Terra's Hunger Game [edited]

Trying to map Terra's increasingly terrible choices going forward

A few thoughts after the nuclear fallout of the last 72 terrable hours. I don’t have much time to post more detail yet, I will try to get to it over the weekend.

• Only the survival of the network matters now.

• What matters for the survival of the network?

  • Network security: is it worth validators’ time to keep securing a shitcoin network? Their electricity, AWS, etc costs are in fiat. Validators are burning money by sticking around unless they think the NPV of the network can regain equilibrium. They must not leave.

  • Keeping the off-chain assets (users, dapps, developers) committed. Forking UST/LUNA into UST2/LUNA2 is not an option. It would cut off Terra from dapps like Astroport, Kujira etc which feed into it. Most of those developers, even if they’re currently TFL employees, would have no incentive to start over, re-acquire financially devastated users, etc.

• Do Kwon is like Donald Trump after his 1989ish bankruptcy. He has a certain idiosyncratic branding genius, but his arrogance — in particular, keeping the stupid 24% Anchor APY around, sucking in a mountain of unproductive assets, against the urgings of many within his core circle — created the systemic risk that destroyed Terra.

  • Do Kwon can’t be the leader of Terra going forward. He made a couple of critical mistakes that have destroyed any future confidence in his judgment, but his genius and network knowledge aren’t worthless, either. For outsiders to ever trust Terra again, Kwon can’t be running the show.

• If Terra’s peg recovers from this disaster while keeping a loyal core of users, it will be the greatest comeback from the greatest disaster in crypto history. The odds don’t favor it, but it’s a goal worth working towards if you’re already pot-committed and smart, which the Terra ecosystem certainly is.

How to accomplish these things?

1. Let LUNA hyperinflate to zero.

2. Once UST inflows slow — as seems to have begun in the last 24 hours, when LUNA’s supply 8x’ed while the amount of UST burned dropped by 75% vs the prior 24h — do a mass airdrop of newly issued LUNA to LUNA stakers, the ones securing the network.

3. Have stakers vote on temporarily breaking LUNA-UST convertibility, if at all possible. (I don’t know if it is, outside of forking. If forking happens, a large % of Terra’s assets will probably die, because migration will be a big new technical burden on the devs’ very limited time.)

4. Execute a mass burn of all LUNA.

5. Voila, the stakers’ post-burn ownership of the network will have been restored, at the cost to everyone who didn’t stake their LUNA.

This would be reputationally terrible for Terra, since it would represent a default, but I don’t see any other way. Would it be unfair? Definitely. But if outside demand for UST dies relative to the narrowing of Terra’s asset-liability gap, the network dies because the peg can’t be restored. Nobody has any reason to use UST over a non-dead stablecoin. Unlike, say, the Argentinian peso, nobody can be forced to keep using UST for routine transactions.

In theory, given sufficient passage of time and sufficient exogenous adoption of UST, this would have happened on its own. In practice, validators will quit the network en masse because it’s not worth their time to stick around, before that restoration would’ve taken place. So if the network voters (stakers) want the network to survive, they must take more extreme action.

Terra has other off-chain assets, like their BTC reserve, which seems to have been mostly hoarded. It also has its ecosystem’s off-chain holdings, to the extent that any of them want to reinvest at a severely devalued price. But Terra still has net liabilities of at least $5 billion.

They have ecosystem users of, let’s wildly guess, 500k MAUs. But nobody wants to bail out an ecosystem for $10k/MAU. Terra would probably like to re-peg at 50% collateralization, but that won’t work after they just had a bank run. They’d probably need 90% collateralization or more, meaning that at a $5B LUNA market cap they’d need $4.5B of assets and $5B of UST in circulation. All the market cap of LUNA today

======================

Of course, as LUNA hyperinflation goes up, the risk of a network hijacking goes up too, if someone else buys up enough LUNA to stake more than all the LUNA staked today. Then Terra insiders don’t control the voting process anymore — unless they want to buy more LUNA still.

Then a bidding war for LUNA, funded by external assets, will begin. This will allow UST to return to peg without inflating LUNA to zero, with network ownership being transferred to the new-inflow entrants.

So it’s worth watching the dollar value of LUNA staked. This amount of money represents the market value of Terra’s off-chain assets, post a de facto on-chain bankruptcy restructuring that lets the network survive (as just described above).

According to SmartStake, that’s worth about $350M today. “Seems low.” If this number keeps rocketing up, and is attributable to non-TFL wallets, the bankruptcy restructuring games around Terra will have begun.