the money game

The Crash of Crypto’s Perpetual Wealth Machine

Do Kwon – mastermind of the Terra and Luna coins. Photo-Illustration: Intelligencer; Photo: Woohae Cho/Bloomberg via Getty Images

Just about four months ago, billionaire and Wall Street legend Mike Novogratz went to a Brooklyn tattoo parlor a few blocks down from Jim Cramer’s bar and, at 58, made permanent his devotion to a speculative new cryptocurrency. The result, on his left arm, was a large wolf howling at the moon. “I’m officially a Lunatic!!!” he tweeted to his more than 400,000 followers.

The ink refers to Luna, one half of a duo of digital currencies that were supposed to act as a perpetual wealth-creation machine, a way to always make money through the magic of code and financial engineering. At the time, Luna was on a massive run, up more the 1,000 percent over the prior six months. Novogratz is known as much for his career in the buttoned-up world of high finance — he’s an ex-partner at Goldman Sachs and Fortress Investment Group, an investor who lost two ten-figure fortunes and is on his third — as for being someone who has chafed against those boundaries. Several years ago, he was among the first high-profile Establishment finance types to dive all-in on crypto. (The ex-Princeton wrestler also hired Hilary Duff to play at his birthday party a few years ago.) But even for Novogratz, the tattoo seemed a little over-the-top. When someone tweeted their bewilderment that Novogratz would have gone so far, Do Kwon, the creator of Luna, chimed in, unprompted: “don’t worry it wasn’t much.”

This week, though, the critics who warned that Kwon’s perpetual wealth machine was too good to be true and that Novogratz might come to regret that tattoo before long were vindicated when Luna and its partner coin, Terra, both imploded in spectacular fashion. Terra is supposed to be trade reliable at the value of exactly one U.S. dollar, but it plummeted to 29 cents on Wednesday morning. Luna was down 99 percent since its highs last month. More than $40 billion in wealth — no small part of it from retail investors — was gone in a matter of hours. The shock of the sudden collapse sent the price of bitcoin falling to its lowest point since July, exposing how a coin labeled a Ponzi scheme by its critics had impacted the larger market in digital assets. Meanwhile, shares in leading U.S.-based crypto exchange Coinbase were off by 25 percent, and the trillion-dollar-plus crypto industry is teeming with rumors about large funds or companies that may be on the brink of failure.

Many of the same crypto players who today are much poorer and more anxious than they were a week ago used to be vocal fans of the Terra-Luna currency duo. Kwon, a 30-year-old resident of Singapore and, naturally, a Stanford graduate, launched the coins in 2018, but they really caught fire among crypto speculators only in the past few months. The idea is this: The two tokens are supposed to act as a balancing mechanism for each other, by which one is automatically created or destroyed based on the supply and demand of the other. While Terra should always be at $1, Luna could rise and fall with the markets — and the coins could freely be exchanged for each other for small profits. Kwon wasn’t the first person to come up with this arrangement, but he put a twist on it that made it immensely popular, fast: Get $10 billion and instead of putting it away for safekeeping, like a central bank, pay people to use the coins. The plan was pure Silicon Valley — subsidize the masses and, eventually, Kwon and his backers would remake the digital markets in their image. It grew so fast that by last weekend it had $18 billion in assets, much of it in bitcoin. The company that oversaw all this, Terraform Labs, had backing from major investors like Coinbase Ventures, Pantera Capital, and Novogratz’s own Galaxy Digital, according to Bloomberg.

Kwon’s machine was a bright spot in an otherwise dreary year for crypto. After peaking in late October, the markets plummeted in January, then didn’t really move. NFTs — the digital tokens made famous by the Bored Ape Yacht Club and other digital artworks — were stalled out. By early spring, the Federal Reserve started sucking money out of the system, the price of a monthly mortgage payment was a few hundred dollars more, and all of a sudden crypto stopped being so hot. Crackdowns in China and a wobbly bitcoin adoption experiment in El Salvador seemed to stop the currencies’ utopian ambitions. For a while, it had been a cool way to make money out of nowhere, an excuse to move to Miami and show off your wealth. As 2022 wore on, it all started to feel more and more like the domain of weirdo-rap alleged money launderer Razzlekhan.

What made Terra so popular was a lending program called Anchor that gave users 18 to 20 percent interest a year, bleeding its coffers of millions of dollars a day. Matt Lorion, a TikTok star with a talent for gravitating toward crypto scams, claimed to be buying a house via this play. At a moment when savings accounts yield approximately zero percent, the program was so lucrative for users that the substantial majority of Terra coins in circulation were locked up to harvest this yield (and therefore not in use for trading). Kwon even had a plan to defend Luna and Terra: There was a whole other pot of money, funded by $1 billion from large investment firms like Jump Crypto and Three Arrows Capital, that would buy up Terra in case of a bank run. (The terms of the deal were not announced). If this sounds complicated, it is. This is, in the words of Bloomberg columnist Matt Levine, “insane.” Other critics have been less polite, accusing Kwon of running a straight-up Ponzi scheme. The goal, said Cory Klippsten, CEO of the exchange Swan Bitcoin, appears to have been keeping the price as high as possible for as long as possible so investors could make a profit after a lock-up period ended and then bounce. “This is purely a Ponzi. There’s no reason for this thing to exist,” Klippsten said. “It’s such a window in time where you’re just outside the reach of regulation you have absolutely no restrictions. You can create a token out of thin air, market it however the heck you want. Insider info, insider trading — everything that would be illegal in traditional markets, they can do it all day long with no repercussions.”

What caused the crash is still being sussed out. Defenders have called it an “attack,” though it’s unclear if this was anything more than a large withdrawal of money they weren’t prepared to cover. At one point, while the stablecoin was in free fall, Binance stopped it from trading. Kwon’s nonprofit took $1.5 billion, half of it in bitcoin, and tried to bail out Terra, which got back up to 90 cents a coin on Tuesday. Kwon tweeted that he was “deploying more capital,” then there was mostly silence until a Wednesday-morning thread took on a more formal tone and ended with a promise that Terra would “return.”

The rout was so severe that Treasury secretary Janet Yellen weighed in, calling for more federal regulation on stablecoins. On Twitter, where the crypto community lives, the tone was dour, as though the party was over and the government was ready to crack down at any moment.

The repercussions have been very real for people who had their savings in these cryptocurrencies. Just about every one of the largest 100 digital tokens lost value, with some losing one-third of their market capitalization in the past 24 hours. Tether, another so-called stablecoin that has been the subject of a suit brought by New York attorney general Letitia James for misrepresenting its holdings, spent most of Wednesday below the $1 price it should be. On the Reddit community board for Luna-Terra holders, users posted that they were contemplating suicide after losing everything. Kwon — who had built up a persona as a proud crypto asshole, even saying once that he doesn’t “debate the poor” in a thread about, I’m not kidding, financial panics — has lost whatever goodwill he had among his followers.

Novogratz has so far given no indication that he will dump his investment, but on an investor call on Monday he appeared to show some doubt that Luna’s future would be as permanent as what’s on his left biceps. “This is a really big test of that whole model of algorithmic stablecoins,” he said. “This is a full-on-out Category 5 earthquake globally.”

Correction: This article originally said that Kwon was a Stanford University dropout. It was corrected on May 17 to reflect that he is, in fact, a graduate.

The Crash of Crypto’s Perpetual Wealth Machine