The Breakdown - Weimar Luna and the Maginot-Saylor Line

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.io, near NFTX, and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, May 14th, and that means it's time for the weekly recap. Before we get into that, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review. You know the spiel. Also, come check out the Breakers Discord. It's a great place to talk about the types of topics we cover on this show. A disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. And finally, if you have not signed up yet, I highly recommend you come check out CoinDesk's Consensus 2020.

Starting point is 00:00:55 It's happening in Austin, Texas, between June 9th and June 12th. And the thing that makes it different is it's got such a wide array of topics from within this crypto ecosystem. If you are interested in the sort of big picture power shift side of crypto that we talk about so much here, you won't want to miss speakers like Congressman Patrick McHenry or Senator Kirsten Gillibrand. If you are interested in going, use code breakdown to get 15% off your pass at coin desk.com slash consensus 2022. All right, now to today's show. There is a poignant irony that in an industry that was sprung out from a project specifically designed to programmatically

Starting point is 00:01:34 prevent the problems of inflationary currencies. A huge number of market participants have just participated in a hyperinflationary event. So what happened? Last we left the Terra-UST Luna story, Luna was trading for Under Ascent. It was a stunning, catastrophic reversal that had destroyed $40 billion in value. However, the last couple days, the end of this Luna story were just as fascinating as the big moves that happened at the beginning of the week. To understand it, we have to review the core mechanism in the ecosystem, which is the one-to-one redemption between Luna and UST. The idea of this algorithmic stable coin is that you can always exchange Luna and UST for one another at a guaranteed price of UST equals $1. So the idea is if UST went down to 90 cents, you could

Starting point is 00:02:25 buy UST, redeem it for that guaranteed $1 of Luna, and make the 10 cents difference. When you do this, the UST you redeem is burned, and the Luna that you get is minted or created. Now, this is all well and good when things are working fine. It theoretically creates a stabilizing mechanism that uses market forces and natural arbitrage incentives to keep the price of UST at that dollar peg. But let's now consider a scenario where things are not going fine. Let's say, in fact, that there is a bank run in the ecosystem. People have lost all confidence in the collateral asset of Luna and are racing to get out. Now, you have all these people who still hold billions in UST. They redeem it for Luna, which creates more supply of Luna, and then instantly

Starting point is 00:03:10 dump that Luna on the market. This is a double hit on the price of Luna, right? Because it's an increase in supply, as well as selling pressure. So let's now imagine that Luna is down at a dollar. If someone redeems one million UST with Luna at a dollar, one million Luna are created. But let's say that happens a lot and it drives the price down to 10 cents. Now when someone else redeems that same amount of 1 million UST, they're creating 10 million Luna. The price falls further to 1 cent. And now when someone redeems 1 million UST, they're creating 100 million Luna. You see where this goes. It basically makes the protocol design hyperinflationary during a bank run. That's exactly what we've seen the last few days. The normal supply of Luna has ranged between 350 and 420 million for the past two years.

Starting point is 00:04:00 The supply was around 350 million going into this catastrophic event, and it maintained that level of supply until Wednesday. When the price of Luna hit around $1, the controls in the system designed to help Luna expand in a linear fashion started going exponential. So on Monday, circulating supply of Luna was at $350 million. On Tuesday, it was $386 million. By Wednesday, it was $1.5 billion. Over the course of Wednesday night and into Thursday morning, it expanded exponentially as redemptions continued, printing a few billion an hour at first

Starting point is 00:04:33 before getting to the point where total supply was doubling in less than 30 minutes. The rate of printing basically doubled every hour or so, and by the time the blockchain was halted for the first time, the supply of Luna had increased to just under $170 billion. The supply now, as I'm recording this on Friday afternoon, sits at 6.9 trillion Luna. What we saw then was the expansion of supply of Luna tokens by around 50,000 percent in a few days, even before things got really, really crazy over the last few hours of the process. This is essentially a textbook hyperinflation, from attempting to calm the public

Starting point is 00:05:11 with a gold reserve, i.e. the LFG, to opening up capital controls while printing a lot to try and make people whole. Zero X-Tuba writes, it's pretty unusual for crypto projects to actually go to zero. Usually coins get sold until there are no more sellers and no more new buyers, and the coin becomes a zombie, death by apathy. In Luna's case, there is literally infinite cell pressure until absolute zero. Now, it's important to note here that this isn't some malfunction of the design of the system. This is the design of the system. It's just a scenario that was never really considered. Looking for ways to step up your crypto game? Then go with Nexo. For starters, you get free crypto for each purchase or swap. How about earning guaranteed yield?

