CZ’s FAQ Series - LUNA, UST and Taking Risks

CZ’s Rules of the Jungle

Binance CEO Changpeng Zhao (CZ) recently shared his tips and advice on all things LUNA, UST and taking the right risks.

Posted to the Binance blog on May 20th, CZ broke down a series of lessons and thoughts in light of the LUNA situation that has gripped the crypto world. CZ notes that every interview he’s participated in since the LUNA/UST crash has required him to comment on and speak to Binance’s involvement. So with that being said, CZ has elected to break down this thoughts in more details beyond the series of twitter threads he’s shared over the last couple of weeks. 

‍Inherent Flaws

For CZ, the issues start at the design stage.

“When you peg to one asset using a different asset as collateral, there will always be a chance for under collateralization or depegging,” he says.

He also adds that among the design flaw is the idea that producing (or minting) more of one asset will somehow increase the total value (market cap). It’s the same logic as central banks printing more fiat currency. It doesn’t make it worth more, rather it devalues the asset of existing holders. In CZ’s words, “whoever designed this should have their head checked.”

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Don’t be Fooled by APY

The project was shiny and attractive to investors looking for high-yield options and a 20% fixed APY did just that. While incentives are important to attract user growth, income generation is a must.

“It’s now obvious that the whole thing was built on a self-perpetuating, shallow concept. While Terra did have an ecosystem with some use cases, the speed of growth of the ecosystem did not match the speed of the incentives used to attract new users.”

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Restore the Peg?

A case of too little too late as the Terra team was slow to react to the shifting landscape. Rather than using their reserves to restore the peg when the de-peg was at 5%, they waited until the coins had effectively lost all their value (approx. $80 billion) to act. They tried to use $3 billion to restore the peg but that ultimately failed.

“In this case, it didn’t look like a scam. It was just (sorry for the lack of a more polite word) stupid,” notes CZ. 

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Collateral Damage

An inevitable side effect of this catastrophe is the residual damage that has and will continue to shape the entire crypto ecosystem. Cryptos across the board were hit hard and continue to navigate the fallout of this. USDT de-pegged briefly before regaining stability. Some projects were more fortunate and fared better than others. “Some shocks are good for building a solid foundation. Some solid projects actually benefitted in a way. BUSD went 1.1 in pegging and saw an inflow of funds over the last weeks.”

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Crypto Resilience

Decentrtalization was a contributing factor that led to the space being able to, for the most part, withstand such a crash of this scale.

“In a centralized system, all the banks operate similarly (the regulations require them to do so). They all take reserves from a central bank, and when one bank fails, it has a spillover effect on all the other banks.”

CZ notes that UST and LUNA combined was bigger than Lehman Brothers but decentralization meant that the spillover damage on other stablecoins, while present, is smaller. 

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Crypto Regulation

CZ notes that talks of regulation on stablecoins has been encouraging from the people he’s spoken with (no names provided). He believes that more guidelines and regulations are needed on stablecoins and how they work. Regulation on these types of services would bolster support for users and protect the system. 

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Lessons Learned

In a world where every asset comes with some share of risk, CZ notes that it’s important to do three things: 

1. Diversify your portfolio. Don’t put all your holdings in one place because of the attraction of a high APY. 
2. Stay away from ultra high APYs as they are not sustainable and come with greater risk of loss. 
3. Education is key. It’s imperative that investors take the time to learn and study the fundamentals of the projects they invest in. 

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