The latest episode of Odd Lots' Podcast talks about the crash process of Luna: https://castbox.fm/episode/This-Is-How-the-Terra-Stablecoin-Actually-Imploded-id4460195-id495103603

《This Is How the Terra Stablecoin Actually Imploded》

First part:

Continuing with the second part:

Tracy: (42:04)

So how is that different? Sorry.

So, what's different here? Sorry for interrupting.

Kevin: (42:06)

Yeah. Because I would say that certain boxes are a little bit more honest in the sense that, you know, it's kind of like a chicken game, right? So it's like users competing with users and the earlier you are, the better that you do. I know it sounds really bad. It is really bad. But what I'm saying is that this is even worse than that because it's not really just users competing against users. It's more like users thinking they're competing against other users, but really getting all their funds siphoned out by, you know, investors and the inside team.

Yes. Because I want to say that some boxes are more honest in this sense, it's a bit like a battle royale game, so it's like user-to-user competition, the earlier you are, the better you do. I know that sounds really bad. It is pretty bad. But worse than that is that it's not just user-to-user competition. It's more like users think they're competing with other users, but actually their funds are being siphoned off by investors and the internal team.

Tracy: (42:56)

So one of the other things that's been happening this week is now Tether has deep pegged. And initially at the start of this week, when Terra was going down, when UST hit point three or whatever it was, everyone was talking about, oh, it's a problem with the algorithmic stablecoins only, this thing is worse than a lot of other stuff. But now we've seen strains on Tether, which is supposed to be reserved, backed, but of course there have always been questions swirling around what those reserves actually are, what they look like. We've also seen some stablecoins, I can't remember exactly what it was, but stuff like USDC BUSD and things like that seem to have done relatively better. So those are holding up. So I guess my question is, is this now a shakeout in the stablecoin space or what happens now? Do people go to stuff that they perceive to be safe or does the safe stuff get liquidated because a bunch of hedge funds have Luna Terra exposure and need to raise money? Like what exactly happens?

So one of the other things that happened this week is that now Tether has become deeply unpegged. And initially at the start of the week, when Terra fell, when UST fell to $0.30 or whatever, everyone was talking about how this was just an algorithmic stablecoin problem, and this was much worse than many other things. Now we've seen pressure on Tether, which is supposed to be backed by reserves, but of course there have always been questions around what these reserves actually are and what they look like. We also saw some stablecoins, I don't remember exactly which ones, but something like USDC or BUSD seemed to be holding up relatively better. So these were maintaining. So I guess my question is, is this a shakeout in the stablecoin space, or what's happening now? Are people buying what they perceive as safer assets, or is it because a group of hedge funds had exposure to Luna and Terra and needed to raise funds, so safer assets got liquidated? What's going on?

Kevin: (44:03)

Yeah. You know, I think a lot of those things, so let's first talk about the general sort of financial contagion, right? So like a lot of these guys who are just like these funds and other types of investors who are just really long by let's say Luna or UST, or sometimes even doubling down on the position, you know, they basically, you know, as the price moves against them, they're facing margin calls. So I think what a lot of them did is that they sold their other hard assets, right? So other coins, Bitcoin, Ethereum, whatever they had to meet these margin calls. And then eventually, some of them even got wiped out on the entire fund. So I think that's probably why you're seeing all of this contagion. I mean, some of it is just correlated to equities. But I think for the most part, there's also some psychological contagion and, you know, people just all of a sudden, you know, they see this huge, you know, top 10 coin implode, they start to feel a little bit less safe about all their other investments in general. And then some of it is this, like to meet margin calls, and to finance themselves, you know, some people have just sold off actually much better assets than Luna and UST to defend their position in Luna and UST. So I think that that definitely happened. So I forget what the first part of the question is.

I think there are a lot of these kinds of things, so let's first talk about general financial contagion. So a lot of these funds and other types of investors, they were heavily long, for example, Luna or UST, or sometimes even doubled down on futures. Basically, when prices moved against them, they faced margin calls. I think what a lot of them did was sell their other hard assets. So other coins, Bitcoin, Ethereum, whatever, they had to meet these margin requirements. Eventually, some of them were wiped out entirely within their funds. So I think this could be the reason why you see all this contagion. Some of it is stock-related. But I think in most cases, there's also some psychological contagion where people suddenly see this huge crash of a top 10 coin, and they start feeling a bit uneasy about all their other investments generally. Then some of it is like, for instance, to meet margin requirements or to recapitalize themselves, some people sold actually better assets than Luna and UST to defend their positions in Luna and UST. So I think this definitely happens. I forgot what the first part of the question was.

Tracy: (45:13)

I guess, how does the stablecoin market shake out now? Does more money flow into things that are perceived to be higher quality? Or how do people start to differentiate?

I think, how is the stablecoin market swinging right now? Is more money flowing into those perceived higher-quality assets? Or how are people starting to differentiate?

