In the cryptocurrency world, stablecoins like USDC and UST are meant to have a fixed value of one U.S. dollar, and a corresponding verifiable backing of some form. That was not the case for the UST token from the Terra project, which crashed in 2022 (no relation to USDT aka Tether). Do Kwon, the project's South Korean leader, was sentenced to 15 years in prison in the aftermath of a scheme that caused an estimated $40 to $60 billion in damages to investors.
The U.S. Department of Justice charged Kwon on nine counts, including securities fraud, wire fraud, commodities fraud, and money laundering. The charges stem from the fact that, despite Kwon's promises and maneuvers, UST, as designed, was neither properly backed nor sustainable. According to the CNBC report, Kwon pleaded guilty to misleading investors about the actual stability of the stablecoin during high-volatility periods in the crypto market.
Kwon now joins FTX's Sam Bankman-Fried and Celsius' Alex Mashinsky in the list of convicts who used crypto trading as a means for heavy-duty financial fraud. In the sentencing, Judge Paul A. Engelmayer reportedly told Kwon that "[...] there are few frauds that have caused as much harm as you have". That may be a fair assessment in this arena, as even FTX and Celsius' crashes rang in at "only" $9 billion and $4.7 billion in damages, respectively.
The proverbial hook that caught Kwon was that when UST was starting to lose its $1 peg, he lied to investors about how he would fix the problem. He claimed that the "Terra Protocol" would automatically restore the coin's value, but in reality, he hired a high-frequency trading (HFT) firm to buy millions of dollars of UST to artificially prop up its price.
The whole proposition of the project was to have a decentralized, Ethereum-based network with its own governance token (LUNA) that supported the UST stablecoin, offering the theoretical best of both worlds. Like many other financial ventures, the scheme only ever worked in perfect market conditions and in the context of continuous growth.
As an oversimplification, unlike the long-running USDC and USDT tokens, which are wholly or partially backed by verified financial assets, UST was de facto tied to the Terra Project's LUNA token and the actions of the related Anchor Network, a decentralized lending platform.
UST maintained its $1 value because the network's "burn-mint" mechanism meant that whenever it fell below that value, UST tokens would be destroyed (shrinking the supply and restoring the price), and more LUNA would be issued. Users could also do this voluntarily for a profit.
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The Anchor network and its ANC token come into play, as users can buy UST and deposit it into Anchor, lending it to other users who repay them with interest. All functional in theory, but Anchor initially promised investors yields of 20% APY on UST, and it temporarily accomplished as much by minting new ANC tokens—mindlessly printing money, for all practical purposes.
Eventually 70% of all UST was deposited in Anchor. However, to prevent a hyperinflationary scenario, ANC eventually lowered its APY to 20%, triggering a loss of confidence and kickstarting withdrawals. A few big trades turned into a massive tide of UST outflow.
As those withdrawals happened, the algorithm minted a virtual metric ton of LUNA, crashing its value and thus unpegging UST from its $1 value, in a death spiral. As with any other financial promise of high-yield returns with little risk, caveat emptor—buyer beware.
Bruno Ferreira is a contributing writer for Tom's Hardware. He has decades of experience with PC hardware and assorted sundries, alongside a career as a developer. He's obsessed with detail and has a tendency to ramble on the topics he loves. When not doing that, he's usually playing games, or at live music shows and festivals.
