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Sunday, June 26, 2022

How Terra Luna Founder Built a Crypto Cult

Photo-Illustration: Intelligencer; Photo: Getty Images

Last fall, when crypto founder Do Kwon threw a big bash in New York to celebrate and showcase the potential of his own work, he was a rising celebrity in the insular world of digital currencies. He had created two of the fastest-growing projects in the space: TerraUSD and Luna. At the time, the two interrelated cryptocurrencies were worth about $15 billion, on their way to more than quadrupling in just a few months.

Before the event kicked off, the 30-year-old did a preshow interview that was livestreamed on YouTube. He sat before a microphone, wearing a bulky blue jacket with a pair of Ray-Bans tucked into the breast pocket, and placed a nearly full beer on the table. Kwon’s shtick — the hyperconfident smirk in service of vague promises of transforming the world and building a global community of users — is familiar stuff to anyone who has paid attention to Silicon Valley over the past 20 years. What was new was that, instead of an app or a mobile device, Kwon wanted to dominate by upending the way everyone spends money, an ambition so huge he might as well have wanted to replace the air we breathe or the water we drink. In his vision, his decentralized currencies would become so ubiquitous and trusted that he could eventually step back from promoting and running them. “Anything that stands the test of time, it’s a cycle of life,” he said. “You begin from nothing and go back to nothing. That’s exactly where I want to be.” But he also acknowledged the possibility of failure, admitting there was a “kill switch” that would end the whole project if it spun out of control.

When he took the stage a half-hour or so later, though — before the 300-capacity crowd in front of a backdrop of the Manhattan skyline — any hint of caution was gone. “What we need to remember always is our true North Star of why we started this in the first place, and that is to make sure that our money is the most decentralized and the most useful on the face of this fucking planet!” Kwon shouted to huge applause.

Not even eight months would go by before Kwon’s whole project collapsed — about $60 billion was gone in a few days. The trillion-dollar global crypto market was thrown into chaos as prices plunged and panicked sellers began to doubt whether there was any really value in the entire sector. If this high-profile project could collapse in few days, could all the others? In Washington, regulators took notice and promised action. The scale of the disaster matched the scale of Kwon’s ambitions. To get to a $60 billion valuation, Kwon had sold legions of investors around the world — ranging from retail noobs to sophisticated Wall Street veterans and seasoned VCs — on his vision of himself as the next coming of Satoshi Nakamoto. In the aftermath, he’s trying to dig his way out of a failure that is garnering comparisons to the collapse of Enron. “He was definitely trying to build a Musk-style cult of personality on Twitter,” one Terra developer, who asked to go by Norman, told me. “He will unfortunately have to live with this shame forever and will be the new Ken Lay type.”

Kwon was born in South Korea in 1991. Details about his early life are unclear, but in 2010 he enrolled at Stanford University, where, according to officials there, he received a degree in computer science in 2016. He appears to have kept a deliberately low profile during his college years, though a public page he created says he worked for short stints at a “Microsoft business partner” and Apple. (A representative for Microsoft said they have “nothing to share” about Kwon, and Apple didn’t return an email seeking clarification.) After college, he was secretly behind a notoriously failed crypto project called Basis Cash, which bore some strong similarities to his work at Terra Labs. The project was billed as an outgrowth of another project called Basis, which had been shut down by the Securities and Exchange Commission in 2018. (That project was backed by Nader Al-Naji, a Princeton alum around Kwon’s age, who was also involved in the celebrity crypto-reputation market BitClout.)

Terraform Labs came into being in the wake of Basis’s failure. The idea behind this new venture was to create two interrelated digital currencies that had vastly different purposes but were designed to balance each other out. One was TerraUSD, called UST in shorthand. This was a so-called stablecoin, made to stay pegged at a value of $1. Stablecoins, which date back to 2014, are used by investors to buy into and cash out of cryptocurrency markets. Most stablecoins are backed by real assets that sit in actual bank accounts. UST, however, didn’t rely on any real-world financial holdings to underpin its value. Instead, as an “algorithmic stablecoin,” it was created to be in a constant, dynamic relationship with another digital token, Luna, whose value would rise and fall with the markets. The trick that Kwon used to keep the coins in balance — and to keep UST at a dollar — was the ability to exchange one for the other at fixed values, even if the price of UST wobbled. So if Luna was trading at $100, and the price of UST fell slightly below $1, an investor could exchange the latter for the former and make a little bit of profit on that small difference in price. That trade would also destroy that quantity of UST, lessening the supply, and causing the price to rise back to equilibrium. At least that was the theory. Making it work was a key step on the path of Kwon’s ultimate ambition to create the equivalent of a crypto central bank for the entire world — his “North Star,” as he put it in September. If it worked, it could potentially displace official national currencies as well as other stablecoins.

