn’t know what was happening with the transfer of the liquidity from 3pool to 4pool and just got kind of concerned about their investment that it could’ve been something like that, but you know, to me, I do think that the timing is suspicious.

A few things I do want to clear up. I’ve just seen so much on Twitter and elsewhere where people are saying that this happened when someone, first of all, borrowed 100 thousand Bitcoin, or they started shorting Bitcoin. There’s like a number of these things where you would only know that if you like worked at the place, you know, where they did that trade, or something. Like, which they’re not going to be publicly talking about that. So, I just want to kind of separate fact from speculation here. You know, I mean, clearly, there was actually…can somebody describe it? It was something on Curve that basically is what kind of kicked off the depeg. They did a large trade on Curve. Can one of you explain what that was?

Eric Wall: Well, I can give it my best shot. So, there was a migration that was supposed to happen on Curve, where there’s a so-called 4pool, where you tie the liquidity of FRAX, USDC, UST, and I think USDT together, and they were supposed to move the liquidity of UST from another pool into the 4pool, and while they were doing that migration, they’re just taking UST out, and it was we’re talking about hundreds of millions of dollars that they had just taken out, which if the 4pool, which it was going to be billions of dollars in that pool, if they would’ve attacked when the 4pool was up and running, then there would’ve been billions of dollars that would’ve cushioned the fall in the 4pool, but now, since they were pulling the liquidity out of the UST pool on Curve, the liquidity there was much, much lower. I think we were talking about like 150 millions of dollars there instead of like 3, 4 billion.

So, if someone wanted to short UST and cause the peg, the price to depeg, there was much less liquidity in Curve at that particular moment, but I’m not an expert on like that exact particular mechanic that happened, right there. So, I can’t speak exhaustively to it, but that’s like roughly a summary of what happened.

Laura Shin: Right, and then that kind of kicked off the depeg, basically?

Eric Wall: Well, someone started to sell a huge amount of UST, which started the depeg, and if there was a Curve pool to arbitrage the price difference, then that would’ve cushioned the fall extensively, but now, that liquidity wasn’t there, it was just a couple hundred millions of dollars there, it was much easier to make that price of UST go down relative to other stables.

Laura Shin: Yeah, and I saw people also saying that if all of this had happened once 4pool was up and running, then it would’ve been even harder. So, this was just like kind of a weak moment, but you know, we’re not saying that we know anything happened deliberately because, you know, as I mentioned, Kevin Zhou had a really plausible explanation for how it could’ve been accidental, but Nic, I wanted to go back to something you said earlier, which was that you said that you felt that the way the UST ecosystem had been developing was irresponsible. You used that word. Can you talk a little bit about, you know, what you saw there that you felt was irresponsible?

Nic Carter: Yeah. I mean if you look at the history of seigniorage share style stablecoins, which is such a mouthful. We need a different term for them. They never got big, because basically people don’t trust them, right, and so, that’s always limited their fallout when they collapsed. Like, NEWBIT’s was miniscule, ESD, I think, was a seigniorage shares one, which collapsed, Basis Cash never got big, it didn’t really get off the ground. The biggest, probably, was the Iron TITAN one, and that wiped out a fair amount of capital, but very small compared to this.

So, you know, basically, like people aren’t dumb. Like, they don’t park their cash in seigniorage share stablecoins for the most part. If you want to actually use a stablecoin in crypto, you use it as a medium of exchange or collateral in a smart contract or for settling trades with exchanges or for international trade. You’re going to use USDC or USDT, you know? They’re just trusted, and so, you know, the question is like why did UST get so big? It got to 18 billion, I believe, at peak. It’s because of the subsidy in the anchor pool. That interest rate was way higher than what the market was paying out.

Laura Shin: Yeah, the 19.5 percent interest rate.

Nic Carter: Yeah, and if you overlay that against other interest rates available in crypto, you know, you’ll see like single-digit rates, and so, you know, mid-single digits at the time. So, that is very high, and that is like any central bank raising interest rates. It sucks capital in, right? That’s like what central banks do when they want to suck dollars into the banking system. It’s actually kind of very similar, in a way, to what happened in Lebanon, where they realized the banking system was failing, and they wanted to draw in as much capital as possible, so they hiked rates, in like a Ponzi-like way, actually, in the case of Lebanon.

So, Anchor was subsidized, and that caused, you know, capital to enter the Terra ecosystem through UST and through LUNA, as well, right, like, so it had an effect on the price of LUNA. That, to me, was the biggest mistake because that caused the thing to grow so large, and for the safety of the system to be ensured, you would want UST to actually be relatively small relative to the market cap of LUNA, because all redemptions had to processed through LUNA, and so, as UST grew, due to this high interest rate, relative to the size of LUNA, the system became more and more imperiled.

So, to me, if there’s one thing I would pinpoint, it’s actually the subsidy in the Anchor pool, which I think was the one biggest mistake that caused the harm from this to be really, really high, instead of like, if there hadn’t been that, UST creation would’ve been much less, and you wouldn’t have had the fallout that you did.

Laura Shin: And one other thing I want to ask you about is you started by saying that you felt like reliable stablecoin were USDC and USDT, which are obviously centralized stablecoins, and you know, something like UST at least was aiming to be decentralized. Whether or not it actually was, we could debate, but you know, I think one of the appeals of a UST-style stablecoin is the fact that it could eventually be decentralized even if it isn’t now. So, do you feel that when it comes to stablecoins, it doesn’t matter if they’re centralized instead of decentralized, or do you still…?

Nic Carter: Actually, I reject the framing of UST as decentralized or as having this decentralization teleology where it was progressing towards decentralization. I think that’s false. It never looked decentralized to me, and I don’t think they could plausibly get there. It would always require management. It would always require a central bank doing open market operations. I didn’t see a way…even if they backed it with Bitcoin. Backing something with Bitcoin doesn’t make you decentralized. You know, like, MicroStrategy owns a lot of Bitcoin. They’re not decentralized.

There is no…and frankly, backing a dollar liability with a Bitcoin asset, even if they’ve been fully reserved, that’s still an asset liability mismatch. So, you know, I view that as entirely pretextual. I think the decentralization narrative was a pretext for supporting, you know, like rhetorically, the importance of UST, relative to other stablecoins. I don’t think there’s a way to do a so-called decentralized crypto-backed stablecoin that’s under-reserved.

The best model that I would want to see there would be the Maker model, which is over-collateralized, but that wasn’t what they were pursuing. So, maybe if they’d been explicitly doing that, saying they’re going to have a significant over-collateralization with just Bitcoin, then I’d believe it, but I didn’t believe it. I reject that framing.

