Proof of Misgovernance

3 weeks after Terra 1's default, Kwon's hostage-taking of the Terra 1 network begs the question: Why?

June 02, 2022

3 weeks after USTC/LUNC’s de facto bankruptcy, LUNC ($700 market cap) trades a mind-boggling $300m USD per day, fueled by a massive contingent of new speculators. LUNC also dwarfs UST’s market cap ($185m).

Other fragments of the Terra 1 network retain considerable trading value. The Anchor token (ANC) somehow trades over USD $100M per day, if CoinGecko is to be believed.

LUNC-USTC (formerly LUNA-UST, i.e., Terra 1) retains far more potential to the crypto industry, and indeed global finance, than LUNA (Terra 2) will ever have. However, that value can’t re-accrue as long as Kwon and/or Jump control a supermajority of staked LUNC.

There’s considerable outside interest in recapitalizing Terra 1, modifying its collateralization structure to something more conservative, decentralizing the reserve, and trying again. This interest is shared by Terra protocol members, ex-TFL employees, and deep-pocketed outside investors.

However, Kwon’s “temporary” takeover of Terra 1 governance on May 12th, now in its fourth week, makes this impossible. This is turning into a major, underreported cautionary tale around Proof-of-Stake in general. The concept of protocol “governance rights” were circling the drain already, but Kwon’s conduct around Terra 1’s governance represents a new low in protocol mis-governance.

The Not-So-Temporary Terra 1 Takeover

On May 12th, as LUNC (then LUNA) was hyper-inflating towards zero, Kwon bought 244m near-worthless LUNA and staked it across friendly validators. (It’s relevant to note here that Kwon always closely controlled which validators were whitelisted, and a large majority of validators on Terra were somewhat or very closely connected to him.) The total amount of staked LUNA went up from around 320m to 610m (out of trillions). In other words, 610m LUNA out of trillions could actually vote on anything. According to reports at that time, Jump had around 36% of staked LUNA, Kwon had 45-50%, and OG’s owned the balance.

The rationale was that as LUNA’s economic machine was falling apart, “governance attacks” — an outsider buying up lots of LUNA to take network control — were a growing danger. Because Terra was imploding towards zero so fast that Terra had literally run out of decimal points to express LUNA’s hyperinflation towards zero, “the community” — of validators who were generally somewhat closely connected to Kwon — agreed.

Since then, the amount of staked LUNA/LUNC dropped to 360m. Given the volume of dumped LUNC, it seems highly likely that Jump and many other stakers blew out, leaving Kwon with a supermajority of staked LUNC.

LUNC-UST Today: The Opportunity

Fast forward to today. Terra 1 has $11.115B of bad debt: 11.3bn of USTC circulating supply, and a $185m USTC market cap.

Terra 1 also has $515m of net equity: $700m LUNC fully diluted market cap, and $185m of mark-to-market debt (USTC market cap).

After the airdrop-launch of Terra 2.0, LUNC staking remains completely disabled, with no end in sight.

The ingredients are actually in place to resuscitate Terra 1. By my math, an outside syndicate could recapitalize Terra 1 as a 50-75%-collateralized algostable with $1.5-2B of total capital.

However, Kwon has been completely mum on the fate of the Terra 1 network, and has given no insight into when Terra 1 will be opened up to the wider world. Meanwhile, he very likely controls a large majority of staked LUNC. Until outsiders are allowed to stake validators who aren’t related parties of Kwon, “governance rights” on Terra 1 are worthless.

What Is Terra 1’s Value Today?

There are many sources of perceived value in a modified version of Terra 1 — the undercollateralized algostable combined with the governance token.

  1. Terra 1 was an attempt to answer one question: “Could a private-sector actor create an on-chain, deregulated, autonomous eurodollar?” The TAM of such a financial product, if it worked effectively, would be in the trillions. It’s a risk worth taking. The chance of such a product working is somewhere between 10% and 100%, with a payoff in the trillions.