But for a long time, Terra was not living up to Kwon’s utopian dream. The problem was that, up until last fall, hardly anyone used UST, and Terraform Labs needed to make it more appealing. In July 2020, the company launched Anchor — a program that would pay UST holders an eye-popping interest rate, up to 20 percent annually, to lend back their token. Essentially, it was a way to get people to buy the stablecoin even if they had no use for it. At a moment when government bonds were paying 2 percent and savings accounts less than one percent, money flooded into the project. Kwon reeled in some of crypto’s biggest investors, including Wall Street veterans Mike Novogratz and Dan Morehead, and Changpeng Zhao, the unfathomably wealthy founder and CEO of Binance, the world’s largest crypto exchange. Borrowing a page from Silicon Valley’s playbook — remember when venture capitalists subsidized Uber rides for years, making them too cheap not to take? — the idea was to use the money-losing high interest rate as a way to rapidly gain market share. Soon, Kwon would establish the Luna Foundation Guard (its initials a common cryptoworld shorthand for “Let’s Fucking Go!”), which would buy up billions of dollars in bitcoin as a kind of flexible reserves war chest for his project.

Billionaire investor Mike Novogratz, a major investor in Do Kwon’s project.
Photo: Eva Marie Uzcategui/Bloomberg via Getty Images

But as the Terra project grew, so did the chorus of concerns expressed by doubters. Kevin Zhou, the head of crypto hedge fund Galois Capital, predicted its demise for months, comparing its coming downfall to the Romans’ siege of Carthage. Others outright called it a Ponzi scheme. Kwon appeared to relish the fight. His favorite put-down against his doubters was to call them “poor.” He tried to avoid litigation from the SEC over another Terra project that created crypto products that acted like derivatives by rising and falling with the price of certain stocks. (He was served a subpoena right before heading onstage at one U.S. conference but later claimed the SEC doesn’t have the jurisdiction.) Just about a week before Terra lost its peg to the U.S. dollar, Kwon bragged that “there’s also entertainment in watching companies die.”

Internally, Kwon was a brash figure even in the world of massively wealthy crypto founders. Norman, the Terra developer, remembered how Kwon belittled an engineer over a Discord channel in December after a glitch had accidentally cashed out about 250 Terra holders. “He was extremely impatient and rude and seemed like he was annoyed at having to be there,” he said. “Kept telling the organizer he needs to speak in shorter sentences to not waste his time. He embarrassed him very badly, and it was shocking behavior.” Tweets show that Kwon bragged about his heavy alcohol consumption — “I sleep three hours a day and drink heavily” — and seemed to encourage his employees to do the same. Kwon didn’t respond to an interview request for this story.

However much it put some people off, Kwon’s followers only rallied behind him more. On Twitter, Luna investors called themselves Lunatics, like they were part of the Beyhive or the Beliebers. People put moon emoji in their names and memed incessantly about Kwon. Novogratz got a large tattoo to show his devotion:

“We were passionate about the idea of decentralized money in the era of high inflation and bad Fed Reserve policy. It gave the little guy a chance to have something,” Norman told me. Successful crypto projects tend to have large and enthusiastic communities — the Bored Ape Yacht Club, behind the NFT image series that blew up in popularity last year, is maybe the prime example. Community members both kept demand going and spread the word to outsiders. As the online community grew, so too did the Wall Street interest. Steve Armatas, crypto trader at the Woodstock, New York, firm AlphaGrep Securities, first noticed Luna around the summer, when it was one of the few digital currencies soaring after bitcoin had crashed and dragged down the price of most other digital tokens in the market. “I read the description. It sounds logical. It makes sense,” he told me, describing his thinking at the time when he invested in it last year. “It’s backed by somebody who seems to know what they’re doing. It’s backed by money. It’s internally consistent. It seems well conceived.”

