The LUNA-Terra fallout is catastrophic as billions of dollars have been wiped out. While the dust settles, people are still trying to figure out how widespread the effects will be and their impact on the larger market. With macro conditions worsening, it is clear that the bear market is here. But in bad times, those who are cash-rich will have many opportunities to buy the blood.
Read on as we explain what happened, and what possibly lies ahead in the near future for crypto.
Bitcoin
Source: CoinGecko
Worsening macro conditions and the onset of the equivalent of the Lehman brothers crash in crypto accelerated the somewhat inevitable dump over the past week. For the first time in history, Bitcoin experienced its 7th consecutive red-week. Nonetheless, BTC’s bounce at $26k towards the end of the week matches the overall market structure support line, despite its deviation from $30k-28k. Many are claiming that this is the end, giving hope that bottom signals are kicking in. Notably, every bounce has bled lower over the past few months but the latest one does show signs of strength. Hopium would even call it a possible V-reversal.
The key point to watch moving forward is whether BTC is able to maintain its larger market structure. We are already seeing short-term resistance as the $30k trendline flips from support to resistance. Bulls will need to show larger strength moving forward. Again, keep a close eye on the S&P 500 which largely dictates intra-day momentum.
Altchain Price Returns during Terra / UST Crisis
Terra’s demise is a double-edged sword for other altchains. On one hand, everyone might give up on altchains altogether and revert back to ETH, especially with the impending Merge. On the other hand, newer chains like SOL, AVAX, and BNB might see a revival in TVLs as liquidity (whatever’s left of it) flows out from Terra.
While predicting longer-term winners is much harder, we take a look at how altchains have performed since the start of May and throughout the crisis.
Source: CoinGecko
From a price returns perspective, only TRON (TRX) has managed to thrive during the crisis, with a +17.8% price return since 1st May 2022. This is probably due to the launch of Tron’s own USDD algorithmic stablecoin, which shares more than a few similar mechanics with UST, on May 5th. Throughout the crash of UST / LUNA, Justin Sun, the founder of Tron, has been carefully crafting a counter-narrative for USDD, which seems to have largely worked.
Amongst the other L1 chains, BTC, ETH and BNB were the most resilient, down by ~20+% respectively, largely in line with the overall crypto market cap, which was down -27.1%. AVAX, ATOM, and SOL were the worst hit, down by ~40%. There are probably a few obvious reasons for this: Terra was part of the larger Cosmos ecosystem, and had recently inked a partnership with Avalanche to incorporate more UST in their network. Meanwhile, two of Solana’s largest DeFi lending protocols, Solend and Orca (together with Coin98) had exposure to UST pairs and were just starting their liquidity incentives for UST.
Outside of Tron, the only other major coin which saw any positive price movement was MKR, the governance token of Maker DAO, which at one point was +13% from its price on May 1st. However, it has since largely retraced back to ~$1,500 levels. This temporary bounce was probably the result of speculators punting on a potential flight to safety from UST to DAI, possibly driving up the price of MKR. Unfortunately, fellow stablecoin governance token FXS didn’t see a bounce, instead also declining, possibly as FRAX shares the same “algo-stablecoin” label with UST.
Wither DeFi?
Source: DeFiLlama
From a DeFi TVL perspective, the picture is markedly different. Total TVL was dragged down by -42.3% as of 14th May 2022. Terra had ~11% share of TVL on 1st May 2022, but their share has since declined to <0.4%. Meanwhile, within this period of retreat, Ethereum’s dominance of TVL has risen from ~51% to 59%, the highest it’s been since the start of the year after steadily losing market share throughout Q1 2022.
Source: DeFiLlama
TRON and NEAR largely managed to sustain their TVL, despite losing most of the gains made throughout the Terra / UST saga. Polygon also made gains but quickly surrendered them within the week, closing out at -18.8% down. The rest of the chains pretty much lost between ~25 - 30% of TVL within this period. Avalanche was again the biggest loser amongst the main altchains, losing -43.8% TVL since the start of May.
Predictably, Terra-native DeFi protocols suffered the most, with big names such as Astroport, Mars Protocol, Anchor, Terraswap pretty much wiped out from this crisis. However, any protocols using UST / LUNA as collateral were also at risk. For example, Blizz Finance on Avalanche and Venus Protocol on BNB lost all their TVL, as they relied on the Chainlink oracle for the price of LUNA, which somehow had a hardcoded lower limit of $0.10. When the price of LUNA fell below $0.10, arbitrageurs could effectively buy cheap(er) LUNA, and use it to withdraw other collateral assets from these protocols.