Kevin: (45:24)

Yeah, definitely. I think, you know, these days you're starting to see like some of these coins trade above parity that are, you know, the non-Tether stablecoins, at least for a little bit. I think a lot of stuff was trading like dollar and 2 cents, dollar and 3 cents, that sort of thing. I think generally the consensus right now in the market is that USDC is the safest. And there's a little bit of worry about Tether. I think that's fair, but I do think the worries about Tether are a little bit overblown. And I want to qualify that statement by saying that although Tether as a company has done some really shady stuff in the past, I actually happen to believe that they're actually more than just fully collateralized. I think they're actually overcollateralized. So, you know, if you think about some of the weird and wacky stuff they did, that they shouldn't have done, they actually backed some of the Tether with crypto right. With Bitcoin itself. And this was like during a bull run. So first of all, they really shouldn't do that because that's not the point of what their business is.

Yes, sure. I think these days you start to see some of these coins trading above par, non-Tether stablecoins, at least a little bit. I think a lot of other stablecoins versus USDT trading pairs reached $1.02 or $1.03, stuff like that. I think the general consensus in the market now is that USDC is the safest. There are still some concerns about Tether. I think that's fair, but I do think the concerns about Tether are a bit exaggerated. Let me qualify that: although Tether as a company has done some very shady things in the past, I actually happen to believe that they are not only fully collateralized but over-collateralized. So if you consider some of the weird things they've done, which they shouldn't have, they're actually backing some Tethers with cryptocurrency itself, with Bitcoin. And this was during the bull run. So first of all, they really shouldn't have done that because that's not the point of their business.

Tracy: (46:24)

Crypto exposure squared, right?

The square of hidden currency exposure?

Kevin: (46:26)

Yeah. I mean, they really should just be keeping like really dollar like instruments or actual dollars -- that would be the absolute safest in the bank account. So then they shouldn't be speculating with client funds like that. But given that they actually did do that --something that they shouldn't -- it actually worked out for them. So they kind of got lucky. And with, you know, I don't know if they kept a lot of the profits themselves or whatnot, but if at least some of that profit still was held on the vaults, then they should actually be over collateralized. And then the, you know, the other crazy stuff that they did, you know, where they loaned money to themselves because, you know, Tether is also owned by iFinex, which is the parent company of Bitfinex. They basically loaned money to Bitfinex because of, you know, some bad debt that Bitfinex had because they were like short like 800 million or something because of like crypto capital something.

They should really just stick to being like a real dollar instrument or actual dollars, which would be the absolute safest thing in bank accounts. So, they shouldn't speculate with customer funds. But given that they did, and they shouldn't have done it, it actually worked out for them. So they were a bit lucky. And I don't know if they kept a lot of the profits for themselves or whatever, but if at least some of the profits are still sitting in the vaults, then they should actually be over-collateralized. Then all the other crazy things they did, they lent money to themselves because Tether is also owned by iFinex, which is Bitfinex's parent company. They basically lent money to Bitfinex because Bitfinex had some bad debt since they were missing like 800 million or something due to Cryptocapital or whatever.

I don't remember exactly, but it was something like that. So they were basically like doing all these crazy loans between their own companies and, you know, that's I think definitely something that they shouldn't have done, but technically they, you know, they made it out of that too. They issued the Leo token, they sold it to investors, raised a billion, put that money back in, gave that money back to Tether. So, you know, technically it should still be whole. I mean, they keep doing things that they shouldn't do, but yet they always get lucky and they come out of it. So I actually tend to believe that Tether is pretty safe, but, you know, they really should stop doing crazy sh*t.

I don't remember exactly, but it was something similar. So they basically just did all these crazy loans between their own companies, and I think this is absolutely something they shouldn't do, but technically they profited from it as well. They issued the Leo token, they sold it to investors, raised a billion, put that money back, paid Tether back. So technically it should still be intact. They keep doing things they shouldn't do, but they always get lucky and they get away with it. So I actually lean towards believing Tether is pretty safe, but they really should stop doing crazy stuff.

Joe: (47:49)

So I want to ask about the more the Terra fallout in a different direction. So clearly there's this sort of pure financial contagion. You see a top 10 coin crash, etc., or you start to wonder about the safety of some of these other yield boxes and so forth. But the other thing that's striking, and I mentioned this in the intro, which is that we're used to hacks and crashes and crypto, they happen all the time. And most of the time they're too boring to even mention, but this one was like backed by legit, or people who are respected leaders in the industry, people who go on TV. And obviously Mike Novogratz who has the…

So what I want to ask is more in different directions, more about Terra's aftermath. So obviously, there's this pure financial contagion. You see the top 10 coins crash, and at this point you start questioning the safety of some other yield boxes, etc. But another striking thing is, as I mentioned in the introduction, we're used to hacks and crashes in cryptocurrency; they keep happening. Most of the time, they're too boring to even mention, but this one was supported by legitimate or respected leaders in the industry, people who go on TV. Obviously, Mike Novogratz has...

Tracy: (48:25)

Does Novagratz’s tattoo mean nothing?

Does Novagratz's tattoo mean anything?

Joe: (48:27)

Seriously. So, you know, but it's others too. And if you look at, you know, I saw the press release of the first time when Terra got funded and it's some of the biggest names in crypto. And so I'm curious how that affects the industry, that this is not like some like Bitconnect, weird thing where everyone sort of knew it was really terrible. Like a bunch of people really stood by this.  