  2. Terra 1 was laps ahead of competitors in demonstrating product-market fit. In my opinion, there is room for 1 or 2 low-velocity, ETH-based reserve algostables (DAI / FRAX; the Swiss franc) and 1-3 non-ETH high-velocity algostables that could mediate everyday transactions (a la the fiat USD & RMB today). These are winner-take-most markets, which means that rapid growth has high relative value.

  3. Users: 4.5M total wallets; 990k MAWs (Monthly Active Wallets); 489k active wallets in last 14 days.Terra 1 was by far the most successful attempt to build the latter high-velocity algostable to date. Evidence suggests that that its unique user base expanded by 100-200% during the crash, as new spec users poured in (South Korean data suggests an almost 200% increase). No other algostable came close to this level of onboarded concurrent users, and no other network sustained that level of usage with a modestly decentralized network combined with very low transaction costs.

  4. $400M (USD) of daily turnover on LUNC, USTC, and ANC alone. Value: $1M+/day, but will depreciate over time.

  5. A mostly-completed decentralization roadmap. Progressive decentralization is extremely risky. The founder(s) needs to give up countless opportunities for insider trading/grifting the community, as well as the intoxicating media attention given leader-founders (Kwon) over follower-founders (Buterin). The good news for Terra 1 is that decentralization finally happened by force: no central entity owns much LUNC due to the hyperinflation of LUNC supply.

  6. A (potentially) unparalleled redemption-arc narrative. Cryptocurrency valuations in the medium term are driven by narrative, builder participation, and credible relative yield, in that order. A salvaged Terra 1 narrative would take Terra’s narrative from zero to hero.

  7. Blockspace: This can be valued as total protocol fees and value accrual to stakers. It’s extremely subjective, but everyone can agree that in its current state it’s extremely depressed. Value potential: $1-5B

Kwon’s conduct disqualifies him from running a new algostable. A partial list of Kwon/Jump’s unforced governance errors, mostly repeated from prior posts, is outlined at the end of this document for easy reference.1

Current Community Proposals To Save Terra 1

The Terra Agora has been overrun with community proposals to save Terra 1. Formally submitted proposals are shown here to anyone with a Terra Classic wallet.

Most of the proposals are shitposts.

The serious proposals focus on Tobin-taxing Terra 1 trading volumes ($400M+ per day) to gradually recapitalize the USTC peg. While theoretically feasible, these suffer from several drawbacks:

  • The trading volumes will drop significantly after the tax is introduced

  • Without opening up validator delegation, the swap tax will accrue to Kwon who control 75-85% of staked LUNC

  • Kwon, by controlling a large majority of staked LUNC, have de facto control over the efficiency threshold of any USTC burn. A purposefully inefficient burn threshold would generate very high USTC swap taxes which would accrue to LUNC stakers (mostly Kwon).

The most theoretically viable proposal redirects most validator commissions towards buying back and burning LUNC.

Unfortunately, Terra 1 will take months to recapitalize itself organically, while better-capitalized competitors move in. Terra 1 has a narrow window to be recapitalized by an angel syndicate and be revived. However, Kwon’s governance hijack of Terra 1 makes that impossible.

If Kwon, as the presumed owner of 75%+ of staked LUNC today, dumped his 75%+ share of UST (from swap fees as UST were “burned” into new LUNC) on the open market and extracted it from the Terra 1 protocol, it would keep the peg broken while massively enriching Kwon and the few other remaining LUNC stakers. Alternately, if Kwon dumped his swap tax revenues and exchanged it continuously for LUNC, he could build a large share in a recapitalized LUNC at no cost to himself.

Kwon seems to be aggressively flexing his pocket veto regarding proposed governance changes. Important governance votes receive very little participation from staked LUNC holders and don’t come close to the quorum required to pass (120M LUNC votes). Assuming Kwon now owns more than 250M staked LUNC, it’s not possible for any governance proposal to reach a quorum without his assent.