Finally, the saga also made victims of Curve and Lido, previously two of the largest DeFi protocols in terms of TVL. Throughout the crash, Curve lost -53.4% in TVL while Lido lost -50.7%. MakerDAO, by virtue of its TVL declining by only -20.4%, has now ascended to be the largest DeFi protocol by TVL ($10.5B), with 9.3% share of the market. Curve not only lost its crown as the largest DeFi protocol but is also now behind AAVE (AAVE + AAVEv3) in terms of TVL of lending protocols.
Given Maker DAO’s singular feature set, and no visible growth in DAI’s market cap despite the collapse of UST, it is unlikely that the protocol will be unable to hold down the top spot for too long. It is likely that Curve and/or AAVE, will recover their market share as the value of their underlying collateral base recovers.
Managing the contagion spread
Terra’s far-reaching impact would not have been possible without its strong cap table and backing of prominent VC / hedge funds. As the value of UST and LUNA collapses, they will leave a dent in their respective portfolios. These are the list of investors that we are aware of (although there are likely more):
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Jump Crypto
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Binance
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Hashed
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Delphi
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Three Arrows Capital (3AC)
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Defiance
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Pantera Capital
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Galaxy Digital
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Coinbase
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GSR Ventures
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Tribe Cap
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Chiron
As with all investments, earlier investors would be facing a smaller paper loss, while investors which only came in in the later rounds would be more badly affected. While it is likely that most of these funds would have only taken paper losses on their positions, it’s also possible that some would be looking to liquidate part of their crypto portfolios in order to preserve value or unlock additional liquidity. After analyzing the portfolios of these VCs, it is worth highlighting some of the investments that likely represent a significant size of their portfolios:
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$AVAX
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$DOT
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$SOL
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$FTM
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$NEAR
A lot of this is a mixture of speculation and public statements about their investment size. In any event, do keep an eye out for their press releases about their exposure to LUNA/Terra, and what steps they are doing to mitigate their losses if any. Some funds such as Binance and Galaxy have already come forward to clarify their positions.
Closing Thoughts
We’re still seeing the fallout of this collapse. All eyes are now on Do Kwon and the Terraform Labs team, as they look to put together a proposal to rescue or relaunch the chain. With LUNA / UST essentially dead, the focus has now shifted towards saving the technology, protocols, and developers on Terra, and providing a path forward for them.
Terra / UST was a darling of VC / hedge funds. With its collapse, coupled with a broader bear market and recession fears, expect this to result in a more challenging fundraising environment for crypto projects moving forward, and for this to significantly impact the valuation of funding rounds.
Finally, with significantly large numbers of retail being impacted by this collapse, we should expect more pronouncements and reactions from regulators. Whether this will result in concrete regulations for stablecoins remains to be seen, but this catastrophic event would likely lead to greater calls for regulators to act.
Things we are looking out for:
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While it has been a horrific week for the crypto market, it has surprisingly been a strong week for crypto funds, with CoinShares reporting that funds added $274M in inflows last week as institutional investors “buy the dip”.
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Past cycles tell us that during a slow bleed or period of consolidation (especially $ETH), market traders lose interest and revert back to trading JPEGs. Keep an eye out for a potential revival of trading volumes on NFTs, though likely only in the short term. SOL NFTs, in particular, look to be taking off.
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Be prepared for intense volatility. Inexperienced traders should avoid leverage and just DCA into the dip with spot. Stop-hunts will be prevalent and will punish late longers/shorters.
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Insurance in DeFi has been around but has always been less popular because of the number of degens in the space. However, with the black swan event, certain Terra-based insurance protocols (e.g. InsurAce, Unlslashed, and RiskHarbor) have risen to prominence as they pay back the UST guarantees in light of the depeg event to insurance holders. Perhaps more market attention will revert back to insurance protocols in general?
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Ethereum’s path to Merge continues. From the latest Ethereum All Core Dev’s Call, Ropsten, the first out of four Ethereum testnets, will be undertaking its Merge upgrade (yes no longer just a shadow fork Merge!) on June 4th. A successful merge on one of the four public testnets will be a key progress milestone towards the eventual Merge. A total of 12.6M ETH are now staked in the Merge staking contract, representing ~10% of total circulating supply of ETH.
This article was produced in collaboration with Zhong Yang Chan. You can follow him on Twitter here.
Benjamin is an ex-consultant who is tapping into his legal roots to explore the world of crypto. Follow the author on Twitter @NeBB399
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