I'm serious. So, but this is also true for other people. If you look at it, I saw the press release when Terra got its first round of funding, it was some big names in crypto. So I'm curious about what this means for the industry, and this isn't like some weird thing like Bitconnect, which everyone knows was really bad. It's like a group of people who really stand on this side.

Kevin: (48:51)

Yeah, definitely. You know, I think historically we've seen stuff like that happen before, you know, look at like the DAO, for example, you know, when that came out and it got hacked, I mean, that was also backed by a lot of heavy hitters in the industry. And then, you know, at some point there was like the whole Bitcoin cash fork, and I wouldn't, I don't want to say it was backed by like everybody, it wasn't the majority, it was still a minority within the industry, but it was a very healthy minority. Right? So we've definitely had situations like that in the past what I would say, and I don't want to cast any aspersions on most of the investors in Luna and Terra. What I would say is that I think it's a combination of three things.

I think historically we've seen this kind of thing before. Look at something like The DAO, for example, when it came out and it was hacked, and that too was backed by a lot of heavyweights in the industry. Then, like the whole Bitcoin Cash fork, I don't want to say it was supported by everyone, it wasn't the majority, it was still a minority within the industry, but it was a very healthy minority. So we've definitely had such situations in the past, and what I want to say is, I don't want to slander most investors in Luna and Terra. What I want to say is, I think it's a combination of three things.

I think the first is that people got used to too much easy money in the bull cycles. And, you know, before the Fed started hiking up rates, you know, they were used to this kind of access arbitrage, right? As VCs they're very well connected. They can get into these very early seed round deals, right. And massive discounts, mark that stuff up, you know, crazy amounts, you know, 10X in a week, you know, 10X in a couple of months, a hundred X in a year, you know, even thousand is possible. So I think they just saw that as a continuation of business as usual. And you know, that also beget some questions, like why should the returns be so high in the first place? But, you know, that's, I think another philosophical discussion, I mean, but I think, you know, they got kind of used to that and for them, they hadn't really switched their mindsets yet to more of a bearish, more of a hawkish kind of Fed environment.

I think, first of all, people have gotten used to too much easy money during bull market cycles. And, before the Federal Reserve started raising interest rates, they were accustomed to this kind of entry arbitrage. As venture capital firms, their relationships were very good. They could get into these very early seed round deals. A lot of discounts, mark these things up, crazy amounts, 10 times in a week, 10 times in a few months, 100 times in a year, even 1000 times was possible. So I think they just saw this as a continuation of business. This also raises some questions, like why are there such high returns in the first place? But, I think this is another philosophical discussion, but I think they're a bit accustomed to it, and for them, they haven't really shifted their mindset to more of a bear market, more of a hawkish Federal Reserve environment.

So I think that's one part, I think the second part is that generally some of them tended to be true believers. And what I mean by that is that they thought that, yeah, maybe most likely this thing fails like 90% chance this thing fails, but maybe 10% chance this thing thing succeeds, and it goes up a million X. So then that still makes the investment positive EV right. Positive expected value. So I think from that standpoint, they thought that this was still maybe a good bet to make. And it was an honest bet. You know, they thought it was good at the time. Maybe they don't think so anymore, but maybe some of them even still now made money because they got out in time. 

I think the second part is, generally speaking, some of them tend to be real believers. They think, maybe the most likely scenario is that this thing fails, like a 90% chance, but maybe there's a 10% chance that this thing succeeds and it goes up 1 million X. Positive expected value. So I think from this perspective, they think this might still be a good bet. And it's an honest bet. They think this was good at the time. Maybe they don't think so now, but maybe some of them are still making money even now because they got out in time.

And I think the third thing is that probably some of these investors realize that this thing would never work, but they figured that they could make some money in the short term and being a bit on the more cynical side within that demographic of investors, they figured that they could exit out of this thing before it blew. So I think it's a combination of those things, you know, just, you know, true belief and plus EV cynicism and quick flip, and hopium not being adjusted to a new bear market.

I think the third thing is, maybe some of these investors realized this thing would never succeed, but they thought they could make some money in the short term, and among these investors, they are the more cynical ones, thinking they could exit before this happens. So I think it's a combination of these things, genuine belief plus the cynicism and quick flip of electric vehicles, and hoping not to adjust to the new bear market.

Joe: (51:33)

So before we go, I want to like talk a little bit more about sort of what's happened or where we are now. And again, one of the things that we've seen with Terra and Luna specifically is Terra continues, the stablecoin continues to have these periods where it drifts up back towards the peg of a dollar. Meanwhile, Luna’s just absolutely blown out. And every day it's going down by like 99, 95 or 99% in a day. And the total issuance of, I think there was like a hundred million, I don't know now there's like billions and billions, can you walk us through this sort of like weird rigor mortis or something, or this sort of like afterlife of the coin right now? What is actually this weird phenomenon that we're seeing right now?

