I'm not a crypto expert, but effectively what we've seen is a classic short attack similar to the Soros attack on the pound which led on Black Wednesday to the pound breaking the peg with a proto-Euro formed from a basket of European currencies. The concepts are familiar, but some of the terminology isn't. So I'll start from scratch but most here can skip at least the first half, and people who know crypto can skip to the last 4 paragraphs...
So you know classic gold standard - "money" is expressed in terms of pounds of gold. But it's inconvenient to cut up a gold ingot to pay for a pint down the pub. So instead the central bank issues piece of paper saying "I promise to pay the bearer £5" or whatever, and that promise is enough for a pub customer, and the pub, and the brewery to accept that piece of paper as though it was £5-worth of The One True Currency, gold.
Except we are no longer in a world where most currencies are backed 1:1 by gold. Instead we have fractional reserve banking, where bank reserves (made up of a mix of gold, US$, €, £ etc) only cover a fraction of the currency they issue and the value of the currency is taken on trust. If trust is lost and everybody demands repayment of their pieces of paper, the value of the currency collapses as the central bank can only physically pay out x% of the face value of the pieces of paper. On the flip side, it allows the central bank to manage money supply by creating or destroying currency "out of thin air" (hence the name "fiat" currency, from the Latin for "let it be made") - as for instance happened with quantitative easing in response to the 2008 bank crisis.
In effect, the piece of paper trades at a massive premium to the value of the underlying assets - but normally with eg investment trusts, the problem goes the other way, the piece of paper representing a group of assets trades at a discount to value of the underlying assets. Exchange-traded funds (ETFs) such as iShares were created to solve this problem and keep the value "honest" or "pegged" to the underlying asset, as they allow institutions to exchange the paper for the underlying. If the underlying asset is gold, then it looks very much like a currency on the gold standard - you're exchanging physical gold for a piece of paper that promises you to pay the same amount of gold in the future. But with ETFs the underlying assets can be anything - so you can swap £1m of FTSE-100 iShares for a basket of £~100k of Shell plus £~70k of AstraZeneca plus...all the way down to £~1k of Harbour Energy representing the members of the FTSE-100 in their weighted proportion in the index.
As investors you'll be aware of the concept of liquidity, how easy it is to buy or sell something which in turn affects the frictional costs of entering and then exiting a trade. FTSE shares have very liquid markets, you could buy or sell £1m of Shell or AstraZeneca in seconds, and the price would barely move. Whereas it can be impossible to trade even a few £k of an AIM share without it moving the price against you. Those of you who have used a traditional phone broker will be aware of the kind of conversations that they will have with a marketmaker "they can do you 50,000 at 10p, but if you want 100,000 it will have to be 11p. Or we can leave a limit in the market until close, see if you can pick up some more at 10p" That's because while the market maker in an AIM stock is obliged to have a certain "inventory" of the stock on hand, they try to minimise the amount they carry. In contrast, this process is transparent for the big FTSE stocks as the exchange provides an automated order book, where you can see that between them the market participants eg have 10 million shares to sell at 100p, 20 million at 100.5p and 60 million at 101p. Effectively that's what is happening inside the marketmaker's head based on his knowledge of the market, but while an order book system is transparent, it doesn't really work for AIM shares where they can be only one or two trades worth a few £k a day. In that situation the order book is likely to contain only have a few offers to trade, and it only takes someone with a few £10k 's to accept those offers and then you have nothing in the order book and no idea of what the market price is, the whole system just breaks down.
An example of an order book is the Betfair exchange - you can see some of it in the market for next PM here :
https://www.betfair.com/exchange/plus/p ... .160843673and if you log in you can click on the chart symbol by the names to see the full order book for that person. So for instance, the headline price for the Green MP Caroline Lucas is 1000/1, but at the time of writing it would only take £7+£1+£5 =£13 to "exhaust" the market and the next best price you would get would then be 50/1. That's a very illiquid market, as small amounts of money can move it a lot, whereas you could put the same amount of money on Keir Starmer it would maybe move his price from 7/1 to 6.8/1 - that market is more liquid.
But equally you could place a similar bet with a traditional bookie, who operates as a marketmaker in stock market terms. And the big corporates like Ladbrokes have the resources to provide more liquidity - can take bigger bets - than a one-man-band bookie.
I know this is granny-suck-eggs to many here, but it's worth emphasising how important liquidity is - it allows bigger trades to be placed and reduces round-trip costs of trading. Conversely when it dries up the market breaks down, you get panic and the proverbial "run on the bank". The Luna story is partly about arbitrating between liquid and less liquid markets, and what happens when liquidity dries up.