Laura Shin: And do you feel that it’s, like, some people say that kind of the Holy Grail of stablecoins is to have a decentralized one. Do you feel that’s like a worthy goal, or you just feel it’s not even possible to create such a thing, unless it’s over-collateralized?

Nic Carter: Well, you’re constrained by the laws of economics, you know? So, like, I do think it’s a worthwhile thing to pursue, but I would like to see it pursued in the Maker approach, although Maker, itself, has problems because it’s just a USDC thing, now, basically, but yeah. So, I agree that’s a worthwhile goal. Like, I don’t believe we should all be using stablecoin…we’re just very exposed to the US Government, the banking system, if we all use USDC and Tether. There’s risks. So, yeah, I think digital cash should be free of the risk of arbitrary seizure, but you also have to do it in a way that makes sense and like isn’t liable to cause fragility.

Erik Voorhees: So, I want to comment quickly on this. So, Nic is right that to call Terra/LUNA decentralized in the state it was in is misguided. However, I don’t think it’s misguided to say it had become and was becoming more decentralized than the alternatives of USDT and USDC. There are aspects of it which were very decentralized, the chain itself, the inability to freeze or reverse funds is nowhere in that code, whereas in USDC, Circle can actually freeze accounts, right? So, there are elements of it which were becoming more decentralized than the alternatives, but it was nowhere near sufficiently decentralized for people to comfortably call it that. I think that’s a fair point.

It didn’t need open-market operations, necessarily. The main mechanism that was intended to hold that peg was the smart contract itself. That didn’t require any human intervention. Now, layered onto that was some human intervention, especially when they decided to start partially backing LUNA with Bitcoin. That started to require some more people getting involved, but in theory and in practice, these mechanisms can be set up to be decentralized. This one failed. I would hope that it can be done better than that.

Laura Shin: Eric Wall, you have thoughts?

Eric Wall: Yeah. Well, I don’t think that a decentralized stablecoin is necessarily impossible. I think that probably the best example that we have currently is RAI. It’s not particularly well-known, but the trade-off that RAI makes compared to DAI, I mean, DAI had the problem, like, they didn’t want to introduce negative interests, interest rate in DAI to stabilize the price. They wanted the price to be exactly one dollar. So, instead of having a negative interest rate, what they did was they opened up for other collateral types.

So, that’s why you have USDC in DAI, which now makes DAI more centralized, but there is another way to have a looser peg, which is what RAI does, and the reason that RAI isn’t very successful is that it didn’t start out with the price of RAI being traded around one dollar. Instead, they made the price of RAI trade around 3.14, basically PI, so, no one understands what RAI is supposed to be, but the mechanism of RAI, itself, it’s an over-collateralized, decentralized stablecoin that actually works. The peg is not 100 percent pegged to an exact price, but it sort of hovers around that. That’s a pretty reasonable stablecoin that we can have that would’ve been way better than putting all our eggs in the basket of something like UST.

Laura Shin: And wait, and I’m sorry, it’s 3.14 dollars?

Nic Carter: Yeah. They started it at PI dollars. It’s sort of gimmicky.

So, they introduced a new unit of account, which was also a mistake.

Laura Shin: Okay, but wait, I’m sorry, because I was so thrown by that, I just need to understand. So, what is it, is it over-collateralized? How does it work?

It is over-collateralized, but the price peg isn’t like hardly super-focused. It’s a bit looser. So, it trades around 3.14. It can go up, but it can go down, but throughout its history, it hasn’t deviated that much. So, that’s an alternative to DAI. So, DAI has the problem that you now have centralized stablecoins that are in the collateral mix. If you want something that is more decentralized, one example to go about that is RAI that isn’t exactly pegged to…that doesn’t have a very tight peg but has a peg that works, somehow.

Laura Shin: And it’s over-collateralized with crypto? It’s like backed by crypto, not…?

Eric Wall: Yeah, this one is over-collateralized by ETH, yeah.

Laura Shin: Oh, so, it’s like the original Maker, or the original DAI?

Original DAI except not tightly pegged to one dollar but more loosely pegged so that they don’t run into the problem where…the problem with DAI was that the price of DAI started to deviate from the peg, and then they had to either introduce negative interest rates, or they had to introduce collateral types like USDC to bring the price back down again. So, RAI is another example to do that without, yeah, it’s kind of complex, but yeah.

Laura Shin: Yeah. I mean just listening to all this, I’m a little bit like, yeah, so many of these have flaws. I end up sort of going back to feeling like the more centralized ones are the best, sort of like Nic was saying, which, you know, is probably very kind of anti-crypto, anti-decentralization philosophy, but I don’t know. That’s my takeaway.

Like, what is your big takeaway when you’re looking at this whole history of all of these failures and the fallout from UST? Do you feel that seigniorage shares stablecoins are just sort of dead in the water from now on? Because, I mean, I don’t know if you saw, the community is saying they’re going to try to revive. Do you think that’s possible?

Like for me, personally, this failure of LUNA sort of puts the nail in the coffin of something that I’ve felt for a long time that we should not assume that these death spiral mechanics can be avoided even with a 3 billion dollar Bitcoin reserve. It’s just not…like, the death spiral mechanic is so pernicious and is so unstable that it doesn’t matter how many billions of dollars you have in a shitcoin to sort of stabilize the price, or how much Bitcoin you raise.

When the death spiral kicks in, it just leads to disaster, and I don’t think that it’s responsible to play around with those mechanisms, and I think that we should hold the people who…the industry leaders who vouch for this more responsible because this was not unknown. This was not an unknown attack vector. The people that have studied stablecoins, we all knew that there was a big inherent death spiral risk there, and it was just a matter of time, like, how long can this go on before it collapses, and I think, Nic, you give yourself too much credit here. I think that you were the one that more confidently added that this experiment with LUNA was going to end sooner rather than later. I was willing to give it a year, you know, 1 or 2 years.

So, I was like taken aback a little bit, here, that it actually happened so soon. Like, I knew that it was going to happen at some point, but Nic was more like it was going to happen like soon-ish, in the next couple of months or weeks. So, I don’t think that it’s a good idea to keep experimenting with those algo stables. I think that we should focus on over-collateralized stablecoins, but I don’t think that we someday abandon the dream of a decentralized stablecoin, at all. I think that we should give more experimentation to experiments like RAI, for example.

I guess I’ll say that like the nature of experimentation is one in which most things fail. I have a lot of tolerance for failure. I have a lot of tolerance for experimentation. The Byzantine Generals Problem, for example, was unsolvable for decades, right, and had been like kind of given up on by lots of people. It’s just like can’t be solved in computer science, right?