So, before we wrap up, I want to touch on one more point about what's already happened or where we are now. Again, one thing we saw with Terra and Luna is that Terra, the stablecoin, continued to have these periods where it floated around its dollar peg. Meanwhile, Luna was absolutely getting crushed. It would drop 99%, 95%, or 99% within a day. The total supply, I think started at like ten million, I don't know how many billions there are now. Can you walk us through this strange kind of ossification or whatever, or this afterlife of the coin, now? What exactly is this strange phenomenon that we're seeing now?

Kevin: (52:18)

You know, I totally agree with you. It's actually pretty bizarre, but there's a couple of theories here. So the first theory is that LFG, Luna Foundation Guard, still has some reserves left. And they know the timing of it. They decide, okay, at this point, you know, UST is too low. We're just going to exhaust the rest of it. And we're just going to support the price either for A) for people on the inside to get out or for B) you know, altruistically to just get whoever wants to get out, whatever remaining bagholders want to get out of UST, they can with the remainder of these reserves. So that could be the case. Another possibility is that it's the arbers that are closing up this step that are pushing the UST price up because the Luna protocol itself, the underlying virtual AMM will always consider UST as worth $1 of Luna. So as long as Luna has any bid in the market and any market price in the market, you can always generate some kind of hyperinflating value of Luna in order to create these dollars.

I completely agree with your perspective. It is actually quite strange, but there are a few theories here. So the first theory is that LFG, the Luna Foundation Guard, still has some reserves left. And they know the timing. They decided, okay, at this point, UST is too low. We will just use up the rest of it. We will just support the price either for A) letting people inside get out, or B) altruism, just letting whoever wants to get out, any remaining bag holders who want to leave UST, they can use the remaining part of these reserves. So that could be the situation. Another possibility is that arbitrageurs closed this step, pushing up the price of UST because the Luna protocol itself, the underlying virtual AMM, will always consider UST as $1 worth of Luna. Therefore, as long as there is any bid for Luna in the market, any market price for Luna, you can always create some excess value of Luna to create these dollars.

Joe: (53:17)

So the issue is if you're guaranteed to get a dollar for UST, all that happens and let's say Luna or sorry, a dollar's worth of Luna for UST, and then Luna plunges by 99%, then to continue to redeem those, you just have to create billions and billions of fresh Luna to meet that obligation that pushes it down. Then the next wave of redeemers that makes even more billions. And so you have this like true hyperinflation to defend the peg. But that's what the AMM is supposed to do. I mean, this is the bot basically working as the code had instructed it to.

So the question is, if you guarantee to exchange UST for a dollar, all this happens, say exchanging UST for a dollar's worth of Luna, then Luna crashes by 99%. To continue redeeming these, you must create billions and billions of new Luna to meet the obligation of pushing it down. Then, the next wave of redeemers will make more money. Thus, you have this kind of real hyperinflation to maintain the peg. But this is what the AMM is supposed to do. This is basically the robot working according to the code's instructions.

Kevin: (53:53)

Yes, exactly. And I think this is actually a really great point that you bring up, Joe, and I think there's a lot of interesting nuance here, which is that, first of all, this is hyperinflation, but this is actually worse than hyperinflation. This is hyper hyperinflation. Because it's hyperinflation, which itself is accelerating. So it's like, it's hyper inflation of hyper inflation basically. It's like exponentially bad. Right? Because basically as more and more Luna get created, pushing the price further down exponentially, more Luna needs get created. Right? So like maybe you, like, you burn a clip of UST and you have to mint a million Luna and then the next time that you do it, you have to mint a billion Luna, and next time you have to mint a trillion Luna, next time you do it, you have to mint quadrillion Luna.

Yes, that's correct. I think this is actually a very good point you raised, Joe. I believe there are a lot of interesting nuances here. First, this is hyperinflation, but it's actually worse than hyperinflation. It's super hyperinflation. Because it's hyperinflation, and it itself is accelerating. So it's like, basically hyperinflation of hyperinflation. It's exponentially bad. Because basically, as more and more Luna is created, it pushes the price down further exponentially, and more Luna needs to be created. So, maybe you, for example, burn a UST, you have to mint a million Lunas, then the next time you do it, you have to mint a billion Lunas, the next time you have to mint a trillion Lunas, and the next time you do it, you have to mint four hundred billion Lunas.

So it just like exponentially gets worse. So on one hand, yes, this still does allow the UST holders to get out. But now there's kind of a political consideration, right. Because the holders of Luna and the holders of UST are not aligned. The UST holders don't really care about the Luna price. Point zero zero zero one. That's fine for them, you know, as long as they mint enough that they can get out a dollar worth or, you know, close to a dollar worth of UST. While the Luna holders, you know, they're not happy that the UST guys are just continuously crushing this price with no end in sight. I mean, we’ve got yards to go, you know, there's no end in sight. So I think there is some political disconnect between the interests of either the holders.

