In the unpredictable landscape of cryptocurrencies, market downturns are a frequent occurrence. However, recent research suggests that one of the most significant crashes was not merely a random anomaly or a consequence of the inherent volatility associated with digital assets lacking intrinsic value. Instead, it appears that a small group of coordinated individuals orchestrated the downfall of two major cryptocurrencies, casting a shadow over the integrity of the market. While the identities of these individuals remain unknown, their collaboration left a distinct mathematical imprint.
Collapse of TerraUSD and LUNA
During the period of April to May 2022, the stablecoin TerraUSD and its affiliated cryptocurrency LUNA plummeted from a valuation of $3.5 billion to nearly worthless within a matter of days, primarily due to aggressive short-selling. Such a drastic decline was unexpected for a prominent stablecoin, which is designed to provide stability amid the fluctuations commonly seen in the cryptocurrency market.
The ultimate trigger for this collapse stemmed from a wave of panic among holders of TerraUSD and LUNA, who were alarmed by the declining values and rushed to sell off their holdings. This rush mirrored the dynamics often seen in stock market crashes or bank runs. However, it was the events leading up to this turmoil that drew the attention of Dr. Richard Clegg and his team from Queen Mary University.
Investigation into Trading Patterns
Clegg and his colleagues employed a sophisticated analytical method known as temporal multilayer graph analysis to scrutinize trading activities involving TerraUSD and LUNA. Their investigation extended to four additional cryptocurrencies during the same timeframe. The researchers discovered that a series of significant trades were executed in TerraUSD and LUNA with a timing that seemed highly improbable to be random, thereby undermining the value of these coins and catalyzing the ensuing panic.
“What we uncovered was remarkable,” stated Clegg. “In the days leading up to the collapse, we detected trading patterns that deviated sharply from the norm. Rather than a wide distribution of trades among numerous market participants, we identified a small number of traders exerting control over nearly the entire market. This behavior serves as clear evidence of a concerted effort to destabilize the system.” In contrast, trading patterns for comparable cryptocurrencies remained normal during this period.
Suspicious Trading Activity
The unusual trading activity was particularly pronounced on April 3 and April 19, 2022. This finding was made possible despite the researchers lacking direct access to the LUNA/Terra ecosystem data, relying instead on “wrapped” transactions.
While the timing raises suspicions, one might contemplate a scenario in which several affluent investors independently recognized the potential for TerraUSD to fail and decided to capitalize on it. However, if such a situation were true, the scale of each individual’s investment would likely differ. The researchers found that the amounts invested by each participant were strikingly similar, implying that those behind the crash likely coordinated their efforts and agreed on a uniform investment strategy to bring down the coin.
This level of cooperation was likely crucial for the scheme’s success. TerraUSD possessed sufficient reserves to withstand the short-selling efforts of any single participant, thereby maintaining its peg and preventing widespread panic. It would take substantial capital and a collective strategy to execute short-selling of this magnitude safely.
Regulatory Implications and Future Analysis
Even if no laws were violated, the identification of these trading patterns years later may not attract significant attention from regulators. Nevertheless, the team has developed a software system specifically designed for such analyses, which could potentially facilitate real-time monitoring.
“Cryptocurrencies are often perceived as the untamed frontier of finance, lacking adequate oversight and accountability,” remarked Clegg. “Our study demonstrates that by applying rigorous mathematical methodologies, we can uncover the underlying patterns and behaviors influencing these markets. This research is not just about dissecting past failures; it aims to foster a safer and more transparent financial ecosystem in the future.” The same analytical tools could be adapted for monitoring various complex systems, potentially reducing risks and pinpointing illicit activities.
Stablecoins and Market Dynamics
Cryptocurrencies were initially promoted as a viable payment alternative, aimed at avoiding high exchange rates and facilitating anonymous transactions. However, their rise as speculative assets has overshadowed these original purposes, as extreme price fluctuations make sellers hesitant to accept currencies that could significantly decline in value before they can convert them.
Stablecoins were introduced as a remedy to this issue, being pegged to stable fiat currencies like the US dollar, which typically experiences minimal fluctuations. However, the stability of such coins hinges on having sufficient reserves to withstand short-selling attempts, which bet against the stablecoin’s value. Many stablecoins, like TerraUSD, are linked to other cryptocurrencies through intricate formulas.
While a loss of $3.5 billion may seem minor compared to the broader market turmoil, the LUNA-Terra crash played a role in the downfall of FTX, which resulted in losses estimated to be at least tenfold. The crash also contributed to a decline in Bitcoin prices, although Bitcoin eventually rebounded to new heights, while LUNA and TerraUSD have not recovered.
With the values of the two targeted currencies reduced to nearly zero, those orchestrating the scheme likely achieved substantial profits. It seems unlikely that they will view this as a one-time venture, as they may wait for opportunities to disrupt other speculative markets in the future.
This study has been published as open access in ACM Transactions On The Web.