So much theory went into that, and then there was a breakthrough, and it was solved, and Bitcoin happened, and it changed the world, and I think a spirit in which we see big failures and then give up on a line of scientific or economic pursuit, that’s actually the bigger disaster. So, I certainly wish that LUNA had not gotten so big before it collapsed, but I think if the industry decides that this line of pursuit is unpalatable, that it cannot be pursued, and it should not be tried because of the danger, that that is actually a bigger problem than the losses.

Yeah. I sympathize with that, but I think that the big problem here was just the cult around Do, the cult around Do Kwon, and how much support he was given, and I mean if you want to try an experiment like that, I mean, go ahead, by all means, but the problem here was that he was aggressively calling everyone that tried to point out flaws retarded and useless and spreading FUD, and he had a huge community of greed-driven LUNA shills that were helping him push that narrative and silence critics and harass them, and we even had huge hedge funds and institutions that were also backing all of this, and I like what you said, very much, Erik, that we should not give up on experimentation, but I think that you might have erred a little bit in the case of UST in describing it as, you know, decentral.

Like, you were kind of pushing UST, a little bit, as well, I think, not only as, you know, this crazy experiment but more of something that we should embrace and start to use and include in all of our products. So, I think that, yeah, it’s fine with experimentation, but we did not treat this as an experiment. There were so many parts of this industry that treated this as the solution to the decentralized stablecoin problem, and partly including you, Erik, I regret to say.

Erik Voorhees: Yeah. I mean I’ve always treated it as an experiment. I still treat Bitcoin as an experiment. I wake up every day and think like Bitcoin could go to zero today, accept that reality, and move forward with it, and I’ve done that every day for like a decade. These are experimental systems, and I absolutely agree that a lot of the way that this got marketed really undercuts that experimentation, right? Like, on Anchor, a website like that should be saying loudly, this is an experiment, you could lose all your money, right? Like, if I ran Anchor, I would say that.

That’s absolutely important, and there’s no one that I ever proposed utilizing UST to that I told them, like, this is a safe investment, right? It’s not. It’s risky. It has 100 percent risk of loss. That message has to go along with the experimentation. So, I’m absolutely with you, and I think, you know, I probably could’ve done a better job of that with LUNA, myself, and I think it’s incumbent on anyone in the industry that as you’re advocating anything that you feel is important to sometimes even over-emphasize those risks. I think that’s fair.

Nic Carter: I’ll say one thing here. You know not everyone’s as sophisticated as Erik Voorhees here in terms of sort of taking risks. In fact, you know, very few people are, right? So, what happened with UST, like, that’s worse than some, you know, crypto asset, you know, free-floating, you know, whatever, collapses.

This is worse because it was advertised as being a dollar, being stable, had stablecoin in the name, and the free market of information didn’t clear, right? The information order book had a massive spread because, as Eric says, Do Kwon was extremely hostile to informed critics, and he had an army of supporters, and it certainly kept me from saying more about it, 100 percent. I wish I had, but I also didn’t have the heart to go toe to toe with these people and get blackballed from the industry, because I was, you know, critical what other funds were investing in, right?

So, the information market did not clear. There was insufficient amount of skepticism. The warnings, you know, didn’t percolate, and you had products built on top of Anchor, right? There were neobanks built on top of Anchor, pitching retail, pitching Anchor yields to retail, right, unconscionable stuff, like a subsidized yield that was denominated in unstable coin. I mean that’s dangerous.

Like, you know, big lenders, like Celsius admitted they were involved in this thing. They put client funds in this stuff. So, because it was advertised as a stablecoin, despite having a huge amount of default risk, and because the marketplace didn’t actually internalize the risks here, properly, because criticism was stifled, you know, the outcomes were bad.

I just feel like we have to separate out two things, with Anchor and UST, because you could’ve run something like Anchor on top of USDT. You could’ve run an application where you say you can borrow USDT here if you deposit collateral, if you over-deposit like 2X the amount of collateral that you want to borrow, and then the staking returns of those assets that you deposit as collateral are going to be paid as interests into the people that lend out their UST. I mean Anchor had real revenue streams.

They had real interest streams that went to the people that borrowed out their UST, and you could’ve subsidized that interest that was paid out from a centralized company as a growth strategy. There are tons of businesses that subsidize the utility and the benefit of a product at the cost loss to themselves just to make their product more popular, and if the reserve, like the Anchor were a yield reserve which was being topped up by LUNA all the time, if that ran out, if they didn’t have any more money to top that up, the only thing that should’ve happened is that, well, the interest rates on UST should’ve dropped. They should’ve dropped from being 20 percent down to 4 percent, but it shouldn’t have led to an explosion of the whole ecosystem collapsing with even the chain halting.

That was another problem. That was a problem of UST, itself, having a death spiral mechanic built into itself that could easily depeg if something happened in the market with the value of UST. So, I don’t think that, you know, necessarily, it’s if someone is offering you a very high interest rate on your asset as a growth strategy to make your stablecoin popular, let them do that, and if they fail, the only thing that should happen is that the interest rate should fall. You should not have a catastrophic failure. That failure comes from the reckless experimentation with algo stables, in and of itself.

So, I think it’s important to sort of separate out those two things. I mean the one thing that makes it sort of intertwined is that the reason that the Terra foundation had so much capital to subsidize these yields for UST was because the LUNA ecosystem was growing, and the LUNA ecosystem was growing because UST was expanding, and UST was expanding because people were depositing funds into Anchor.

So, they saw the market cap of UST growing. They saw the expansion of this new stablecoin growing. The value of LUNA grew, and that gave the Terra foundation enough capital to subsidize the yields with, which we made this such a big vehicle that drew so many people in and which is the reason that we have now this Lehman Brothers’ type failure and not just some small, small blip of a failure, instead, but I think it’s just important to separate those things out, there, a little bit.

Laura Shin: So, are you saying that you feel that a decentralized coin like UST could work if it grew more slowly and less aggressively, meaning it could be tied with this kind of savings vehicle that, you know, attracts people to the stablecoin, but if it offered something less than 19.5 percent, obviously probably quite a bit less, do you feel that, then, it would work, and frankly, do you think people might try that in the future?

Eric Wall: I’m saying, like if you take RAI, for example, let’s say that RAI wanted to pay out a fixed interest rate for a while so that people start using RAI more. That’s a perfectly fine growth strategy for them to use. If they run out of governance tokens to issue to subsidize those yields with or the money that they raised in an ICO to subsidize their yields with, the only thing that would happen with RAI in that example is that they’d have to turn off the subsidized yield and then perhaps less people would use it.