So it gets exponentially worse. On the one hand, yes, this still allows UST holders to exit. But now there is a political consideration, right? Because Luna holders and UST holders are not aligned. UST holders don't really care about the price of Luna. $0.01 is fine for them as long as their minting volume is large enough to get a dollar's worth or close to a dollar's worth of UST. And Luna holders, they are unhappy that UST holders are just continuously driving down this price with no end in sight. We still have several yards to go, with no end in sight. Therefore, I think there is some political disconnect regarding whose interests are being served.

And then I would say, finally, you know, how does this actually end? Well, what I think is that in the end, you don't actually fully redeem out all of this UST at a dollar, you know, even if it takes forever. And even if you hyperinflate Luna to like a Googleplex or whatever, right. Like, I don't think you actually get out this UST because at the end of the day, there is still a tick size constraint on exchanges. Right? So let's say the tick size on the exchange is one penny, right? 

Eventually if Luna, its actual fair value price is below half a penny, which rounds down to zero and is technically below one tick, then there will just be no bids in the order book. It'll just be a one-sided order book with only offers and no bid. So at that point you can't actually complete this arb. You can't actually, you know, sell that. No matter how much trillions or googles of Luna you have, there's just no market to sell it because it's worth less than a tick.

Then I want to say, finally, how does this all end? I think in the end, you actually don't fully redeem all these US Treasuries for a dollar, even if it takes forever. Even if you inflate Luna to something like Googleplex or whatever, I don't think you actually get this UST because, at the end of the day, there's still a tick size limit on the exchange. So let's say the exchange's tick size is one penny. Eventually, if Luna, its actual fair value price is below half a penny, rounded to zero, technically below a penny, then there's no bid on the order book. It will be a one-sided order book with only offers and no bids. Therefore, at this point, you can't actually complete this low-buy high-sell. You actually can't sell it. No matter how many trillions or how many gobies of Luna you have, there's no market to sell it because its value is below a tick.

So like if once that happens, then basically everything remaining in UST is just bad debt. So what is the market saying right now? I think it's being first of all, a little bit optimistic. I think it's saying that, you know, 38 cents on the dollar, basically they're saying that if everybody takes a haircut of 62 cents, everybody can have 38 cents. First of all, I think this is wrong, but let's say that this was right. So if this was right, then maybe that would be the fair thing to do. Everybody just takes a haircut. Everybody gets 38 cents, but what's actually going to happen is not quite that. What's going to happen is that 38% of people are going to get a dollar and 62% of people are going to hold that debt worth zero.

So, if once this happens, then basically everything left in UST is bad debt. So what is the market saying now? I think first, it's a bit optimistic. I think it says that at 38 cents, basically they're saying if everyone takes a 62 cent cut, everyone can have 38 cents. First, I think this is wrong, but let's say it's right. So if this is right, then maybe this will be the fair thing. Everyone just accepts a little loss: everyone gets 38 cents. But what's actually going to happen isn't exactly that. What will happen is, 38% of people will get a dollar, and 62% of people will hold debt worth zero.

Tracy: (57:15)

Wow. That's really depressing. Speaking of depressing. So one of the things Joe and I were doing was we were looking at the subreddit, the Terra Luna subreddit. And there are some really sad stories out there. You know, people claiming to have lost their life savings, threatening, to commit suicide, things like that. And one of the stories that struck me, it was someone who said that they had done all their research. They really believed in the project and this happened to them and they've lost a lot of money. And one of the interesting things about crypto, at least to me, is it is such a polarizing space. On the one hand, there are people saying this is going to be the next big thing, web 3.0, a new financial system. And on the other side, there are people who are saying that this is an outright ponzi. So I guess my question is, you know, someone comes and they see the same things, they read the same things about Terra and Luna that you do, presumably, and they come to completely different conclusion. How does crypto as like a wider space try to solve some of that tension? And what advice would you give to people who are trying to evaluate these different projects -- or boxes?

Wow. That's really frustrating. Speaking of frustration. So one thing Joe and I are doing is we're looking at the subreddit, the Terra Luna subreddit. There are some very sad stories there. People claim they've lost their life savings, threaten to commit suicide, things like that. One story that struck me was someone who said they had done all the research. They really believed in this project, but this happened to them, and they lost a lot of money. An interesting thing about cryptocurrency, at least to me, is that it's such a polarizing space. On one hand, some people say this will be the next big thing, Web 3.0, a new financial system. And on the other hand, some people say it's a total Ponzi scheme. So I guess my question is, someone comes along, they see the same thing, they read the same things about Terra and Luna as you do, roughly, and they come to completely different conclusions. How does the broader space of cryptocurrency try to resolve this contradiction? What advice do you have for those trying to evaluate these different projects - or boxes?

Kevin: (58:29)

Yeah. You know, I think you bring up a lot of very interesting topics there. Maybe just starting with that, what I would say, and this is a bit more on the brutal side, but I think in crypto, you know, it's literally the Wild West. Everybody needs to be personally responsible for their own decisions and accountable to themselves, do their own research. And that's kind of how a market works. Two people can look at the same mechanics, do the same research and come to different conclusions. And then based on the market mechanism, eventually one side is right and the other side is wrong, but that is basically the function of the market. The betmaking here is exactly what creates the price discovery. So I don't think that there's anything particularly wrong about that, but I do think that people should think very clearly for themselves, whether or not they want to put up their mortgage on a bet that they think is good, but maybe, you know, have some doubt. Maybe have some skepticism, have a little bit more skepticism.

