Date: 12/07/2021
Author: Mr. X
The cryptocurrency sector recently plummeted. It was a classic “flash crash.” While it’s recovering, bitcoin fell below $50,000 and is only now recapturing lost ground. Ether and various alt-coins were also caught in the decline.
What lay behind it? A controversy over stablecoins was probably part of it.
Tether has “minted” billions of its coin USDT over the last few weeks, including USDT reportedly worth over $1 billion on December 4. These reports, and concerns that Tether may not have sufficient fiat currency for its reserves, destabilized the entire sector. Tether has a key role as an intermediary in the crypto ecosystem. Any questions about it are going to have a wide impact.
Yet the decline was not universal. Luna from Terraform Lab became one of the ten largest cryptocurrencies by market cap. While this may not remain true for long, as the cryptocurrency market is changing fast, Luna hit an all-time high on Sunday of almost $78 per token. It’s declined since… but is still up more than 12,900% over the last year.
“Terra,” Luna, and other terms are often used interchangeably but they refer to different things. However, they are part of the same system, the Terra blockchain protocol.
What can be confusing is that the word “Terra” also encompasses several different stablecoins that track different fiat currencies. Luna is the Terra Protocol’s token that helps prevent volatility, enables mining, and facilitates governance. Together, these two main tokens sustain the Terra Ecosystem. Just remember that the Terra tokens (the various stablecoins) are part of a larger Terra Protocol.
The ecosystem supports what it calls a “suite of algorithmic decentralized stablecoins which underpin a thriving ecosystem that brings DeFi to the masses.” Crucially, it is based on a “Proof of Stake” model rather than the more power-intensive (and increasingly politically unpopular) “Proof of Work” model. It’s not surprising that the TerraUSD stablecoin linked to the U.S. dollar (UST) gained attention as concern grew about Tether.
By bringing “DeFi to the masses,” Terra means creating a system where stablecoin algorithms allow for payments to be transferred for a low fee and with relatively low volatility. For example, fees are lower than that charged by most credit card companies. The various stablecoins (UST is not the only one) allows people within the Terra ecosystem to spend tokens without feeling like they are taking a huge risk with an investment.
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This gets around the “digital gold” problem that many have with bitcoin. If you are buying bitcoin because you think it is a store of value, you are metaphorically locking up that spending power in a vault, to be used only at the utmost need. Movie chain AMC’s wishes notwithstanding, you probably aren’t going to spend it to go see Resident Evil: Welcome to Raccoon City.
The opportunity and danger of Luna (amazing how those two concepts often go together) lies in the value of Terra’s ecosystem. Luna is set up so that is deflationary, which should encourage a gradual growth in price. Yet what it really depends on is many people using the various applications set up within this ecosystem using the Terra protocol. Unlike bitcoin, Luna won’t grow in price simply by existing.
The Terra Protocol has expanded its reach by becoming part of a bridge protocol that links it to other blockchains. For example, ETH, SOL, BSC (Binance Smart Chain), and LUNA are all linked together via the Wormhole V2 protocol. Others will emerge as the sector matures.
Without getting into the major technical aspects of all this, the takeaway is that different blockchains now have greater interoperability. This is going to be a necessity if blockchain technology is ever going to unlock its full promise – and if cryptocurrencies are going to be anything more than pump and dump schemes.
Considering the concerns surrounding Tether, Terra (and thus Luna) looks far more attractive because of the ecosystem’s solution to the problem of stablecoins. This is arguably its greatest value.
Through its various stablecoins, the relationship between the stablecoins and Luna, and the growing number of applications that can be used within this ecosystem, there’s the possibility of a massive flight into Terra if Tether is ever discredited. Terraform Labs is based in Singapore and its ecosystem has proved especially popular with merchants in Asia, especially because of its e-commerce wallet “Chai.”
Yet Terraform Labs faces a major problem – the American federal government. One of the critical parts of the Terra Network is the “Mirror Protocol.” The Mirror Protocol allows the creation of “synthetic assets,” crypto tokens that can “track” assets in the real world like real estate, stocks, or just about anything else. To proponents, this “democratizes” ownership of real-world assets, as you can “invest” in certain assets without actually owning them. These are called mAssets.
You can see why this would be exciting and useful. You can also see why many would think this is a potential red flag.
If you are creating a “synthetic” asset that has the risks and benefits of a “real” asset, one might argue that you are issuing securities. In fact, that’s precisely what the Securities and Exchange Commission is investigating.
On November 12, the SEC announced that it filed an action against Terraform Labs demanding compliance with subpoenas for “documents and testimony” surrounding this issue. While the SEC is still investigating and hasn’t concluded that anything illegal took place, there is still a great deal of uncertainty. The fact that the company is based in Singapore only adds to the confusion. Does the SEC’s reach extend that far?
More broadly, regulators are grappling with a crypto sector that was partially designed to overcome national boundaries and barriers to trade and communication. There are many issues with this case that are similar to that facing Ripple Labs and its token XRP. XRP is still a popular token – but you can’t buy XRP on Coinbase [COIN] because of an SEC lawsuit against Ripple.
American firms and investors are not going to throw themselves into something that could potentially be considered illegal. At the same time, the Terra ecosystem may simply thrive outside the United States, even if the SEC decides that Terraform Labs (or Ripple) have broken the laws.
Regulation is inevitable and at this point is probably desirable because of the need for clarity. Yet the technology is far outpacing regulation. Certain legislators, especially those in the Congressional Blockchain Caucus, have their own ideas about what should be done. Local and even state officials, especially Miami mayor Francis Suarez, are championing blockchain technology.
Finally, let’s not forget that bitcoin itself is legal tender in El Salvador under the charismatic (and controversial) President Nayib Bukele. In other words, even if we get some kind of regulation or legislation, it could rapidly be outpaced by technology, rendered irrelevant by the actions of other countries, or simply be repudiated if another political party takes power.
The Terra Ecosystem is one of the most widely used and innovative projects among blockchains today. However, until the legal situation in America is settled, investors have to be cautious.
Still, considering the murky situation surrounding Tether, it’s a comfort knowing that something else is out there. If Terra can survive both the current investigation and isn’t simply crowded out by Ethereum 2.0, its rise may be just beginning.
Again, the best way for investors to judge the project is not to look at Luna as a speculative instrument, but as another tool for exploring what blockchain technology is capable of. Remember, this technology is meant to be used… and not for gambling.
Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for RogueInvesting.com three times a week to bring you news on what those with power are debating, planning, and doing.