But the problem with LUNA is that when less people use LUNA, when less people use UST, the value of LUNA starts shrinking, and then people around starting to want to get out of UST. The peg starts falling, and it turns into this vicious cycle where everyone wants to get out of both UST and LUNA, and the whole system collapses. That wouldn’t have happened in an over-collateralized system. That could only happen to an algo stable like UST, and I think that people are sort of conflating those issues with the aggressive growth strategy of Anchor with the death spiral mechanic that was built into UST.

Laura Shin: So, in a moment, I want to discuss a little bit more this issue around kind of like the cult of DO, but first, a quick word from the sponsors that make this show possible.

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Back to my conversation with Erik Voorhees, Eric Wall, and Nic Carter. So, earlier, we were discussing how people really supported Do Kwon, and he displayed quite a bit of arrogance. You know when I had him on my show, I remember, it wasn’t that I felt certain that UST was going to fail. It was more that I was very confused by the history of failures of seigniorage share coins and his level of confidence in his system.

That like was such a mismatch to me, and I just frankly didn’t understand that, but you know, there were a lot of very reputable venture capital firms behind the Terra ecosystem, which I, this is why, like people have been saying this is similar to Mt. Gox or the DAO, and the way I think it’s differentiated is that, you know, Mt. Gox was being run by somebody who never should’ve been an entrepreneur. The DAO was like these coders created the thing, and you know, but you had reputable companies like, you know, Coinbase Ventures, Pantera, ParaFi Capital, Polychain. I mean there were so many, obviously, Mike Novogratz, Galaxy, like, these are kind of…these places have…to my mind, lend credibility.

And I was just curious why you thought maybe none of them kind of reined Do in, because I also felt when I interviewed him, like, he’s a young guy, like, maybe he just kind of hasn’t learned that humility goes a long way in leadership, which, frankly, you know, after working on my book, I actually feel that that is one of Vitalik’s strengths as a leader, that he is humble. So, I don’t know if you feel that the VCs either share in any of the blame or if you want to express anything about why it is that they kind of didn’t say like, hey, you know, what you’re doing is risky, maybe you don’t want to be walking around so confident?

Erik Voorhees: A few long-form discussions I heard with institutional investors in Terra, they did acknowledge the risk even of the death spiral concept, but that generally only comes out in a long-form discussion, like on a podcast, right? These firms are not going around, advertising that there are risks of this portfolio company. That would be a little strange, and certainly, the arrogance looks so bad, right, like, regardless of whether LUNA worked or didn’t, the arrogance is inexcusable, and that’s the kind of behavior that we should eschew out of the community wherever we see it.

So, yeah, I mean, but ultimately the real problem here is that the mechanism broke, and the focus of this long-term should be what that mechanism was, why it broke, and can it be changed into something that plausibly works better? Everything else is kind of, you know, an interesting detail.

Nic Carter: Laura, I have a lot of sympathy for your view, here. I think the information sort of gathering mechanisms and curation failed in this case. Certainly, the firms that were supportive of Do Kwon and the Terra ecosystem, I mean, frankly, it was a good bet for a long time. It was the most popular trade of 2021. It was the consensus trade. So, basically, everyone in the industry was exposed to this in some way or another, everyone in the formal investment management side of the industry, and there was an insufficient amount of skepticism, and certainly, this was, I think, the way in which this was worse than other Ponzi-like schemes that failed was because of the credibility of the firms that were involved, and people outsourced their diligence, then.

They said, well, X and Y firms, they can’t possibly be getting this wrong, so, of course, it’s safe, right? Like, you know, like you assume that these firms do their diligence properly. The other stakeholder group I would, you know, lightly criticize would be the press, not yourself, Laura, but I personally reached out to a number of journalists about two months ago and said this thing is going to collapse, you need to look into it. Personally, I have receipts, to everyone I knew in tradfi journalism, and said like this thing is a ticking time bomb, you need to look into it, it’s going to be really bad, and none of them, really none of them, investigated it seriously, and Do, in his MSM appearances, like, didn’t receive a lot of pushback.

It was mostly like enthusiasm that he was buying Bitcoin, frankly. Like, that was a huge PR coup, like, Do is buying Bitcoin, you know, like, that was clever. He got the Bitcoiners on his side, too, but yeah, I didn’t see enough pushback from interviewers. So, you know, look, nobody likes it when something collapses and lots of people lose money, and then, you know, you go around, pointing fingers, but like we need to introspect, at some point, like these mechanisms failed. This thing got enormous, and like, the recriminations are only just beginning here.

Eric Wall: I think that…I agree with Nic, and I also think that we give way too much credibility to these big names, these VCs, and the amount of credibility that they add is very artificial in my opinion, because I don’t want to toot my own horn here, but many of these VCs, when they’re doing their due diligence on some of these projects, they contact some of the nerds in this industry and they’re like, hey, can you tell me about, like, is this thing safe, what are the risks in that thing, and I’m one of those nerds that they reach out to.

I get these kinds of questions where, like, is there a risk that I should be…and I’m talking about the biggest names in the industry here. Like, that’s often how they do their due diligence. They ask some geek who they think is very deep in the weeds and just rely on that kid to know the mechanics of that thing. So, I’ve had those conversations, and I don’t think that those VCs are well-versed in the structural risks in many of these blockchains and many of these experiments, and I don’t think that you should, just because, you know, that big firm with X much capital invests in that thing…you got to understand, like, many of these VCs, they get a deal, like, when they’re investing, because their name is so popular, they get a much cheaper deal when they’re investing in something than other people in the market do.

So, their risk/reward, when they’re looking at it, it’s like, okay, I’m buying it at a 50 percent, 75 percent, or even sometimes more, discount. This doesn’t necessarily apply to specifically LUNA, but in many of those cases, they get huge discounts. So, for them to just, you know, buy something, it’s still an extremely good risk/reward bet for them, but it might not be for the people that are buying that on the open market. So, you have this, you know, misalignment of incentives, where people are looking at the credible VCs, who are taking easy, low-hanging fruit, and they’re thinking that that means that they believe in it, and it’s so credible because of that, but the due diligence that they do is often not very good. You can look at a number of completely crap, bullshit blockchains that these VCs have backed that ended up failing that was predictable to many of the people who are experts in the technology of this field.

