Proof of Misgovernance
3 weeks after Terra 1's default, Kwon's hostage-taking of the Terra 1 network begs the question: Why?
3 weeks after USTC/LUNC’s de facto bankruptcy, LUNC ($700 market cap) trades a mind-boggling $300m USD per day, fueled by a massive contingent of new speculators. LUNC also dwarfs UST’s market cap ($185m).
Other fragments of the Terra 1 network retain considerable trading value. The Anchor token (ANC) somehow trades over USD $100M per day, if CoinGecko is to be believed.
LUNC-USTC (formerly LUNA-UST, ie, Terra 1) retains far more potential to the crypto industry, and indeed global finance, than LUNA (Terra 2) will ever be. However, that value can’t re-accrue as long as Kwon and/or Jump control a supermajority of staked LUNC.
There’s considerable outside interest in recapitalizing Terra 1, modifying its collateralization structure to something more conservative, decentralizing the reserve, and trying again. This interest is shared by Terra protocol members, ex-TFL employees, and deep-pocketed outside investors.
However, Kwon’s “temporary” takeover of Terra 1 governance on May 12th, now in its fourth week, makes this impossible. This is turning into a major, underreported cautionary tale around Proof-of-Stake in general. The concept of protocol “governance rights” were circling the drain already, but Kwon’s conduct around Terra 1’s governance represents a new low in protocol mis-governance.
The not-so-temporary Terra 1 takeover
On May 12th, as LUNC (then LUNA) was hyperinflating towards zero, Kwon bought 244m near-worthless LUNA and staked it across friendly validators. (It’s relevant to note here that Kwon always closely controlled which validators were whitelisted, and a large majority of validators on Terra were somewhat or very closely connected to him.) The total amount of staked LUNA went up from around 320m to 610m (out of trillions). In other words, 610m LUNA out of trillions could actually vote on anything. According to reports at that time, Jump had around 36% of staked LUNA, Kwon had 45-50%, and OG’s owned the balance.
The rationale was that as LUNA’s economic machine was falling apart, “governance attacks” — an outsider buying up lots of LUNA to take network control — were a growing danger. Because Terra was imploding towards zero so fast that Terra had literally run out of decimal points to express LUNA’s hyperinflation towards zero, “the community” — of validators who were generally somewhat closely connected to Kwon — agreed.
Since then, the amount of staked LUNA/LUNC dropped to 360m. Given the volume of dumped LUNC, it seems highly likely that Jump and many other stakers blew out, leaving Kwon with a supermajority of staked LUNC.
LUNC-UST today: the opportunity
Fast forward to today. Terra 1 has $11.115B of bad debt: 11.3bn of USTC circulating supply, and a $185m USTC market cap.
Terra 1 also has $515m of net equity: $700m LUNC fully diluted market cap, and $185m of mark-to-market debt (USTC market cap).
After the airdrop-launch of Terra 2.0, LUNC staking remains completely disabled, with no end in sight.
The ingredients are actually in place to resuscitate Terra 1. By my math, an outside syndicate could recapitalize Terra 1 as a 50-75%-collateralized algostable with $1.5-2B of total capital.
However, Kwon has been completely mum on the fate of the Terra 1 network, and has given no insight into when Terra 1 will be opened up to the wider world. Meanwhile, he very likely controls a large majority of staked LUNC. Until outsiders are allowed to stake validators who aren’t related parties of Kwon, “governance rights” on Terra 1 are worthless.
What is Terra 1’s value today?
There are many sources of perceived value in a modified version of Terra 1 — the undercollateralized algostable combined with the governance token.
Terra 1 was an attempt to answer one question: “Could a private-sector actor create an on-chain, deregulated, autonomous eurodollar?” The TAM of such a financial product, if it worked effectively, would be in the trillions. It’s a risk worth taking. The chance of such a product working is somewhere between 10% and 100%, with a payoff in the trillions.
Terra 1 was laps ahead of competitors in demonstrating product-market fit. In my opinion, there is room for 1 or 2 low-velocity, ETH-based reserve algostables (DAI / FRAX; the Swiss franc) and 1-3 non-ETH high-velocity algostables that could mediate everyday transactions (a la the fiat USD & RMB today). These are winner-take-most markets, which means that rapid growth has high relative value.