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Starting point is 00:07:36 thousands of investors, has been shut down. The last words admin said were, This is really over. Validators are leaving too. He's going to sell the house and run. Laura Shin tweeted a link to a Korean newspaper story, quote, police are investigating a report that an unknown person visited the home of Terraform Lab CEO Doe-Quan and rang the doorbell. CEO Kwan's spouse requested the police to designate a person for emergency personal protection. And then, of course, there's the question of how this is impacting funds who held Luna, or UST. Frankly, we still haven't heard much about potential contagion, or even really the implications

Starting point is 00:08:12 for individual funds. Altcoin Psycho says, happy to be wrong, but we haven't seen a single post-mortem yet from any big protocols that had their treasuries on anchor. I'm sure they'll emerge soon. In my opinion, it's too early to call a bottom when we don't even know the true scale of the damage here. That said, a number of funds have said that they are fine despite rumors. Frank Chaparro from the block says,

Starting point is 00:08:33 I don't know who needs to hear this, but Jump did not quote-unquote blow up and is not dead. Obviously not defaulting either, absurd. He also quoted one river saying, everyone is asking us, is stable coin a systemic risk? No. Our assets at Coinbase Secure? Yes. Digital assets are demonstrating resiliency,

Starting point is 00:08:49 but market pressures also demand accelerated regulatory clarity. The block also published a story about crypto hedge fund ARCA, which says that it's solvent despite those blow-up rumors. One interesting first-person testimony came from Suu of Three Arrow's Capital. He writes, Some people ask me why I am keeping Luna in my profile. It's because I invested in it, believe in the community, and share in the common purpose. The attacks and subsequent DPEG risks were flagged by critics.

Starting point is 00:09:16 The fast-growing ecosystem should have done more to move slowly and safely. This has been an incredibly humbling week and it's difficult to find the right words. The critics had genuine concerns about peg risks and going forward discussion must be encouraged. Fudd must be met with refutations, growth must be organic even if slower. This is Tara's Dow hack moment. I will not pretend to know what the future holds, but I will do my part to help. As for critics of me personally, I accept it all. I'm sorry. In a different life where I wasn't invested in it, I would have been far more likely to be cautious. Going forward, being able to separate analysis from bags is my focus. People appreciated that Sue was one of the only people in this situation who actually said the

Starting point is 00:09:53 words I'm sorry, but there was also a bit of consternation about the idea that this was Tara's Dow hack moment. Given that this was not, it doesn't seem currently a malicious attacker, but more one possible outcome of a flawed design. In the public markets, Galaxy Digital has been hammered because of concerns around Luna. Analysts have said that they're overblown and unwarranted, but Mike Novogratz very famously just got a Luna tattoo, so you'll forgive Markets for being nervous. One important additional note, came from Meltem to Mirrors, who wrote what grinds my gears, saying X-fund blew up to describe realized or unrealized losses resulting from Luna or U.S.T exposure. In the traditional fund world,

Starting point is 00:10:33 blowing up implies becoming insolvent and often creating a cascade of other liabilities and losses with your counterparties. For example, when the $20 billion family office, Archegos blew up, prime brokers were stuck with $10 billion of losses and liabilities. Because Arcos had 5x margin, they only needed $1 of collateral per $5 of debt. In the Luna-UST situation, no firm had more than one-to-one leverage, if any, and likely needed to over-collateralize any debt, and more importantly, no firm was 100% in Luna or UST. While some may have incurred significant losses, it is highly unlikely any are insolvent now. Most VC firms are privately owned and operated using LP Capital. They have no obligation to report gains or losses to the market, only their LPs. If the gains

Starting point is 00:11:14 were never materialized as cash in hand, then it's a markdown on the fund's net asset value, which is a paper mark. Some VC firms lost eight, nine, or ten figures of net asset value, but these firms aren't insolvent. They have other assets and positions and deploy cash out of a separate pool earmarked for investments. It just hurts their returns and potential to get paid performance fees. What is more concerning is the contagion from companies and defy protocols using UST to generate yield for their users. For every dollar they manage, they have a dollar of liability to their users. If they lost 30 to 40 cents per dollar of UST, they may not be able to cover this. So let's stop focusing on funds blowing up. They just have less net asset value now. The real blow