Erik Voorhees: I want to push back on something here, which is that this idea that like because a VC invests in something, that means they don’t see the risks in it. That’s not my experience at all. I mean, like, generally, these firms recognize huge risks. Their default assumption is that the thing they’re about to invest in is going to zero. Most of the things they invest in do go to zero. That’s where they stand. So, when you see a firm investing in something, that firm’s default position is that that thing is going to zero, and if there’s this like story going around that just because some big name puts money into a project, that means they believe there’s no risk, where’s that coming from? I mean that’s a strange myth.

No, I’m saying that the risk/reward that they’re investing in when they’re doing private deals is not the same as the public investors are exposed to when they’re investing in the project. There’s a mismatch there.

Erik Voorhees: True, although generally the public investors are buying it when the project is far well-established, so the risk/rewards is absolutely different because they’re buying something that has already gotten built and has gotten traction in the marketplace. I mean this is certainly a separate debate, here, but I see what you’re saying.

Nic Carter: Well, there’s one other thing worth mentioning is that like a lot of people’s perception of Terra, you know, UST was that it was sort of indirectly also backed by the whole Terra ecosystem, you know, like that there is like this association between like the usage of Terra and like the backing of the peg and that this thing could have a soft landing if the Anchor yields have operated.

Like, everybody knew that Anchor was subsidized. Like, that wasn’t like a secret, but the view was like there could be a soft landing, and I think that like really misled people because they have these like folks theories of like tokenomics, you know, where they think, oh, like it’s a vibrant blockchain, like, you know, they’ll figure it out, they’ll have like the tools and the firepower to figure it out, as long as this thing is big enough, there’s enough apps, there’s enough utility, enough usage, and you know, like, that was also a prevailing method I saw is like, okay, look, UST will survive because they’ve got all this like stuff going on in the Terra ecosystem, but the theory like was just unsound.

Laura Shin: Let’s shift a little bit. I was going to ask a few more questions about Do, but I don’t necessarily like want to pile on, at this moment in time, but I do think there’s like a lot of questions kind of about his behavior that could be raised. Actually, well, before we move on, I am curious, do people feel like someone like Do or like people involved with Terraform just wouldn’t have any future in this industry? You know I saw that the community is saying that they want to revive the ecosystem without Terraform Labs, and I was kind of curious what your thoughts were on whether that was possible or a good idea.

Erik Voorhees: Possible, yeah. I mean that’s part of what makes LUNA somewhat decentralized is that like it can actually get pulled away by other people in the community and rebuilt in some other way. That could never happen with USDC, for example. So, yeah, I have no idea if it has any future at all. You know probably not, but it’s possible.

I mean I think the credibility’s been lost, and I think we need a lot of answers before we actually get to the final sort of diagnosis here, which is, like, for instance, what happened to the Bitcoin? Where’s the Bitcoin? Like, what did they do with it, right? Like, the Bitcoin was claimed to be used in support of the peg. Like, they had several billion dollars’ worth of Bitcoin. They’re not transparent about that. Like, that is something that we deserve answers for before we can move on. Like, we’re still in a state of uncertainty regarding that, and I think if they sacrifice the peg and let the system collapse and just hung onto the Bitcoin and kept it in their reserve, like, then, that becomes like…it’s already a serious matter, but that enhances the severity.

Laura Shin: But I’m sorry, wouldn’t that be visible? We would see…?

Nic Carter: We know that the coins are somewhere on chain. They moved from the reserve wallet. We don’t know what happened to them, and they haven’t said anything about it, whether they were deployed in the market, whether they borrowed against them. We just don’t know.

Laura Shin: Oh, and did they make any announcement saying that they were…I feel like I saw some announcement saying that they were going to be working with market makers to try to…?

Erik Voorhees: It’s not clear. Yeah. It’s not clear.

Nic Carter: Yeah. So, like, the level of transparency has been very poor, but yeah, they did say something when it was sort of starting to suffer, a little bit, but nothing since then.

Eric Wall: I think probably the important thing here is to look at the assets that were bridged into the Terra ecosystem. They need to be safely bridged out from there, and there are other issues like, for example, Chainlink Oracles, their reporting on the LUNA UST price, because the spec of Chainlink didn’t expect the price of LUNA to go down, so way down into the zero digits, that there’s now a mismatch, like, there’s trillions and trillions of LUNA out there that the like Chainlink protocol, for example, can interpret as being worth more because they don’t have like the granularity of digits to describe what it’s actually worth, and there’s already been attacks because of that where people deposit trillions of LUNA into a protocol, and they get to withdraw some of their asset because these protocols aren’t pricing LUNA correctly, anymore.

So, that’s one thing that needs to be resolved. Getting those assets out of LUNA is also something that needs to be resolved, and then there’s also, like, it’s so cheap to attack the LUNA ecosystem, right now, because it’s a proof of stake-run chain. I think that’s why they halted the thing. So, just getting the thing up and running and not having it be like easily attacked and reversible is another thing that needs to be addressed so that like the connections with the Terra blockchain, using the IBC protocol, in the Cosmos ecosystem, that’s also something that needs to be carefully handled.

So, I think that we are not in a moment where we should be thinking about how do we relaunch this thing and make this into a success. This is all about just putting out the fires that these irresponsible people have started, and once we’ve done that, like, maybe you can relaunch Terra, maybe you can air drop a token to the people that held Terra and LUNA before the crash, but I mean who cares? Who’s going to give credibility to those initiatives? Like, what is the interest in that experiment, right now? Like, maybe some other project that we’re building on top of the ecosystem, they might still want to do something. They might want to have somewhere to build, but I see no reason like why that should have to be like a Terra fork or something. Like, it can be on some other system now that the stablecoin is dead.

Laura Shin: And in general, where else do you see a risk of contagion in the rest of the crypto markets, because I did see…Lido, I guess, was talking about some of the…I think it was like staked ETH and bonded ETH that had been bridged over to Terra…I don’t know if the rest of you kind of know some of the other ecosystems, but I was curious if you saw risks elsewhere for crypto?

Eric Wall: Yeah, so, UST was…like I think the Cosmos ecosystem is most at risk because they were like trying to make UST their…the pioneered stablecoin in that ecosystem. So, Osmosis, for example, which is a decentralized exchange, had lots of pools with UST in it, I think. The other part of the Cosmos ecosystem that were leveraging the UST asset inside of lending protocols, like that’s where you’re going to see these risks, I think.

So, the Cosmos ecosystem needs to sever its bounds with UST in a safe way, and there might be like liquidations happening across the board inside of that ecosystem. That’s where like I’m mostly worried about. I think like getting the staked Ether that was being used as collateral bridged into LUNA, that’s just a matter of bridging that back out. You know what happens to LUNA doesn’t really matter. As long as the chain is working, you can wormhole those assets back out, or you can just use a bridge and get those assets out of Luna.

