Terra $45bn face plant creates crowd of crypto losers

This week’s undoing of the TerraUSD algorithmic stablecoin and its sister token Luna has ramifications for all of crypto. First, there’s the immediate impact: The rapid collapse of a once-popular pair of cryptocurrencies sent a ripple effect across the industry, contributing to plummeting coin prices that wiped hundreds of billions of market value from the digital-asset market and stoked worries over the potential fragility of digital-asset ventures.

Then there are the knock-on effects. In addition to delivering punishing losses to individual users and investment firms, the spectacular failure of a market darling like Terra threatens to have a cooling effect on the fundraisings that have jacked up crypto startups’ valuations in recent years. Venture capitalists who have long been some of the industry’s biggest cheerleaders may not have quite the same risk tolerance now — especially those directly caught in the crossfire.

“It’s something the scale of which crypto has really never seen in terms of a top-five project just absolutely imploding,” said Matt Walsh, founding partner of Castle Island Ventures, a blockchain-focused VC firm. Almost $45 billion evaporated from the market caps of TerraUSD (known as UST) and Luna over the course of a week, according to CoinGecko.

There were some winners in this scenario — like the investment firms including F9 Research that shorted TerraUSD. Stablecoins backed by reserves rather than algorithms also came off looking like better options. But it’s the losses from these bruising past few days that will resonate.

Read: TerraUSD’s stablecoin meltdown holds the crypto market hostage

Individual holders of UST and Luna, the token that’s part of the peg mechanism for the algorithmic stablecoin, are now deeply in the red, with tweets lamenting dashed fortunes flooding Crypto Twitter this week.

“The biggest losers from all of this will be retail [investors] that didn’t understand the risks they were taking,” said Kyle Samani, co-founder and managing partner at crypto VC firm Multicoin Capital.

Other losers include the venture capitalists and investment firms that have backed Terraform Labs, the startup behind UST, and Luna Foundation Guard, the nonprofit managing the Luna token. Galaxy Digital Holdings Ltd., Pantera Capital and Lightspeed Venture Partners invested in Terraform’s last $150 million fundraise in July, while Jump Crypto and Three Arrows Capital participated in a $1 billion sale of Luna tokens in February.

These backers, who once hoped that their investments would deliver massive returns, instead found themselves being solicited to prop up UST and Luna in a $1.5 billion backstop. In essence, they were asked to “put their money where their mouth is,” a test of whether these institutions actually believe in what they’re investing, said Billy Dishman, investment and research analyst at crypto VC firm CoinFund. So far, they haven’t shown much interest.

Terraform Labs is working on another contingency plan in which ownership of the blockchain network would be distributed to investors, according to a blog entry posted Friday that was attributed to co-founder Do Kwon.

1/ I’ve spent the last few days on the phone calling Terra community members – builders, community members, employees, friends and family, that have been devastated by UST depegging.

I am heartbroken about the pain my invention has brought on all of you.

— Do Kwon

Investors and startups with no direct connection to UST are also finding themselves on unsteady ground. Chris McCann and Edith Yeung, general partners at Race Capital — a VC firm that focuses on early-stage crypto startups — have heard of deals falling apart or being repriced and said that founders are getting “ghosted” by potential investors. They’re urging their portfolio companies to take caution and ensure that the funds they’ve raised so far are in fiat, not crypto.

“If you’re in the middle of a fundraise period, close it,” McCann added. “If you’re not, don’t do it now. Now’s not the time.”

Yeung said she also has a playbook in case a portfolio company finds itself in crisis. She said part of Race’s strategy is to find a better way for founders to communicate – lengthy Twitter threads have the potential to spur rumours and spread discord.

“I have a blog post template ready to go,” she said. “It’s kind of silly, but it’s happened now so many times now.”

‘Downstream impact’

Castle Island Ventures’ Walsh said that later-stage companies are more likely to see valuation hits as they raise more funds because of their proximity to public markets, where stocks like Coinbase Global Inc. have plummeted. Coinbase stock slumped 35% this week and ended the week with a market value of $15 billion.

“Coinbase trading at $17 to $18 billion market cap, that’s going to have a downstream impact on the venture community in the crypto space,” Walsh said in an interview.

This will eventually trickle down to the seed stage, where newer crypto startups could take valuation cuts, Walsh added. He said that there also could be a shift in the types of firms investing in crypto, noting that a lot of of traditional funds have gotten more interested in the industry in the last year.

“There’s a question of are some of those funds just tourists that in the bear market back away,” Walsh said.

Traditional take

Dana Stalder, a general partner at tech VC firm Matrix Partners, said it’s important to note that it’s not just cryptocurrencies caught in a downturn: Tech stocks are struggling as well.

“There’s a flight to safety out of the equity asset class,” Stalder said in an interview.

The firm is still excited about its investment in crypto startup Lightspark, which it announced Thursday. The company was founded by David Marcus, who left Meta Platforms Inc. last year after overseeing its crypto efforts. Lightspark is building infrastructure to help support payments for Bitcoin, which traded at less $29,000 as of Saturday morning in New York and is down about 25% this month.

“I don’t think this cycle will have any impact on what the Lightspark team is building — it is a very long play,” he said.

Peter Fenton, a general partner at Benchmark, said that there will likely be a slowdown in crypto investing as many VC firms were likely “playing out of their winnings” and using returns from previous crypto investments to fund new ones in the space.

However, his firm, which has already backed crypto startups Chainalysis and Sorare, is still committed. Fenton said Benchmark plans to pursue three to five crypto investments a year because it still has confidence in the industry and its startups.

“People forget that Google’s best financings were done in really the worst venture years,” he said.

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