Yes. I think you bring up a lot of very interesting topics. Maybe just starting from this point, it's a somewhat cruel side, but I think in the world of cryptocurrency, it's simply the Wild West. Everyone needs to take personal responsibility for their own decisions, be responsible for themselves, and do their own research. This is also how markets work. Two people can look at the same mechanics, do the same research, and come to different conclusions. Then based on market mechanisms, eventually one side is right, and the other side is wrong, but this is basically how the market functions. The betting here is precisely what creates price discovery. So I don't think there's anything particularly wrong with this, but I do think people should seriously consider whether they should put their mortgage on a bet they think is good, but perhaps, has some doubts. Maybe approach with a bit more skepticism.

Maybe don't put in more than you can lose. And you know, my sympathies, I think go out to all of these folks who, you know, lost their home, lost their life savings, that sort of thing. But what I would say is that better that this happened now than later, you know. If UST was a hundred billion and eventually there was 95 billion of bad debt or 90 billion of bad debt, I mean, it would be way more devastating, right? I mean, even more people would've lost their shirts. I wish it would've unwound earlier, you know, I think it would've been great to have this unwinding last year, but you know, at the end of the day, better now than later, at least.

Maybe don't put in more than you can afford to lose. I sympathize with all these people who have lost their homes, lost their life savings, and things like that. But I would say that what's happening now is better than what might happen later. If UST were 100 billion, and eventually there's 95 billion or 90 billion in bad debt, I mean, that would be more destructive, right? I mean, even more people would be left with nothing. I hope it unravels sooner rather than later; I thought it could have unraveled last year, but at the end of the day, at least it's better to end now than later.

Joe: (01:00:01)

Well, so I want to just go back to your history with it because the reason people said you gotta have Kevin on the show is because you have been a loud critic/skeptic publicly on Twitter about the model and about its unsustainability. But also as we discussed being wrong can, or being early, can be devastatingly wrong when it comes time to place a trade and with UST in particular, because you have pay that 20%, if you're going to short a stablecoin or whatever. And the Luna just kept going up even amid the sort of like broader crypto malaise of the last year, so what did you see that you went from being like, okay, this is unstable to yep, okay, it’s falling apart now.

Okay, so I want to go back to your history because people say the reason you had to get Kevin on the show is that you've been publicly loudly criticizing/skeptical of this model and its unsustainable growth. But as we discussed, when it comes to trading, if you're wrong or too early, it can lead to catastrophic errors, especially with UST, because if you want to short a stablecoin or something else, you have to pay 20% fees. Even in the context of last year's broader crypto downturn, Luna kept going up, so you saw what, from liking, okay, this is unstable, to now, okay, it's collapsing.

Kevin: (01:00:48)

I always thought it was going to fall apart. I just didn't know when. I actually thought the timing was not bad at all because I thought this thing would've lasted a little bit longer, to be honest. So I think this is one of the more optimistic outcomes. But, you know, what I would say is that, you know, with all these kinds of mechanisms, most of the time, you know, you look at all these kinds of, I call 'em money games, right? These algo stablecoins, these rebasing games, they've never gotten this big before. You know, you look at Ohm for example, barely, you know, a billion, I forget how much it was, but wasit was much, much smaller, right. Order, magnitude smaller. You look at MIM, you look at all, you know, all this stuff, , MIM was a collateralized stablecoin though, but I mean, there was still some contagion from the Time Wonderland fallout over there like ESD, DSD, Based, YAMs, Basis Cash, who some people think that Do Kwon was also the, the founder o , I've also heard that rumor.

I've always thought it was going to collapse. I just didn't know when. Actually, I think the timing turned out pretty well because honestly, I thought it would last a little longer. So I think this is a relatively optimistic outcome. But what I want to say is, for all these kinds of mechanisms, most of the time, when you look at all these kinds, I call them money games, right? These algo stablecoins, these rebase games, they've never gotten this big before. You look at ohm, for example, barely, a billion, I forget how much it was, but it was more, smaller, right. An order of magnitude smaller. You look at MIM, you look at all these things, MIM though is a collateralized stablecoin, but still, there was some contagion from time Wonderland like ESD, DSD, Based, YAMs, Basis Cash, and some people also think Do Kwon, the founder, I've heard this rumor too.

Joe: (01:01:43)

CoinDesk reported it, yesterday in fact, May 11th that Do Kwon the creator of Luna, was involved in this other algo stable  crashed called Basis Cash. So at least it has been reported that that is the case. Mm-hmm

CoinDesk reported that in fact, yesterday, May 11th, Luna's creator Do Kwon was involved in another algorithmic stablecoin collapse called Basis Cash. So there are at least reports suggesting that was the case.