Nic Carter: And I mean the staked Ether is just, you know, IOU for post-merge Ether, so, like, there is sort of like an asset underneath that. It’s just that, you know, it’s sort of indeterminate when it’ll be extractable. The one risk I see is certain firms, like Celsius admitted they had exposure to UST, and it seems like they were nimble enough to get out in time, but we’ll probably hear a little bit more in the few days, next few days, about lenders whose yields were derived from Anchor, which is just tremendously irresponsible, especially if you’re passing through those yields to retail investors.

So, my guess is yields come down, you know, just generally speaking, in the stablecoin space, for a lot of these CeFi lenders, and you know, that’s because some of them had it in Anchor, right. So, that’ll sort of be evidence that the yields come down. That’s because you had it in Anchor, the highest-yielding, most liquid pool. I think if any of these things were really going to blow up, we we’ve probably seen signs of that by now. So, maybe, you know, most of these firms were nimble enough to get out, but yeah, I think that’s one, you know, not necessarily catastrophic thing that we’ll see but like one outcome here is that stablecoin yields go down.

Laura Shin: And Erik Voorhees, have you followed any fallout with THORChain? I know you’re kind of a promoter of that in Cosmos. So, I don’t know if you’ve heard of anything and if you have a sense of what might happen?

Erik Voorhees: No, the biggest issues with THORChain was just that during the collapse, you know, which has been ongoing, the Terra chain has been so clogged that the THORChain Terra nodes were not able to keep up with the blockchain, and so, the THORChain validators just turned off that chain in THORChain for the time being, but you know, that’s a good way of handling that risk.

Yeah, I think the damage here is largely by the people that held LUNA and UST. Tragically, it’s also going to be held by people that didn’t realize they were holding UST, right? So, to Eric and Nic’s points, if other companies were utilizing the system behind the scenes and not telling their users about it, that’s a big deal, and that’s a big problem. I wouldn’t assume that we know all those stories yet. You know there could be some very uncomfortable board meetings happening, right now, in which they’re discussing these very things and how to communicate it out to the public. So, yeah, that’s really bad. We’ll see what goes on there. Yeah. That’s about all I know at this point.

Laura Shin: One other thing I was wondering about was whether there are any projects that have their treasuries in Anchor. Have you guys heard anything about that?

Erik Voorhees: Yeah. I’ve heard of a couple. I don’t want to name them on this show, but they had some. It wasn’t catastrophic, but you know, minimal losses from some portions of their treasury, and I think any firm that’s doing that with their own money, you know, that’s fine. That’s their risk, and hopefully they were doing that eyes wide open. The real moral problem, the ethical problem, is if anyone was doing it with customer money and not telling those customers.

Nic Carter: Well, I mean, in my view, corporate treasuries don’t belong to the executives. They belong to the shareholders. So, I think it would’ve been tremendously irresponsible for a firm to put their balance sheet in this thing.

Laura Shin: Yeah. One thing I just wanted to circle back to, a little bit, was Nic, earlier, when you were talking about how when Terra announced that they were going to use Bitcoin as a backstop in their reserves, what do you think that this whole story says about Bitcoin’s use case as collateral?

Nic Carter: I was sort of initially intrigued by it, and then I realized that this was going to be net bad for Bitcoin, because it was going to be sucking up a fair amount of Bitcoin, we thought up to 10 billion dollars, and then disgorging it when the system failed. Thus, merely intensifying the cyclicality of Bitcoin, causing more reflexivity. This is what happened with PlusToken, if you recall. PlusToken scooped up something like 200 thousand Bitcoins. It was much, much larger, and then it spat them back out when it failed.

So, you know, these kinds of unstable systems buying a lot of Bitcoin, obviously, that was a little bit different, but unstable systems sucking up Bitcoin, then spitting it out when they fail, is not good for Bitcoin. Obviously, anybody can buy Bitcoin. I can’t stop them doing that, so, whatever. It’s just I did point this out at the time as like Bitcoin probably shouldn’t be celebrating this. All of that said, like, Bitcoin does have a great story as a kind of pristine collateral, so to speak. I would hope to see it backing a stablecoin in the RAI model.

I think the Reflexer Labs people are thinking about creating something called BAI, which would be Bitcoin-backed RAI, and you know, that would be over-collateralized, in theory. So, that, I like. I think that would be great. That would have to be over-collateralized, but yeah, I think there’s a lot more to be said about Bitcoin acting as kind of a specie in a free-banking model. I’ve long been optimistic about that. I’d love to see more models like this developed where you have, you know, interesting ____ 1:02:14 banks built on a Bitcoin reserve, things like that. I think that’s like the long-term fate of both Bitcoin and Ether is to be more of a collateral than medium of exchange, against which you would issue bank notes or other things like that, but I haven’t seen a ton of experimentation there, on the Bitcoin side, at least.

Eric Wall: I have a sort of controversial take here, which I think that perhaps the addition of the Bitcoin reserve added to the collapse of UST, and I’m going to explain how that might be. It’s because if you have 17 billion of UST and for some reason it starts to depeg, and people are running through the door, those people know that there’s 3 billion of Bitcoin that are standing ready to cushion the fall. You don’t want to be trying to exit the system after all those 3 billion has been used up. You want to be getting out of the door while that big Bitcoin cushion is standing to cover for you.

So, it creates an incentive to even be quicker out of the door because there’s a small door there that can cushion the fall in a much better way than LUNA can. It doesn’t have this death spiral mechanic to it. So, it creates an incentive to be even quicker out of the door, and I think that when LUNA started to depeg and Do tweeted that he’s deployed this 1.5 billion of Bitcoin to market makers, then people are realizing like, okay, I can get out of the system now without losing all of my UST if I just use that 1.5 billion Bitcoin exit liquidity, but if I’m too late, if I’m trying to exit after the Bitcoin’s already been gobbled up, then I’m going to have to try to exit into LUNA, and then I’m going to be second-grade citizen trying to exit the system, I’m probably going to get a worse price. So, by tiering up, if you create like a tier of exit mechanics where one is sort of premium, then you increase the incentive to exit the system quickly.

So, I think that that might’ve…you know if we’re talking about timing, we’re talking about the 4pool in Curve, but I mean this 3 billion Bitcoin reserve also was just established moments before it all collapsed. So, the establishment of the Bitcoin reserve, in and of itself, might’ve been additive to the collapse of LUNA. So, I don’t think that you should use Bitcoin in these under-collateralized pegging systems. If you’re going to do it, it should be an over-collateralized peg, I think.