Speculation thus mounted that Kwon’s governance hijack of Terra 1 was actually a way to starve Terra 1, to subsidize a new algostable on the Terra 2 network.

Cui Bono? A New Kwonzi Algostable

No sooner than I wrote the above sentence, an unsurprising piece of news was reported.

Although @FatManTerra hasn’t been the most reliable narrator, his scoop would explain a lot. Kwon presumably doesn’t want Terra 1 competing with a new Terra-2 algostable in which he owns a much larger share. Kwon knows he’s damaged goods, but he still owns operating control of Terra 1, share-for-share ownership be damned.

LUNC owners today are in a similar position to US owners of Chinese ADRs: they own a piece of scrip that means whatever its ‘government’ (Kwon) wants it to mean.

The high trading volume of LUNC, ANC, and probably other tokens represents an extractive free call option to Kwon, to the extent that they wanted to tax remnant LUNC activity to subsidize Terra 2 (LUNA). If LUNC were restored to solvency, they would lose the free call option, and developer activity would also flow back to LUNC and away from LUNA.

Taking Terra 1 hostage to subsidize a Kwonzi Algostable 2.0 would be a huge wasted opportunity for the industry. Any new Kwonzi algostable governance token would be an all-in short to zero. Kwon screwed depositors and equity owners alike in his bankruptcy reorg of Terra 1, and would use the same exploit (the fact that the network isn’t remotely decentralized) to hijack Terra 2.0 during bankruptcy and once again rinse outsiders for his own benefit.

Forking: Pros & Cons

A fork-airdrop of the Terra userbase would be the best approach if Terra 1’s governance doesn’t change. Active wallets between time X and time Y could be snapshotted, with special consideration given towards wallets which voted constructively on Terra 1 governance, and blacklisting applied to validator wallets which declined to vote for said proposals. This would be a good way of filtering toxic, pro-TFL actors out of an airdrop scenario.

A fork-airdrop to Terra 1 wallets would have much more ‘breakage,’ however, than a brokered takeover would. Terra 1’s users are united in a sort of shared financial trauma and would have very high participation in a Terra recovery, with a restored dapp ecosystem within easy reach. The re-onboarding of exiled Terra 1 projects & unhappy Terra 2 projects would be similarly seamless. Getting the dapp ecosystem on board with a fork would be a significantly messier process.

A brand new algostable starting from scratch would also start too far behind current overfunded competitors such as USN (Near) and USDD (Tron), with no surrounding dapp ecosystem and none of Terra’s well-honed UX.

Based on what we know now, forking Terra 1 may be the most viable option for a syndicate of “adults in the room” (eg, a16z, Maker, and other VCs not involved in Terra 1), if they’d immediately commit to a smart-contract-focused decentralization roadmap.

Terra 2.0 Relaunches according to Do Kwon's Revival Plan

Do Kwon, the co-founder and CEO of Terraform Labs, confirmed the relaunch of Terra’s new chain, Terra 2.0, which aims to revive the fallen Terra (LUNA) and TerraUSD (UST) ecosystem. Kwon’s revival plan for Terra involves hard forking the existing blockchain and reissuing LUNA tokens to existing investors based on a snapshot before the death spiral bled the LUNA and UST markets — effectively resulting in unrecoverable losses for investors.

Eth2 Beacon Chain Launches on Ropsten Testnet, Paving Way for Merge

The Ethereum Foundation launched the Eth2 Beacon Chain on a public testnet yesterday, marking one of the final tests before Ethereum transitions to Proof-of-Stake later this year. The Beacon Chain, Eth2’s Proof-of-Stake consensus layer, went live on the longstanding public testnet, Ropsten. The launch is a major milestone toward Ethereum’s highly anticipated ‘chain-merge’, which developers expect to go live on mainnet during the third quarter of this year.