Kevin: (01:01:59)

Yeah. I've been hearing that rumor for a while too. You know, I don't know if it's true or not, but I tend to believe that that is true. But  anyway, these experiments have all been tried before, but never to this scale. And that's what I thought was particularly alarming because even with the collapse of Wonderland Time with the whole ‘SiFu’ drama, I mean, there was already some contagion, but it was still well contained. But you could see that like any bigger and there would just be massive wipeouts, you know, it's like at some point the cancer really is terminal. And for that one, we did some chemo. We came out of Wonderland Time. For this one, you know, this is stage four, you know what I mean? So this one's a lot worse.

Yes, I've heard this rumor for a while. I don't know if it's true, but I tend to believe it is. Anyway, these experiments have been tried before, but never at this scale. That's what I find particularly shocking, because even the "Wonderland" collapse and the whole "SiFu" drama had some contagion, but it was still well controlled. But you can see, if it were bigger, there would be massive destruction, like at certain times, cancer is really terminal. For this one, we did some chemotherapy. We got out of Wonderland. For this one, it's stage four, so this situation is much worse.

So, you know, that's what really got me thinking about this one in particular. And this is also why I've never really called down any projects in the past. You know, if you look at my Twitter, first of all, I rarely tweet. And most of the times, when I do tweet it's about some new obscure play that I found, I generally share alpha. And, you know, we found FTT, we found WIFI in the very early days. I think, you know, I think you'll find some, you know, interesting alpha mostly on the positive side, but I think this one and,

So, this is what really made me think about this issue, and this is also why I've never really called out any project in the past. If you look at my Twitter, first of all, I rarely tweet. And most of the time, when I do tweet, it's about some new obscure drama that I found, I generally share alpha. And we found FTT, we found WIFI very early. I think you'll find some interesting alpha mostly on the positive side, but I think this one and...

And maybe just to take a step back, one of the reasons that I don't like calling out projects is because in some ways I don't believe you can stop human nature. If people want to gamble, if people want to play these money games, I think even you can't really suppress it and even if you did, it would come out in other ways. But I think for this one in particular, it was just so bad that I felt I had to say something because, you know, this is just going to be devastating for this space. I mean, regulators are going to use this as an excuse to basically put on more regulation and this is going to stifle innovation. You know, it’s just going to be a rough ride.

Maybe it's just stepping back to say, one of the reasons I don't like calling out projects is that in some ways I don't believe you can stop human nature. If people want to gamble, if people want to play these money games, I think even if you can't really suppress it, and even if you do, it will come out in other ways. But I think especially for this one, it's so bad that I feel like I have to say something because this will be devastating for the space. Regulators will use this as an excuse to basically impose more regulation, which will kill innovation. It's going to be a tough journey.

Tracy: (01:03:41)

What are the chances that someone comes to the rescue here and pours more money into it and gets the machine going again?

What are the odds that someone comes in to save the day here, put more money into it, get the machines running again?

Kevin: (01:03:48)

Well, what I would say is that there probably is going to be some residual value in Luna and UST, but not until all of the bad debt unwinds. So I think it's better to wait for the dust to clear out. And then, you know, if you want to, you can bid up Luna, you know, you could have, have some price discovery, but what I would say is that until that bad debt winds down, you're just going to have hyperinflation. You're just going to have massive selling pressure, crushing the price to a tick and then to no ticks. So until that happens, you know, and who knows what the actual intrinsic value of an L1 without the stablecoin really is. You know, it could be actually well higher than like 3 cents or wherever it's trading, 2 cents right now, It could be well, well higher than that, but we won't know that we can't really have that price discovery until all the bad debt winds out.

Alright, what I would say is that there might be some residual value in Luna and UST, but not until all the bad debt is unwound. So I think the best thing is to wait for the dust to settle. Then, if you want, you can bid on Luna, you can have some price discovery, but what I would say is until the bad debt is done, you're just going to have hyperinflation. You're going to have massive selling pressure that pushes the price down to a tick, and then down to no tick at all. So until that happens, who knows what the actual intrinsic value of L1 without the stablecoin really is. It could actually be much higher than 3 cents or where it's trading now, which is 2 cents, it could be much higher than that, but we won't know, we can't really have price discovery until all the bad debt is unwound.

So, you know, for now, I'm really no bid on Luna. I think UST itself is going to go down. I think 38 cents on the dollars still too expensive, to be honest. And then at some point, bad debt clears out and then people will bid up Luna and then it'll settle at its true fair value. But I do think that they're doing the right things. I do think it'll survive as a chain. Will it ever be top 10 again? Very unlikely. I think something like this is so damaging to the reputation that I don't think it'll ever happen again.

So right now, I really don't have a bid on Luna. I think UST itself will drop. To be honest, I think 38 cents on the dollar is still too high. And then at some point, the bad debt clears, and then people will bid on Luna, and then it will settle at its true fair value. But I do think they're doing the right thing. I do think it will survive as a chain. Can it get back to top ten again? Very unlikely. I think something like this does a lot of damage to the reputation, so I don't think it will happen again.

Joe: (01:05:09)

Kevin Zhao of Galois Capital, fascinating conversation. We could talk with you for three hours. You're so clear. You'reso good at explaining things so glad we had you on Odd Lots.