Starting point is 00:11:53 would be C-Fi and D-Fi asset managers having liabilities that exceeded their assets. That's the type of insolvency that actually leads to blow-ups and systemic contagion. Anyways, the point is, Cryptospeak doesn't translate well to finance speak. And I'm probably being pedantic, but the media amplifies our words, so let's be nuanced when we use blow-up and insolvency in this situation. I think Melton's right that it's extremely important to be careful about the words that we use. Now, just as I was finishing this episode, Doquan did resurface, with a new revival plan that's basically an airdrop for a totally new thing. And in the very short amount of time I had to review,

Starting point is 00:12:28 the responses ranged from some version of please fuck off and go away forever to memes and jokes. CMS interns said should have kept it at $50 trillion and rebranded to Luna Enu. Now, we have barely scratched the surface of reckoning with this whole blow up, however, for some folks' attention has already turned to whether there are other dominoes to fall in this bare market. Yesterday, there was a slew of talk about tether becoming untethered. Jim Kramer wrote, Stablecoin has many worried. I have railed and railed about tether and this nonsense to the point that people told me they were sick of hearing it. Now it is front and center as a systemic risk. Basically, the peg went down a couple cents, but then it went right back up. In fact,

Starting point is 00:13:08 frankly, I sort of think this event has done quite a bit to help explain the difference between something like UST and tether to people who might not have really made that distinction before. austerity sucks tweets tether is not us t'n. I will go down with his ship if wrong, buying it 96 cents. The USDT are backed, redemptions open, don't be dumb. Sam Tribuco of Alameda research said, I have an idea for a stable coin algorithm. When you want to create it, you send in dollars. When you want to redeem it, you are sent dollars. Kidding, of course, but it has been nice to once again confirm the existence and efficacy of USDT's redemption mechanism. Alameda did a ton of them today. If you want more on this conversation, check out my interview with Jeremy Aller yesterday. I think there are opportunities for

Starting point is 00:13:50 even more programmatic transparency around these types of backed stable coins, but trying to associate tether and UST is just stupid. One more thing I wanted to flag before we get out of here. I'm calling it the Maginot-Sailer line, and basically everyone is gunning for the quote-unquote liquidation point from the micro-strategy Q1 disclosure. Hugh Hendry writes, imagine you had a leveraged position in Bitcoin that everyone knew about. Imagine they knew you were underwater and where your pain point was, where you'd need to puke, that you'd made shorting less risky for them. Imagine people were questioning the sanctuary of their stable coins. There was lots more like this. Crypto ISO said, market wants sailor. It's just going through the list. This is war. Now, the market seemed to kind of miss that

Starting point is 00:14:31 the 21K number that they were fixated on was the point at which Micro Strategy had to hand over more collateral, not the point at which they got liquidated. Sailor tweeted. Sailor tweeted, Micro Strategy has a 205 million term loan that needs to maintain 410 million as collateral. Microstrategy has 115,109 Bitcoin that it can pledge. If the price of Bitcoin falls below 3,562, the company could post some other collateral. See Slides 11 and 12 in Q1 2020 presentation. Hoddle. Now, to capture my feelings on this, I'm actually just going to read my overnight researcher

Starting point is 00:15:04 Scott's notes because I think they'd nail it. And I got a real kick out of this this morning. Michael Saylor is once again asking the internet to please actually read his financial disclosure. I think that the problem is that everyone is modeling this stuff like they do hedge funds and traditional economy companies. Leverage to the gills, interest rate sensitive, one bad trade away from having problems, and hedged carefully to prevent that. Pressure works on that sort of thing. Yes, Sailor's balance sheet is leveraged, but the debt is mostly long-term uncollateralized junk bonds. The entire time he was doing this, he was very careful to structure this all to only

Starting point is 00:15:35 apply any pressure in around 2025 to start, and mostly around 2030 to 2035. He even explained how he was structuring it to the whole internet via video and financial disclosures. Are these people all really this dumb? Or just like clicks as much as anyone else? I think Scott's right, but I also think it's interesting to note the narrative and this idea that Wall Street wants Sailor to fail. Especially with how Wall Street had been punishing crypto stocks, it would be easy to glom onto this narrative. But then again, all that said, there was a massive rally on Friday with Coinbase's coin up to the 70s from a low in the 40s the day before. So who knows? All I know is it's been a terrible week, but we're still standing, we're still here, and the breakdown's

Starting point is 00:16:18 coming out tomorrow like usual. I want to say thanks one more time to my sponsors, nexus.com, near and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. Come join CoinDesk's Consensus 2020, the festival for the decentralized world this June 9th through the 12th in Austin, Texas. This is the only festival showcasing and celebrating all sides of blockchain, crypto ecosystems, Web 3, and the Metaverse,

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The Breakdown - Weimar Luna and the Maginot-Saylor Line

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