Tim Fries
When Andre Cronje, the “Godfather of DeFi”, quit the DeFi field in March, many recalled his warnings that crypto needs regulation and that many DeFi protocols are experimental in nature.
This has been proven many times, but not as intensely as Terra’s $45 – $65 billion (direct and indirect) collapse.
However, where is the line drawn between cutting-edge innovation and defrauding? Is it likely that DeFi complexity inherently obfuscates potential fraud cases? Nassim Taleb, “The Black Swan” author, trader, and risk analyst, posits that Do Kwon is the Bernie Madoff of crypto.
Is Do Kwon Really the Madoff of Crypto?
Having since died in federal prison, Bernie Madoff had run an investment Ponzi scheme for decades before he was caught. How does he compare to Do Kwon, the founder of Terraform Labs?
The similarity between Madoff and Do Kwon’s Terra is striking. Both promised unusually high returns for investors. In the case of Terra’s Anchor protocol, it was up to 20% yields thanks to the dynamic between LUNA and UST algorithmic stablecoin. The latter underpinned Terra’s entire ecosystem as a frictionless payment network.
Likewise, Madoff promised consistent double-digit returns, only to use new investor inflows to pay back the previous ones. Hence, why it is called a pyramid/Ponzi scheme as the bottom always needs to be expanded. By the same token, Terra’s ecosystem crashed because people started to sell LUNA tokens amid a bearish market.
With the LUNA pyramid bottom shrinking, the UST stablecoin lost its peg to the dollar and triggered a sell-off cascade. Do Kwon tried to defend the peg with $3.5 billion worth of Bitcoin (BTC) reserves, putting additional selling pressure on the market. In the end, the Luna Foundation Guard had to sell 80k BTC, left only with 313 bitcoins.
This begs the question. Bernie Madoff had been an intentional, systemic fraudster. On the other hand, Do Kwon relied on the market tailwinds to inflate Terra’s ecosystem, with Anchor’s 20% yield protocol as the vanguard that entices new investor inflows.
However, is such a system doomed to failure, with open blockchain transparency only masking that inevitable failure?
Is Pegging the Unpeggable Akin to Fraud?
There is a reason Andre Cronje was mentioned at the beginning. After the supposed DeFi exit, Cronje came back with a proposal to fix Fantom’s stablecoin fUSD. Just like Terra’s UST, Fantom’s fUSD is supposed to provide stable returns for lending dApps. However, it has been anything but stable.
That is despite fUSD’s 500% over-collateralization ratio with FTM. One may assume these are growing pains accompanying new tech, but is that really the case with so many de-pegging instances? In fact, Do Kwon was well aware of the massive risks involved with his first project.
According to CoinDesk, Do Kwon was running Basis Cash (BAC) stablecoin under the pseudonym “Rick Sanchez”. Two former co-workers pinned him as the creator of BAC that launched in H2 2020. Of course, it flatlined in the meantime, having at one point in June 2020 reached $154.97, only to plummet to “stable” $0.007.
Speaking of plummeting, the new Terra 2.0 launch is not going well for Do Kwon. Without any kind of stablecoin, and high-yield protocol dependent on a stablecoin like UST, new LUNA has little to offer.
Since its launch on May 28th, LUNA briefly reached $19.53, only to drop by -80%, at $3.9. At press time, LUNA is hovering at $9.3.
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Terra 2.0: Another Attempt at Inflating the Untenable?
Bernie Madoff didn’t have the mystery and allure of smart contracts and algorithms at his disposal. He did his pyramid scheme the old-fashioned way. On the other hand, Do Kwon still goes by the moniker “Master of Stablecoin” in his Twitter bio, as if this is his specialty. Despite Terra 2.0 having no stablecoin, perhaps one is down the road, or is it?
Thus far, South Korean prosecutors subpoenaed all Terraform Labs employees. According to JTBC’s report, one employee already testified there was awareness about UST’s faulty design, which aligns with the Basis Cash (BAC) report.
If that is the case, why did Do Kwon proceed with the project anyway, especially after the BAC failure? Was it just wishful thinking or intention to commit another stablecoin pyramid scheme? Whatever the investigation unfolds, there is already enough information to come to conclusions about these types of DeFi projects.
In the best-case scenario, they are unstable experiments posing as legitimate Finance 2.0 frontier. At worst, they are money-siphoning schemes.
Update (2nd June 2022): Fixed typo in the headline.
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About the author
Tim Fries is the cofounder of The Tokenist. He has a B. Sc. in Mechanical Engineering from the University of Michigan, and an MBA from the University of Chicago Booth School of Business. Tim served as a Senior Associate on the investment team at RW Baird’s US Private Equity division, and is also the co-founder of Protective Technologies Capital, an investment firm specializing in sensing, protection and control solutions.