Kevin Zhao from Galois Capital, a fascinating conversation. We could talk to you for three hours. You are so clear. You are very good at explaining things, so we're glad to have you on the Odd Lots podcast.

Kevin: (01:05:22)

Yeah likewise, really glad to be on and thanks for inviting me.

Yes, likewise, it's really great to be on the show, thank you for having me.

Joe: (01:05:25)

Absolutely.

Of course~

Tracy: (01:05:26)

Thanks, Kevin. That was so good.

Thank you, Kevin. This is fantastic.

Joe: (01:05:27)

Yeah, that was great. Thank you, Kevin. Tracy, just in terms of how crypto, DeFi, these markets work. I think Kevin is the best guest we've had on that.

Yeah, this is great. Thank you, Kevin. Tracy, in terms of how these markets work—cryptocurrencies, DeFi—I think Kevin has been one of the best guests we’ve had on this topic.

Tracy: (01:05:51)

I think he was really good and really clear. He obviously has a lot of credibility on this one as well, because he was such a big vocal critic of Luna Terra. But at the same time, you know, you can't just say, ‘oh, he's an anti crypto guy.’ He doesn’t get it, it's all FUD. He's actually invested in the space and called this one out as a bad actor.

I think he does a really good job, and he’s very clear. He obviously has a lot of credibility on this issue because he was one of the biggest critics of Luna Terra. But at the same time, you can’t just say, 'oh, he’s anti-crypto,' he doesn’t get it, it’s all FUD. He’s actually invested in this space and is calling out this person as a bad actor.

Joe: (01:06:11)

And he's clearly into the space. Because you know, he's clearly of the view that, you know, he doesn't want like massive regulatory response to this. And also that if crypto is going to avoid big regulatory responses in the future, which everyone in the industry wants to avoid, presumably, there has to be like a greater willingness to call out projects that are unsustainable.

And he obviously entered this space. Because he clearly thought that he didn't want a massive regulatory response. Moreover, if cryptocurrency is to avoid a massive regulatory response in the future, which everyone in this industry wants to avoid, it is estimated that there must be a greater willingness to call out those unsustainable projects.

Tracy: (01:06:37)

I also really like the description of the self-reflexivity of the way Luna Terra works. And you know, this is something that I know we've spoken about before, but this idea of, you know, the ultimate sort of momentum play, but the whole system is predicated that at some point people will want exposure. That starts falling away because people start doubting the way the entire thing is working. Then it just feels like there's almost unlimited downside.

I also really like the self-reflective description of how Luna Terra works. This is something I know we've said before, but the idea is that ultimately the dynamic game, but the premise of the entire system is that at some point people will want exposure. This begins to fade as people start questioning how the whole thing works. Then it feels almost like infinite negative effects.

Joe: (01:07:05)

And you asked the key question and I still think that it seems like shades of gray to me and the difference between Terra Luna versus some of these other DeFi things. Because with the stock, when a stock goes down, you're like, yeah, but the company's still selling a bunch of paint and so there's this cash flow that people want. But with a lot of DeFi stuff where it's like token trading all the way down there is not like some natural other source of cash other than, you know, he put it great. He said, if you're getting a yield, you're often just getting money from future bag holders. But if there's no more future bag holders, and I think that still is the case with many coins, even if they're not quite as convoluted or not quite as blatant about how the box worked.

You asked a key question, and I still think that for me, this seems like a gray area regarding the distinction between Terra Luna and some other DeFi things. Because for stocks, when they fall, you feel that the company is still selling a bunch of paint, so there's this cash flow that people want. But for a lot of DeFi stuff, it's like the token trading drops all the way down without some natural other source of cash, except what he said well. He said, if you're getting yield, you're often just taking money from future bag holders. But without future bag holders, I think many coins are still in this situation, even if they're not as convoluted or don't make it so blatant how the box works.

Tracy: (01:07:48)

Yeah. And I mean, the other thing I would say is this kind of arbitrage mechanism, it is not unknown in the world of traditional finance. And I think a few people have drawn analogies with the way that exchange traded funds work and market making for those. But the difference is, you know, you're trading a basket of stocks and the stocks kind of have some sort of yeah value. They're tied to some sort of cash flow for this one. The arbitrage is all about the crypto. And if you don't think the crypto has any value anymore, then it kind of collapses very quickly.

Yes. I mean, another thing I want to say is that this arbitrage mechanism is not unfamiliar in traditional finance. I think a few people have already made an analogy between how exchange-traded funds work and how these funds are market-made. The difference is that you're trading a basket of stocks that have some kind of value. They're tied to some kind of cash flow. Arbitrage is all about cryptocurrencies. If you no longer think that cryptocurrencies have any value, then it will collapse quickly.

Joe: (01:08:19)

Well, we could talk about this a long time and I'm sure we will.

Alright, we can talk about this issue for a long time, and I believe we will.

Tracy: (01:08:21)

Yeah. Our producer is kicking us out of the studio. Alright, shall we leave it there?

Yes. Our producer is kicking us out of the studio. Well, shall we do that?

Joe (01:08:32):

Let's leave it there.

So let's end it here.