Erik Voorhees: That’s a really interesting point. There’s also like some recursive potentials there where because…a lot of people thought that like by backing Terra with Bitcoin, Bitcoin was the mechanism that supported the value, right, which was a misnomer, that the peg mechanism was the mechanism. Bitcoin was meant to be sort of a bonus, but everyone started focusing on like, oh, it’s Bitcoin that backs it, it’s Bitcoin that backs it. So, when the first problems start showing up, people start imagining that all sorts of Bitcoin is about to get sold, and humans are bad at scale. Like, a lot of people felt like Do Kwon owned so much Bitcoin that when he tries to defend this peg, it’s going to destroy Bitcoin. They have no sense of scale of like 3 billion dollars of Bitcoin is actually a pretty tiny part of the market cap.

So, there’s this outsized influence of what people believe will happen with Bitcoin, you know? So, if they’re speculating and trading, they’re going to be selling Bitcoin just in anticipation that others will be selling it, and if the Bitcoin market is falling drastically, that’s generally going to pull down the entire crypto market, which is going to pull LUNA, itself, down further, and so, these things can exacerbate themselves. I think it’s totally plausible that the Bitcoin backing, partial backing, made this worse. It’s possible that if they had far more Bitcoin, it would’ve made it better. So, this isn’t really like a simple question here, but it’s an interesting one and probably one that people are going to be analyzing for a while.

Eric Wall: It’s really the same thing when Russian Central Bank was thinking about adding the convertibility of ruble into gold. If you take just a small part…when if you have way more ruble than you have gold, and now you add a conversion mechanism for ruble into gold, now, the people who want to get out of ruble, they’re going to rush to convert as much…now they have this buy wall with gold that they can just sell their ruble into, and that may lead them to now try to dump the ruble more versus the case where there wasn’t an exit mechanism like that, at all. So, it’s the same type of mechanic there. So, I was also sort of anxious when people were proposing that they would sort of partially back the ruble with gold, as well.

Laura Shin: One thing that I couldn’t help but notice was…so, I’m not going to lie. Like, you know, after all this happened, I just thought algorithmic stablecoins are dead, and so, yesterday, I recorded an episode where, at the end, when the guest said that he felt people would try them again, I was laughing, but actually, overnight, now, I’ve changed my mind, and I do think people will try them again, but I did see people saying things like, well, the US dollar itself is an algorithmic stablecoin, and I think what they’re saying is both of these things, the US dollar and these algorithmic stablecoins require faith in them for them to succeed, and I was curious what your take is on that.

Eric Wall: That you require guns.

I mean like I think that’s vacuous, frankly. Crypto people love to, you know, try and puff their chests out, a little bit, by insisting that the dollar is also a Ponzi or whatever, but I mean, like, there’s genuine structural dynamics which back the dollar, like, most debt, globally, is denominated in it. So, you need to acquire dollars to extinguish the debt. That’s the main thing. We cooked up this inventive petrodollar scheme in the ’70s where, you know, we price oil and commodities in dollars, and we give all these nations guns. As Eric says, like, we have the Bretton Woods system.

We have these gigantic international financial institutions which, you know, promulgate the dollar, give loans in dollars, you know, insist on managing the economies of all these states globally. I mean tax liabilities can only be extinguished in dollars. US securities markets are denominated in dollars. You need dollars to buy treasuries, vice versa. Treasuries pay out in dollars. Like, I could go on, you know, and it’s just like a world of difference, and like, ultimately, nation states have the firepower.

Well, certainly, the US does, but there have been nation states that have tried to fix these pegs and basically say, like, I’m declaring what the market is, I’m going to try and fight the market, and so, like, there have been these analogies to algorithmic under-reserved stablecoins at the nation state level, and the nation states have lost, in those cases, right? So, you know, like the US is not pegging the dollar, and even when we did peg the dollar to gold, you know, we had a trade deficit or current account deficit, I think, in the ’70s, and like that peg came under pressure. So, like, if you’re pegging it, that’s different than having a free-floating currency, but yeah, like the value of the dollar is multifaceted, and I can’t stand it when crypto people just say it’s like a collective delusion, or whatever. There’s like real mechanical things that support its price.

Erik Voorhees: Yeah. Those are not exclusive. I mean the dollar is a collective delusion, and there are mechanical things that support its price. The main difference is between something like UST and the dollar is that there’s no algorithm at all. It’s up to just the whims of, you know, a cadre of men that sit around and like decide things and then announce it to the market and a question of scale. I think anyone that casts shade on something like UST but then embraces fiat currency, generally, should do some deep soul-searching.

I think when and as fiat currencies, themselves, collapse, this kind of microcosm of the danger and destruction of this failed mechanism is going to be writ large across the entire world, and we’re not going to be talking about a 20-billion dollar experiment that fell apart but the entire global financial system. I mean this is the point of building something like Bitcoin as an alternative because dollars are, themselves, the biggest scam and the biggest liability in the entire world, right now.

Eric Wall: But UST was not just an algorithm. Even if we separate out the Bitcoin reserve, Jump were testing liquidity parameters or how much the spread fee should be when you’re trying to push liquidity through the UST/LUNA conversation mechanism in order to dampen the likelihood of a bank run by creating a spread and giving people less LUNA for their UST, and they were tweaking those parameters.

So, you basically have like Jump coming in and saying we tested, we’ve done some simulations, can you adjust these parameters so that the spread fee will adjust differently? They were also tweaking and adjusting the system all the time much in a similar way as the Federal Reserve does when they’re thinking about stabilizing their system, as well. So, I’m not saying they’re completely the same, but there are also similarities there.

Erik Voorhees: It’s fair, but in UST’s case, there was always an algorithm that you could find on a GitHub repo, right, and that it could be tweaked, but everyone knows what it is at all times, right? Like, so for all of UST’s failures and flaws, it was still an open system that everyone could see how it worked on a mechanical level. The mechanism broke and failed. It should’ve been done better, but it’s an open system, and I think this makes it vastly more meritocratic, more valuable, more ethical, than something that is imposed on people through violence in which there is no GitHub repo to speak of.

Eric Wall: But it didn’t make it work any better, in the end, I mean.

Erik Voorhees: This case failed, yeah. This case failed, but the iterative process of money that can be built through open-source software, I think all of us would agree, with time, will produce a superior result.

Laura Shin: I just want to ask one last question, which is I was curious what you thought this whole debacle would result in, in terms of any kind of action from regulators or any other fallout. You know what would you think happens after this?

