Ponzis on the Moon
always has been
A crypto ponzi scheme blew up last weekend. This happens most weekends, but this ponzi was a $40B one which had attracted tons of inflows from people who wouldn't otherwise touch crypto, this one was "stable"! So now Janet Yellen is talking about it, because civilians got hurt too, and the unspoken code is that our PvP games do not extend to them.
a brief-ish history lesson
Matt Levine has a good primer of how the protocol works but the gist is that there's a "risky" token (Luna) and a "risk free" token (Terra). You can swap between the coins in a manner that incentivizes the price of the risk free to tend towards $1 (by pushing the risky token down or up, in the inverse direction). Of course, if the “risk free” token gets depegged, the “risky” token must inflate and reduce the price per token to cover losses, further pushing the price of the “risky” token down and creating a death spiral.
I gotta be honest, I started trading LUNA in October but also had no idea how that “seigniorage” mechanism worked until a couple weeks ago. A lot of these DeFi mechanisms are designed to be confusing and to obfuscate, not to be useful.
Most people don’t touch stuff they don’t understand. That’s a good survival instinct (hey this frog is orange, should I lick it?) and also a huge problem to solve for DeFi, who the fuck knows what
W-veCVX-yvCurve-triCrypto is and is gonna trade it? The TAM of gambling addicts is not small, but it’s also not that big.
LUNA figured that out and didn’t market the seignoriage mechanism to retail - they instead marketed “Anchor” as “Better Savings” (but legally not a savings account 😉😉). Anchor offered 20% APY interest on dollar deposits. That’s much easier to understand: I give you money, you give me more back. A year ago, 20% wasn’t even that eyepopping compared to the garbage OHM forks offering 100k APY or the “real” yield funded by DeFi protocol emissions, so it didn’t seem crazy. After those protocols burned out but Anchor maintained their 20%, Lindy principle, maybe they’ll continue to offer that! Even the “oh crypto people want to borrow money and buy on leverage, nobody else will lend to them, and so a 20% yield makes sense” theory barely holds up: for the protocol to pay 20% yield, the borrowers must be paying more than 20% interest (assuming 100% of assets are lent out), and the borrowers must also be too stupid to compare prices when engaging in commoditized financial activities (borrowing rates across protocols, assuming similar riskiness, should converge).
Anchor was one of the first DeFi protocols I looked at in depth - and was the absolute first which I realized was a ponzi. They’re offering 20% USD interest, but earning only like 6% on their deposited collateral, and that interest is denominated in crypto assets, where does that delta come from? The answer is quite clear, the surplus yield came from Terraform Labs, which funded the protocol with its own seed funding. So I never staked with Anchor - also because the Terra Station desktop client was too confusing to use. A number of companies “solved” the UX problem by wrapping Anchor deposits with an easier UI (eg this YC startup RIP or this one) and getting more retail deposits.
heroes and villains
A quick note on the “coordinated attacker” conspiracy theory: the narratives on both sides (Jump the “hero”, Citadel the “villain”) are easy to digest and fun to think about, but by Occam’s razor: Luna was a ponzi that blew up. There is no need to be angry, there is no need to start pointing fingers towards Citadel (lol) or Blackrock (lmao) as culprits. Blackrock has some hedge fund divisions but its an extremely risk-averse shop and primarily just manages passive assets; Citadel has degens but they pretty explicitly do not trade crypto because of regulatory concerns. Certainly, neither is going to borrow billions and attempt a complex days long attack which would require massive directional risk and further billions in short exposure.
If there is any “attacker,” which I don’t really believe there to have been, it would likely be the major trading firm notorious for pushing markets down and liquidation hunting, and whose CEO took a public victory lap after predicting the coin’s collapse on a massively popular podcast. Certainly lots of desks would have jumped in and helped on the way down when it became clear what was going on, but as to somebody coordinating everything? I doubt it.
So yeah, this space will probably get regulated a bit more, we cannot be allowed to target civilians, or at least they can’t feel like they were targeted. It also looks bad for huge investment firms to make billions on an investment and for those profits to be so nakedly from retail - as with the rest of DeFi, additional smokescreens are required to launder the reputation. LUNA grew bigger than the other ponzis because of civilian involvement, and so it must fall harder.
Probably the biggest story of the last few years for me has been how starkly income and wealth inequality have been exposed. Of course, these disparities existed before, and will continue to exist. COVID laid them even more bare - the “laptop class” worked remote from goat farms and Mexican beaches while restaurant workers died at a +39% greater rate, stocks and real estate soared, benefiting people who had already accumulated wealth, Americans stockpiled mRNA vaccines at the expense of poorer countries and so on. In recent months, the Fed has made it clear that their only lever in addressing inflation is to raise interest rates and bring asset prices down, to reduce the amount of incremental spending from upper middle class folks increasing consumption after pandemic wealth gains. This strategy is, of course, classic hammer-nail fallacy, but it’s to be expected given how weak and dysfunctional nature the rest of the government is.
So broadly, we have seen crypto and meme stock mania, and otherwise strait laced individuals have poured into the markets and tried their hand at investing. Even as I write this in a coffee shop, the middle-aged guy in front of me is watching Bloomberg TV and checking their OpenSea listings (down bad lol). A firm belief I have is that we should not have 401k’s and that the US government should instead vastly expand Social Security. I don’t have the space here to expand on that, but it makes sense even from a pure Taylorist perspective: don’t waste company time trading options on Robinhood, do what you are best at and don’t worry about if you’ll have a retirement, it’ll be fully guaranteed by the American military.
Why did retail trading go up at the same time wealth inequalities were laid more bare? There are certainly exogenous elements - number go up means people get greedy, no sports to gamble on, just kinda being bored at home, less spending on restaurants etc means more savings to yolo. My main theory though is mainly one of panic and FOMO - if everyone is getting rich in nominal terms, and there are finite amounts of real assets, you kind of also have to bid if you want any chance of having that pie.
The rise of Korean culture (aka “Hallyu”) in the last decade is not just the expansion of TWICE and BTS, it’s also the expansion of the sense that there is no social mobility left and life is pointless, that young people are already living in hell. Korea has the highest suicide rate in the OECD and people are splurging on $20 candles because it’s all they can afford (and that growth has only continued). Like Americans, Koreans have dramatically increased their college attendance and graduation rates, and now also have an elite overproduction problem. If you try to imagine what America will be like in a few years, with stalled economic growth and persistent wealth inequality, Korea is a reasonable blueprint, which I’m sure would be quite amusing because many of their economic problems derive directly from American occupation and colonialism. Luna, with its Korean leadership and development team, grew extremely popular with the Korean retail trading community, which was always pretty degenerate. Now Americans have joined the chat - there are no more opportunities to get rich playing the game, so we’re all taking degen lottery tickets.
In some ways, this feels like the endgame because all the layers of obfuscation have been laid bare. Behind all the algorithms and the math was a simple ponzi, behind all the trendy UI’s and fancy graphics was a simple ponzi, behind the VC tweetstorms and “OTC swaps” was a simple ponzi. I’m not going to go so far as to call “the American dream” a simple ponzi, but can you see why people think that?
In closing, I leave you with Gil Scott Heron’s poem, Whitey on the Moon. What good was the wealth creation of the last few years if it was so unevenly distributed? What good was it, now that personal savings are gone (at lowest rate now since 2013) and revolving debt has increased 35% YoY? How did those gains differ along racial lines? Is it a surprise that people were desperate enough to buy into fairly obvious ponzis?