Users: 4.5M total wallets; 990k MAWs (Monthly Active Wallets); 489k active wallets in last 14 days.
Terra 1 was by far the most successful attempt to build the latter high-velocity algostable to date. Evidence suggests that that its unique user base expanded by 100-200% during the crash, as new spec users poured in (South Korean data suggests an almost 200% increase). No other algostable came close to this level of onboarded concurrent users, and no other network sustained that level of usage with a modestly decentralized network combined with very low transaction costs.
$400M (USD) of daily turnover on LUNC, USTC, and ANC alone. Value: $1M+/day, but will depreciate over time.
A mostly-completed decentralization roadmap. Progressive decentralization is extremely risky. The founder(s) needs to give up countless opportunities for insider trading/grifting the community, as well as the intoxicating media attention given leader-founders (Kwon) over follower-founders (Buterin). The good news for Terra 1 is that decentralization finally happened by force: no central entity owns much LUNC due to the hyperinflation of LUNC supply.
A (potentially) unparalleled redemption-arc narrative. Cryptocurrency valuations in the medium term are driven by narrative, builder participation, and credible relative yield, in that order. A salvaged Terra 1 narrative would take Terra’s narrative from zero to hero.
Blockspace: This can be valued as total protocol fees and value accrual to stakers. It’s extremely subjective, but everyone can agree that in its current state it’s extremely depressed. Value potential: $1-5B
Kwon’s conduct disqualifies him from running a new algostable. A partial list of Kwon/Jump’s unforced governance errors, mostly repeated from prior posts, is outlined at the end of this document for easy reference.
Current community proposals to save Terra 1
The Terra Agora has been overrun with community proposals to save Terra 1. Formally submitted proposals are shown here to anyone with a Terra Classic wallet.
Most of the proposals are shitposts.
The serious proposals focus on Tobin-taxing Terra 1 trading volumes ($400M+ per day) to gradually recapitalize the USTC peg. While theoretically feasible, these suffer from several drawbacks:
the trading volumes will drop significantly after the tax is introduced
without opening up validator delegation, the swap tax will accrue to Kwon who control 75-85% of staked LUNC
Kwon, by controlling a large majority of staked LUNC, have de facto control over the efficiency threshold of any USTC burn. A purposefully inefficient burn threshold would generate very high USTC swap taxes which would accrue to LUNC stakers (mostly Kwon).
The most theoretically viable proposal redirects most validator commissions towards buying back and burning LUNC.
Unfortunately, Terra 1 will take months to recapitalize itself organically, while better-capitalized competitors move in. Terra 1 has a narrow window to be recapitalized by an angel syndicate and be revived. However, Kwon’s governance hijack of Terra 1 makes that impossible.
If Kwon, as the presumed owner of 75%+ of staked LUNC today, dumped his 75%+ share of UST (from swap fees as UST were “burned” into new LUNC) on the open market and extracted it from the Terra 1 protocol, it would keep the peg broken while massively enriching Kwon and the few other remaining LUNC stakers. Alternately, if Kwon dumped his swap tax revenues and exchanged it continuously for LUNC, he could build a large share in a recapitalized LUNC at no cost to himself.
Kwon seems to be aggressively flexing his pocket veto regarding proposed governance changes. Important governance votes receive very little participation from staked LUNC holders and don’t come close to the quorum required to pass (120M LUNC votes). Assuming Kwon now owns more than 250M staked LUNC, it’s not possible for any governance proposal to reach a quorum without his assent.
Speculation thus mounted that Kwon’s governance hijack of Terra 1 was actually a way to starve Terra 1, to subsidize a new algostable on the Terra 2 network.
Cui bono? A new Kwonzi algostable
No sooner than I wrote the above sentence, an unsurprising piece of news was reported.
Although @FatManTerra hasn’t been the most reliable narrator, his scoop would explain a lot. Kwon presumably doesn’t want Terra 1 competing with a new Terra-2 algostable in which he owns a much larger share. Kwon knows he’s damaged goods, but he still owns operating control of Terra 1, share-for-share ownership be damned.