So - cryptocurrencies. I'm sure most people here are vaguely aware that they are digital currencies in which ownership is recorded in a distributed ledger, typically in a particular kind of database called a blockchain. The details don't matter for these purposes, only that routing transactions via the blockchain are "difficult" and "expensive", a bit like paying for your pint with gold ingots or buying shares direct from a company via a placing with prospectus etc, rather than buying shares in a secondary market like a stock exchange. So most cryptocurrencies have developed an ecosystem of secondary markets, particularly the ones that want to be used in day-to-day transactions.
This is a bit simplified but.... The original cryptocurrencies like Bitcoin don't have reserves backing them in the way that traditional currencies do, but most of the more recent ones are "stablecoins" that do have some kind of reserves behind them. There are some that are backed by gold as though they were on the gold standard, or a gold ETF - you can swap gold for the crypto. There are some like USD Coin (symbol USDC) that have full backing from assets in traditional fiat currencies like US$ (a bit like the IMF's Special Drawing Rights), and some like Tether (symbol USDT) which have implied they were fully backed but it looks like they're playing the fractional reserve game, with a headline reserve of maybe 75% but some of those assets are loans to related companies. Transparency can be an issue with some of these things to say the least.
Another disadvantage of the cryptos backed by fiat currencies is that the reserves can't be built into the main blockchain, the backing has to happen in a secondary form off the main blockchain. Reserves in the form of other cryptocurrencies like Bitcoin <i>can</i> be integrated into the main blockchain via some clever mechanics - an example of a crypto-backed stablecoin is Dai.
Inspired by the way the moon stablises the orbit of the Earth, a Korean called Do Kwon came up with a family of stablecoins called Terra linked to the crypto-backed Luna. There are different stablecoins pegged to different currencies, of which the most famous is TerraUSD (symbol UST), pegged 1:1 with the US$. These stablecoins maintain their pegs with an algorithmic link to Luna that converts Luna into the stablecoin when demand rises, and converts stablecoins into Luna when fewer are needed. This allows quick responses to the day-to-day deviations from the peg, separate from the long-term reserve backing of Luna. The plan seems to have been to pretend initially that Luna was protected by whizzy perpetual-motion algorithms, but then use the fact that Cryptos Always Go Up to trade their way to a pot of reserves that could then be shown to any regulators who started asking questions. The Luna Foundation Guard (LFG) which is a non-profit that is sort of like the central bank of Luna that would do this trading and also eg loan out bitcoin and UST to the markets to give liquidity. Their claimed reserves are here - went from nothing to $3bn on 22 January this year, they've turned that $3bn into $80m today :
https://datastudio.google.com/reporting ... r-T7NeGLewIt's also worth mentioning that the stablecoins form alliances on crypto exchanges to form liquidity pools, which are a bit like mini-exchanges or marketmakers within an exchange. At the moment there's a bit of a shakeout going on, as lots of mid-size groups try to become the big gorilla on their exchange, the LSE or Ladbrokes rather than the Manchester or one man on a stand by the winner's enclosure. The bigger the grouping, the more liquidity, the lower the costs and so more trades in your stablecoin, there's a network effect. UST and another stablecoin callled Frax were about 2/3 of the $6bn assets of a group called 3pool.
Anyway, so what happened? The
current story seems to go that the attacker - rumoured to be Citadel and BlackRock, although there's been carefully-worded denials - borrowed 100k Bitcoin to build a >$4bn-worth short position in Bitcoin in late March - you can do that because Bitcoin is relatively liquid. They also built a ~$1bn long position in UST, which you can do because it gets created out of Lunas. Around the same time, LFG had been converting over $1bn of its reserves into Bitcoin, so Kwon was probably buying Bitcoin from the attacker.
On 1 April Kwon tweeted that UST and Frax were leaving 3pool to join Tether (USDT) and USD Coin (USDC) in a new group called 4pool, which would likely become the gorilla of that world. However, it takes a little while to transfer assets from one pool to another, during which time liquidity is reduced. The attacker sells $350m of UST to soak up any buyers on 3pool's exchange, but the peg more or less holds, the UST price is now 97.2c. So Kwon starts selling Bitcoin to restore the peg.
Now the attacker dumps the rest of their UST on Binance, the biggest crypto exchange so very visible. This causes panic and more selling until UST is finally suspended at around 60c. Meanwhile Luna holders are also panicking and demanding redemptions, forcing Kwon to sell more Bitcoin out of his reserves that don't cover all of the current value of Luna. The rest of the market is aware of this and is worried just how much Bitcoin Kwon will end up selling so they try to get ahead of him - a classic market panic. The attacker presumably covers their Bitcoin short near the market lows, around $32k. So they make $1bn less costs on their Bitcoin trade, maybe made some shorting Luna too, lose a bit to loan costs and on the UST trades, but you're looking at least at $800m profit.
It works because UST is smaller and less liquid - particularly during the move from one liquidity pool to another - so it took a lot less to cause a panic there, which could then cause ripples in a bigger market like Bitcoin where you could borrow much bigger amounts for shorting. And they knew that Kwon would sell Bitcoin to protect the peg and Luna.