Polygon Unveils ZK and Optimistic Rollup Hybrid Nightfall

Polygon Nightfall, a rollup that uses ZKPs for privacy and fraud proofs for scalability, is now live on mainnet. Ernst & Young (EY), one of the ‘Big Four’ financial services behemoths, started work on Nightfall in 2019 to make its customers’ Ethereum transactions private. The company was so swamped by Ethereum’s high gas fees that in September 2021 it started working with Polygon to cut the costs of those private transactions.

Optimism Airdrop Overwhelmed by All-time High Demand: ‘Scaling is hard’

Ethereum layer-2 scaling solution Optimism has been overwhelmed with “all-time high demand” following the launch of its highly anticipated airdrop on Wednesday. Users racing to collect their tokens were greeted with failed or delayed transactions as the Optimism team raced in the background to add additional capacity to the network.

Staking Assets

Leading Ethereum Development Platform, Infura, Partners with NEAR Protocol, Marking Expansion as a Multi-Chain Connector

ConsenSys announced a partnership between Infura, its leading blockchain development platform, and NEAR Protocol, an infinitely scalable proof-of-stake (PoS) blockchain that is also carbon neutral. The integration, which has been in private beta for two months – and is now widely available – marks Infura’s expansion beyond Ethereum Virtual Machine (EVM)-compatible chains.

Terra 2.0 Receives Broad Support From Known Legacy Protocols and Also New Protocols Announcing Their Launch

Now that Anchor, Astroport, Spectrum and many other protocols have joined the TerraBuilderAlliance, a new AMM will launch on Terra 2.0. Phoenix Finance will be the first decentralized exchange built for Terra 2.0. Their team is composed of Terra-native engineers, all with extensive DeFi experience, with the common goal of bringing the best DEX experience to the Terra 2.0 community.

Mirror Exploit on Terra Classic

Stock synthetics trading protocol Mirror has been exploited for more than $2 million. The exploiter abused the oracle pricing error caused by the Terra incident and may be able to drain the rest of the pools if the bug doens’t get fixed before the next stock market open.

Staking Providers

Coinbase Backs First Enterprise-Grade Liquid Staking Protocol

The exchange published a company blog post stating that its cloud division would be supporting the development of the first-ever enterprise-grade liquid staking protocol. Coinbase Cloud is collaborating with staking platform Figment and software development firm Alluvial Finance to support a group of experienced founders and operators building the institutional-grade protocol.

Stakeall Testnet Is Finally Live

Cross-chain staking shuttle service Stakedall launches testnet. Stakedall enables users to stake MATIC through Lido directly from the Polygon network to avoid high gas staking on Ethereum.

Stader Labs Announcing Liquid Staking Solution for BNB

Stader Labs, a popular liquid staking provider, made a Twitter thread on an upcoming launch on BNB-Chain. After liquid staking solutions for Polygon, Fantom, Terra 1.0 and Hedera, BNB will be the 5. supported chain.

Bitcoin Suisse Integrates Centrifuge Into Vault, Bridging Real World Assets Into DeFi

Bitcoin Suisse has added support for Centrifuge’s native token (CFG) on its proprietary, hyper-secure cold storage solution, the Bitcoin Suisse Vault. Centrifuge is a parachain connected to the Polkadot blockchain, bridging liquidity between blockchains and increasing interoperability. Centrifuge is the first parachain to be integrated into the Bitcoin Suisse Vault.

Stakin Taking Steps Towards a Greener Future for Proof-of-Stake with Regen Network

Stakin announces its collaboration with Regen Network to take active steps towards a greener future for the Proof-of-Stake ecosystem. Over the recent months, the sustainability of the blockchain space has been the subject of much debate and concern.

Lido Finance refuses to support Terra's new blockchain

Lido Finance has decided not to support the new Terra blockchain when it launches, after the sudden collapse of Terra's current chain earlier this month. "We can always join the reboot at a later time if the chain proves to be useful and well-run and has grassroots support. At this time there are too many questions around the reboot and committing poses potentially high downsides with little upside," said one commentator.

Staking at a Glance: SR20

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