Due to the seemingly endless bear market, 2022 has undoubtedly been a difficult year for cryptocurrency investors, platforms, and protocols. The already challenging situation has been made even more so by the slew of insolvencies that have rocked the industry, from lenders like Celsius to venture capital firms like Three Arrows Capital, and even stablecoins like LUNA. A closer look at the LUNA and Celsius networks in particular—which collapsed within weeks of each other— shows that there is much similarity between the two. 

Terra (LUNA)

The Terra ecosystem was a decentralized finance (DeFi) project that offered users high yields on staked deposits of its native stablecoin TerraUSD (UST), as high as 20% in 2022. Terra’s UST debacle in May was the first of the major crypto project failures in 2022, and really the catalyst for the ensuing nosedive that the crypto market took as the fall of Celsius and 3AC followed closely afterward. The crash of Terra is quite significant as it let to the loss of over $2 trillion from the total cryptocurrency market capitalization.

Algorithmic Stablecoin

A stablecoin is a cryptocurrency that is designed to hold a steady value as contrasted with the extreme volatility of other cryptocurrencies like Ethereum or Bitcoin. Rather than making their holders rich by soaring in value, stablecoins are designed to have utility; this is achieved first by allowing crypto holders to transact without having to worry about volatility, and second by offering them a safe haven for their digital assets, protected from the wild swings in the crypto market without needing to convert their holdings into fiat currency. 

To hold their value, algorithmic stablecoins are usually pegged to another cryptocurrency. The peg can be maintained in any one of three ways. The first, like Tether, is having a reserve of cash or cash equivalents whose value theoretically matches the total value of the stablecoin in circulation. Alternatively, like MakerDAO’s DAI, a stablecoin can maintain its peg to the dollar by keeping a reserve of cryptocurrencies rather than fiat currency, but will ‘overcollateralize’ to compensate for their volatility. TerraUSD, however, took the third option which is operating as an algorithmic stablecoin. 

TerraUSD’s Model

TerraUSD (UST) is an algorithmic stablecoin that depends on its sister token LUNA to maintain its peg to the U.S. dollar. UST was designed to sustain its peg to the dollar through algorithms and trading incentives that also involved sister token LUNA. Part of the incentives that made UST so popular was that users could earn up to 20% interest by lending the token on Terra’s Anchor protocol. As the platform grew bigger, Terra’s development team launched the Luna Foundation Group (LFG) to accumulate reserves to provide UST with some other form of backing.

Some critics called UST a new kind of Ponzi scheme, while others politely pointed out that UST’s business model was unsustainable as its peg to LUNA without a peg to anything else only worked if people had confidence in its value-retention and this would only be the case of more people purchased the token. Furthermore, the main selling point was the high APY from making UST deposits on Anchor, which was in turn being subsidized by Terra, casting more doubts on the enterprise’s sustainability. Indeed, between the end of April and LUNA’s collapse in May, Anchor burned almost $100 million worth of its UST reserves to cope with the demand for high yields. 

As the critics pointed out, should demand either LUNA or UST fall, both tokens could evaporate in what is known as a “death spiral”, and that is exactly what happened. On May 2^nd Anchor dropped its yields from 20% to 18%. A few days later Terraform Labs withdrew $150 million worth of UST from Curve and this was closely followed by an unknown user exchanging about $84 million worth of UST for USD Coin through Curve. 

These large transactions, hot on the heels of the interest rate drop, led to more investors trying to withdraw funds from Anchor and knocked UST off its $1 peg. The equivalent of a bank run ensued, and the UST-LUNA exchange mechanism meant that the massive UST withdrawals corresponded with a hike in the supply of LUNA, pushing its value down even further. As of the 16th of May, Do Kwon gave up on trying to save LUNA and proposed launching LUNA 2.0.

Celsius Network

The Celsius Network is a blockchain-based platform specializing in cryptocurrency loans and borrowing. Just like LUNA, Celsius attracted a large number of users to its platform by offering very high-interest rates of up to 17% APY. These generous yields offered by Celsius were powered by its native token CEL. Additionally, Celsius was one of LUNA founder Do Kwon’s largest financial connections, holding up to $535 million in Anchor at some point

In mid-June 2022, Celsius halted all withdrawals citing “extreme market conditions”. The Financial Times reported that just three days after they took this action, U.S. prosecutors from the Department of Justice subpoenaed the Celsius Network. A month later, the company filed for Chapter 11 bankruptcy in the United States, revealing that it is supposed to pay its customers $4.7 billion.

Celsius Network’s Model

Celsius was meant to operate in some way like a traditional bank, only that it dealt with crypto rather than fiat currency. Users stake capital on Celsius and the network in turn utilizes this capital to fund its own investment and cover loans it extends to other users. The network paid users up to 30% interest on a weekly basis, but since the liquidity crisis, these returns diminished. 

While it may have been the fatal blow, this was not the crypto lender’s first controversy; earlier in the year Celsius had been forced to stop offering interest-bearing accounts to non-accredited investors due to pressure from regulators. Additionally, Celsius also fell victim to orders filed by the states of New Jersey, Texas, and Alabama that it stops selling unregistered securities to consumers. 

Before its crash on June 12^th, Celsius claimed to have 1.7 million users with $8 billion in loans made out as well as $11.7 billion worth of assets under management. In a court filing subsequent to the bankruptcy, Celsius claimed to have a $1.2 billion hole in its balance sheet—the document showed that it had $4.3 billion worth of assets and $5.5 billion worth of liabilities. 

Here’s How Celsius and LUNA Are Similar

While the LUNA project is primarily a stablecoin, through Anchor it participated in the market as a deposit taker and lender, similar to Celsius which primarily operates as a cryptocurrency bank that takes deposits and lends them out. Both Celsius and LUNA offered outrageously high-interest rates on staked deposits on their platforms leading to their popularity and surging user numbers.

Additionally, both Terra and Celsius did not have sufficient safeguards for their users’ deposits; TerraUSD was only pegged to LUNA and nothing else making it quite vulnerable, while Celsius failed to maintain a sufficient reserve of currency to secure its liquidity making it a prime candidate for bankruptcy should customers decide to liquidate all their staked assets. 

Finally, the collapse of these two behemoths in the midst of the crypto winter only served to make matters worse in the industry by causing the price of Bitcoin to fall even further and generating FUD. The continued bull run occasioned by these two has contributed to the decline of other platforms like 3AC, and most recently FTX.