A $40 billion crypto collapse pits Korea against the mad” leader

After Do Kwon hinted that he would inject $300 million into the reserves that underpinned the 20 percent return on his Luna cryptocurrency, a Twitter user said I asked him where the money will come from.

Kwon's answer was succinct: "Your mother, obviously."

Now the brash 30-year-old Korean, who routinely derides his critics as "poor," is being blamed for this month's $40 billion collapse of a creation he once called "the oldest and most widely used algo[rithmic] stablecoin in existence," before adding, "Bow to the king."

As casualties mounted, South Korean press reports linked the crash to a local surge in online searches for Seoul's Mapo Bridge, an alleged suicide site. In response, local police announced increased patrols around the bridge.

On Friday, South Korean prosecutors launched an investigation into Kwon's Terraform Labs after five Korean crypto investors filed a criminal complaint for fraud and violating financial regulations, with a total loss of 1.4 billion won ($1.1 million).

“Do Kwon was like a successful cult leader,” said Donghwan Kim of Blitz Labs, a Seoul-based crypto consulting firm. “But now he’s the most hated man in Korea.”

Kwon attended an elite foreign-language high school in Seoul and studied computer science at Stanford University. In 2018, he co-founded Terraform Labs in Singapore with Daniel Shin, the prominent founder of Korean e-commerce unicorn Ticket Monster.

The pair launched the stablecoin terraUSD in 2020. Terra should maintain a constant value of $1. Its dollar peg was maintained through an algorithmic relationship with the Luna cryptocurrency. To buy Terra, users need Luna and vice versa.

This fluctuation dynamic is intended to keep Terra's price stable, but a run took place in early May. When the Luna supply sold off, the cryptocurrency's value plummeted to zero, undermining the ecosystem's delicate algorithmic balance and breaking Terra's peg to the dollar.

The Luna Foundation Guard, a non-profit organization supporting the Terra ecosystem, failed to mobilize enough Bitcoin reserves to ensure Terra's stability and confidence in the model waned.

“The coins’ market cap grew too large too quickly when their reserves or tools to defend their value were not yet ready,” said a close former colleague of Kwon. “They started preparing reserves and bought $3.5 billion worth of Bitcoin, but it was too late.”

Individual investors had been attracted by a program where customers could lend out their Terra for a 20 percent return. But hundreds of millions of dollars of investment in Terraform Labs came from venture capital firms, including Galaxy Digital, whose CEO Mike Novogratz would later acquire a Luna tattoo on his left shoulder.

“Commitments from some of the most respected funds are a testament to the shared vision of bringing decentralized finance to the masses,” Kwon explained in July last year.

Do Kwon's close colleague at Terraform Labs had a different explanation: many investors were "fascinated by his genius."

“Do was able to attract many famous investors because there were many people in the crypto market who agreed with his philosophy and slogans about the need for decentralized finance and DeFi tokens,” said the former colleague. “They found the algorithm model fresh and attractive because there was a growing need for stablecoins and the coins were in no way connected to the real economy, just backed by each other and by Bitcoin.”

Kwon's high-profile backers, global marketing strategy and high-profile social media personality all helped attract attention and retail investors, some of whom formed an online army of supporters dubbed the "Lunatics."

Skeptics were given short shrift. “I don’t debate the poor on Twitter, and I’m sorry I don’t have change for them at the moment,” Kwon wrote last year after a British economist raised doubts about the algorithmic stablecoin model.

“Lunatics believed that his lack of manners was a way to protect their wealth,” said Donghwan Kim, “so his arrogance received a lot of support from the community and soon became his trademark.”

Kwon's former Terraform Labs colleague identified the decision to offer investors a 20 percent annual return as the moment Terra/Luna started "growing too fast."

"About 14 to 15 trillion won ($11 to 12 billion) were deposited in just one year after they started offering the 20 percent yield," he said. "Individual investors were attracted by the high yield, while venture capital was attracted by the rapid growth of the coins. The pace of growth was unsustainable."

Another former colleague, ex-Terraform Labs engineer Kang Hyung-suk, said: "Engineers at the company all knew the risks associated with the 20 percent yield. They all thought it was unsustainable because we didn't have enough money to support it. But no one expressed concern to Do, who often ignored opinions that contradicted him."

Kim Hyoung-joong, head of the Cryptocurrency Research Center at Korea University, said: "Kwon called for decentralized finance, but he made all decisions alone. It is ironic that the company's decision-making was so centralized."

The death spiral has claimed some high-profile victims.

“Poor again,” Changpeng Zhao, founder of crypto exchange Binance, tweeted in response to a news report that the value of his investment in Luna had fallen from $1.6 billion to under $2,500.

Hashed, a Seoul-based venture capital firm that was a prominent backer and promoter of Do Kwon and Terraform Labs, lost over $3.5 billion in the crash, according to estimates from crypto site CoinDesk.

But the most devastating losses were borne by ordinary retail investors.

Ji-hye, an office worker from South Korea and mother of three children under five, said she invested her entire savings in the cryptocurrency after reading about the 20 percent return and seeing that Daniel Shin was involved in the project.

"I tried my best to accumulate savings, but the bank interest rate seemed far too low during this time of high inflation. I was desperately looking for ways to save more money for my three children," said Ji-hye, whose name has been changed to protect her identity.

"I saw my savings growing day by day with the 20 percent interest rate, so I borrowed more money from the bank and invested more in Terra. It's all my fault for not doing more research before investing, but I'm desperate without my savings."

Kwon, who did not respond to a request for comment from the Financial Times, wrote on Twitter after the collapse: "I am heartbroken by the pain my invention has caused you all."

But always defiant, he also tried to get support from developers for a second chance. Terra's failure, he argued in an online manifesto published last week, was "an opportunity to rise again from the ashes."

Additional reporting by Scott Chipolina in London