But on March 7, things started to fall apart. At the time, Terraform Labs was essentially upgrading its systems, switching from a program that had a reserve of tradable UST to a new one that didn’t appear to have any, according to research from Onramp Academy. In doing so, Kwon’s own company made $150 million in UST disappear — precipitating a $350 million drawdown soon after. If you were a crypto trader, all of a sudden you would see that half a billion UST tokens had just disappeared. Soon, Terra slipped from its dollar peg and, after a few days of wobbling, collapsed below 80 cents. Kwon deployed most of LFG’s reserve crypto to try to bring the price of UST back up to a dollar, but it didn’t work, and it would hit lows at 50 cents, then 30 cents, and later at nine cents. An investor who had parked $1,000 in UST in early March would suddenly have $90 left. Meanwhile, Luna — still algorithmically hitched to USD — was also in a death spiral. One effect of Kwon’s arrangement was that the lower that UST went, the more Luna tokens were issued. Within days, Luna had fallen to about one-millionth of a dollar, and there were trillions of them in circulation. While Lunatics called it an “attack,” blaming Wall Street giants for plotting a secret coup to destroy them, Terra’s downfall seems to have been written into the code of the project — the balance between the two tokens was ultimately unstable and vulnerable to collapse if too many people pulled their money out at the same time.

The destruction was widespread. Novogratz disclosed that his firm, Galaxy Digital Holdings, lost $300 million. Armatas, the trader, said his holdings in Luna fell by 90 percent. “It went from $50 billion to zero in two days. If that can happen, how can you value anything?” he said. For amateur investors, the devastation was worse. “I’m almost 100K in debt, and I have nothing left. I quit my job to work in the community full-time, and I thought I had financial freedom with my account size,” Norman said. “I figured I could repay the debt later, as we all expected another 2x based on the speed of mass adoption we were seeing. It was going critical, but I think the growth of UST was so fast that we flew too close to the sun and it got us.”

Kwon has since tried to reset the cryptocurrency. It hasn’t worked. On Monday, he took to Twitter to try to pivot, posting the hashtag #TerraIsMoreThanUST and appealing to the community of users that had pumped up his currency in the first place. “All I meant is that even without UST there is an ecosystem worth preserving in Terra,” he wrote.

The future for Kwon, and really anything that he’s involved in, appears to be in doubt. At the Terra Hacker House in Chicago — a space run by Jump Crypto, a trading firm that invested in Kwon’s crypto ecosystem — the developers there are still planning to present new projects on the blockchain, but the mood is dour. “They’re still going to have a demo day at the end of next week,” Neel Somani, a former quantitative researcher at Citadel Securities who left his job in February to start a project on the Terra blockchain, told me on May 13. Somani said that Kwon was going to be a seed investor in his project, but now that plan appeared to be on ice: “Obviously, whatever I built so far, it’s probably gonna be it’s not really useful outside of the context of this hackathon anymore.” (Representatives for Jump didn’t return a request for comment.)

In the aftermath of the collapse, there is a lot of talk in the industry about a coming “crypto winter” — a long period of recession. Regulators including Treasury Secretary Janet Yellen have called for more rules to protect investors from potentially unstable stablecoins. (In November, the President’s Working Group on Financial Markets released a report recommending consumer protections, such as requiring stablecoin issuers to be insured by the FDIC, like banks. The recommendations haven’t gone anywhere, and anyway, since Terraform is based in Korea, it wouldn’t have mattered.) “The speed at which this has happened has caught everyone by surprise,” Charles Cascarilla, CEO of Paxos, which issues a stablecoin backed by short-term U.S. Treasury debt, told me. “There is a fundamental need to change the financial system and to bring new technologies to bear. The way it works today is laughable.” In the meantime, the Federal Reserve is likely to keep tightening the economy, inflation is only barely slowing down, and a possible recession looms. The implosion of Terra and Luna has left many in the world of crypto questioning whether there was ever anything there to begin with. “It was a star,” Armatas said. “If it was a Ponzi scheme, they did a good job. Well, until they didn’t do a good job.”

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