Nic Carter: Ultimately, it would have to be a Congressional thing in the US that really, you know, draws a distinction between these different types of stablecoins and tries to impose a new regulatory regime. The SEC was sort of looking into Terra but in the context of their mirror protocol, I think, or is that what the one was called…?

Laura Shin: Yeah. It’s like a synthetic. Yeah.

Yeah, and so, that’s why they didn’t like it, because of the, you know, kind of miniscule synthetic equity thing, which is like kind of funny, I guess, you know, that they kind of like didn’t…maybe they were already looking into the other, bigger problem, but…

Erik Voorhees: Yeah. They found the piece that worked fine and had a problem with that and completely missed the part that was broken.

Nic Carter: Yeah. It’s like a classic SEC thing. The problem is that Congress is not doing much of anything right now. They have never passed any crypto, really, meaningful crypto legislation. So, maybe this catalyzes them into action. It might have to wait until after the midterms. I think like long-term, what’s very possible here is that we get something like the Stable Act does go through, and you know, your dominant, major fiat-backed stablecoins become regulated as banks. So, they’re forced to get bank charters, and so, they move away from the state by state models, like the Trust Charter, you’ve got the New York Trust Charter, Nevada Trust Model, or you have the state by state money transmitter, like USDC.

You know the Federal Government reasserts itself and says, okay, you can’t do this federal thing, federated thing at the state level. You have to get a bank charter, you have to be FDIC regulated, the OCC has to regulate you, and that dramatically reduces the vibrancy of the stablecoin system. It reduces competitiveness. It probably increases scrutiny. Maybe it means that stablecoins are less private. You know maybe the model where the issuer doesn’t track the internals of the network, they don’t track the peer-to-peer transactions, maybe that goes away.

So, yeah, I think it’s a shame because stablecoins, generally, are great. I want it to be competitive. I want there to be many issuers, responsible, at least. Yeah. Certainly, I think like they’ll take a much harsher view of any algorithmic stablecoins but also just stablecoins generally.

Eric Wall: I think it’s, if we’re lucky, they’re going to look at this as just another Bitconnect failure.

Laura Shin: If we’re lucky?

Eric Wall: Yeah, if we’re lucky, they’re just going to say, oh, well, you know, another Bitconnect failure, but if you look at the sheer magnitude and size of the value of operation, because of the LUNA death spiral, we’re talking about like almost like an order of magnitude, I think it might be order of magnitudes difference here. Like, we’re talking about, you know, how much was it? Was it 40 billion dollars, or even more?

I mean if you count UST, it was almost 60 billion.

Eric Wall: And isn’t that like Lehman Brothers’ scale failure that we just synthesized here overnight in crypto? I mean that collapse, if we’re unlucky, and they don’t just look at this as a Bitconnect failure, they might look at this as like something that really needs to be clamped down on, and it’s going to damage parts that weren’t even…you know it’s going to touch all of stablecoins. It’s going to touch all of crypto because we heard Janet Yellen commenting on this almost immediately as it happened. I’m just very, very worried that this is going to cause an immense lash back to the entire cryptocurrency industry, and if we’re lucky, it will just be, you know, another Bitconnect failure that will eventually be swept under the rug with other catastrophic failures in crypto.

Erik Voorhees: I think it’s worth pointing out that of all the devastating losses from this, much of the wealth that was lost was first created by LUNA, right? So, this is a little different than like a traditional financial institution that blows up, and 50 billion dollars is gone, and that was like people’s money that came from somewhere else. The majority of the market cap of this whole system was created by LUNA, right, and that’s lost now and is going to be very consequential to people, but that’s important to keep in mind.

Laura Shin: Yeah, except for the people that put in their life savings and stuff, which I have seen social media posts about that, but…

Erik Voorhees: Yeah, I’m not saying that this isn’t devastating for lots of people. It absolutely is, but not every dollar that was lost was some exogenous thing that just disappeared. In terms of the regulators, like, their agenda is pretty clear that they want to move the world toward a CBDC, slowly or quickly, and anyone that pays attention to this stuff realizes how Orwellian and horrible that future would be. So, they will absolutely use this as an example of why it’s so important that we flee to the safety of the heavily-regulated CBDC, you know, ordained by the governments.

They will use this as an example of that, and they will probably use this to bolster further regulation against the industry. I think that’s all inevitable, anyway. This is just like something that they will use to assist in that process. Really, what matters here is the decentralized technologies. Like, we need a decentralized stablecoin, whether it’s done collateralized, or whether an algorithm can be figured out that makes it work.

A decentralized stablecoin is absolutely important, and anyone who’s working on that, right now, I want to, you know, just give a lot of respect to because it’s an extremely important part of what this whole industry is providing, and then, most important of all is like a true decentralized money for the world, and that’s what we have in Bitcoin. So, this is a big event. I don’t want to make light of it. I don’t want to like sugarcoat it. Lots of mistakes were made, and the whole thing fell apart, and tons of people are suffering, and that’s where we stand, but industry will move on from this and hopefully a lot of lessons can be learned, both on the economic level and on the social and game theory levels.

Laura Shin: All right. This has been such a great discussion. Why don’t each of you just quickly throw out your Twitter handle, so people know where to find you?

Erik Voorhees: I’m @EricVoorhees, same spelling as in the profile here.

I’m ERCWL, and by the way, Laura, you introduced me as the chief investment officer of Arcane Assets. I resigned from Arcane Assets and will be moving on from that shortly. So, just a small edit there.

Laura Shin: Okay. Thanks for correcting.

Nic Carter: Nic___Carter, that’s two underscores. Other one was taken.

Laura Shin: Great. Well, it’s been so great discussing all this with you. Thank you all, so much, for coming on Unchained.

Eric Wall: Thank you, so much, for having us.

Laura Shin: Thanks, so much, for joining us today. To learn more about Eric, Erik, and Nic, and the whole Terra fiasco, check out the show notes for this episode. Unchained is produced by me, Laura Shin, with help from Anthony Yoon, Daniel Nuss, Mark Murdock, Shashank, and CLK Transcription. Thanks for listening.

Posted in: 2022, Shows, Unchained Tagged in: algorithmic stablecoins, Anchor Protocol, Arcane Assets, bitcoin, BTC, Castle Island Venture, CBDCs, Do Kwon, Eric Wall, Erik Voorhees, ETH, LFG, Luna, Luna Foundation Guard, Nic Carter, ShapeShift, stablecoins, UST

General Partner at Castle Island Venture

Former Chief Investment Officer of Arcane Assets

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