LUNC owners today are in a similar position to US owners of Chinese ADRs: they own a piece of scrip that means whatever its ‘government’ (Kwon) wants it to mean.
The high trading volume of LUNC, ANC, and probably other tokens represents an extractive free call option to Kwon, to the extent that they wanted to tax remnant LUNC activity to subsidize Terra 2 (LUNA). If LUNC were restored to solvency, they would lose the free call option, and developer activity would also flow back to LUNC and away from LUNA.
Taking Terra 1 hostage to subsidize a Kwonzi Algostable 2.0 would be a huge wasted opportunity for the industry. Any new Kwonzi algostable governance token would be an all-in short to zero. Kwon screwed depositors and equity owners alike in his bankruptcy reorg of Terra 1, and would use the same exploit (the fact that the network isn’t remotely decentralized) to hijack Terra 2.0 during bankruptcy and once again rinse outsiders for his own benefit.
Forking: pros & cons
A fork-airdrop of the Terra userbase would be the best approach if Terra 1’s governance doesn’t change. Active wallets between time X and time Y could be snapshotted, with special consideration given towards wallets which voted constructively on Terra 1 governance, and blacklisting applied to validator wallets which declined to vote for said proposals. This would be a good way of filtering toxic, pro-TFL actors out of an airdrop scenario.
A fork-airdrop to Terra 1 wallets would have much more ‘breakage,’ however, than a brokered takeover would. Terra 1’s users are united in a sort of shared financial trauma and would have very high participation in a Terra recovery, with a restored dapp ecosystem within easy reach. The re-onboarding of exiled Terra 1 projects & unhappy Terra 2 projects would be similarly seamless. Getting the dapp ecosystem on board with a fork would be a significantly messier process.
A brand new algostable starting from scratch would also start too far behind current overfunded competitors such as USN (Near) and USDD (Tron), with no surrounding dapp ecosystem and none of Terra’s well-honed UX.
Based on what we know now, forking Terra 1 may be the most viable option for a syndicate of “adults in the room” (eg, a16z, Maker, and other VCs not involved in Terra 1), if they’d immediately commit to a smart-contract-focused decentralization roadmap.
Kwon/TFL/Jump fabricated a “network attack” narrative, strongly rebutted by Nansen.ai, to justify backdating the airdrop to a pre-“attack” timestamp, thus maximizing their airdropped control of Terra 2
Kwon: minimum 3% of Terra2 (20m out of 750m LUNA tokens), probably significantly higher
Jump: 36% pre-depeg ownership of Terra 1 ~ 30% ownership of Terra 2
Kwon/Jump violated the rights of not only equity buyers who stepped in (LUNA buyers between $70 and $1) but also debt buyers (UST buyers who bought after the peg broke). LUNA buyers during this time would’ve seen a 99%+ drawdown regardless, so the end result doesn’t matter; but UST buyers at $.10-$.25 saw their rights most egregiously violated.
By giving terrible treatment to people who bought in mid-crisis, it completely eliminates one of Terra’s core ingenuities — risk symmetry.
Kwon’s hubris stymied community efforts to reduce Anchor incentives and slow the growth of unproductive Anchor capital. Thus, Terra’s “Anchor unproductive capital ratio” — [Anchor deposits minus Anchor loans] / [Terra TVL] — ballooned from 10% or less in 3Q21/4Q21/Jan22/Feb22 to 30% of TVL by late April 2022. This $9B of “ponzu” capital blew the peg apart when it tried to exit en masse in early May 2022. Jump, the only insider who could’ve forced a stop to this ponzinomic behavior did nothing to stop it.
Kwon’s and Jump’s behavior strongly suggest that Kwon gave Jump senior treatment in exit liquidity, because Jump loaned Kwon money secured by the Terra protocol and/or Kwon’s personal assets to spend the first $1.2B of BTC defending the peg. This backroom subordination of the LUNA community to Jump would be outrageous by any blockchain or fiat legal standard.
Kwon, in collusion with Jump, also launched a bunch of rug-pull non-protocols like the Valkyrie Protocol, which took in millions of assets and created literally nothing for it. I’m informed on good authority that Kwon & Jump made enormous profits from backroom token grants/dumps of these protocols.