Crypto

3 Crypto projects that went wrong | Crypto crashes in 2022

3 crypto crash projects

There are many crypto projects that exist in this world. Every crypto project is, at its core, a coded digital asset or application. Just like any software or coded asset, the project is never prone to attacks by hackers.

Even the 2nd largest cryptocurrency by market cap, Ethereum ($ETH), experienced a hack in its early days, forcing it to perform a hard fork in order to update the Ethereum protocol and effectively recover the funds that the hacker stole. This led to the birth of Ethereum Classic, which is technically the original blockchain, and the hard fork version of Ethereum, which is the Ethereum protocol.

Therefore, even the highest-backed and most promising crypto projects can be prone to attacks and exploits by hackers leading to a crypto crash. Some projects have a dedicated team in place and are able to fix the problem, others are unable to. Even when the crypto project has the best intentions in mind, it can be taken advantage of and exploited, causing losses and unrecovered funds for every participating member.

So, what are three examples of crypto crashes?

Related: Lessons Learned from the Crypto Crash.

Terra ($LUNA

Terra Eclipses All-Time High Thanks to Inflows

The crash of the Terra ($LUNA) ecosystem was the largest in crypto history, supposedly erasing over $41 billion in value overnight. At its peak, $LUNA was worth $119 per coin; now, each $LUNA coin is trading for around $0.000058 at the time of writing this article. So, how did this happen?

The $LUNA ecosystem has an algorithmic stablecoin, called TerraUSD ($UST). Unlike other asset-backed stablecoins, like USDT or USDC, UST’s goal is to remain at a stable price at around $1. It achieves this by having its users able to burn $1 worth of $UST in order to mint $1 worth of $LUNA.

When everything works as it should, in theory $LUNA and $UST should have the same market cap. Like every stablecoin, $UST can have small fluctuations of a penny or so, sometimes being worth $0.99 and sometimes being worth $1.01, but those opportunities would be quickly picked up by arbitrage makers and arbitrage bots. 

For all intents and purposes, $UST remained stable around $1 from October 2020 to May 2022. The Luna Foundation Guard (LFG), the overseeing authority behind the LUNA ecosystem, understood that $UST should be backed by not only $LUNA, but by $BTC as well.

This would add another cushion of reserve assets that the LFG can sell in order to keep $UST at its target peg of $1. The algorithmic stablecoin could lose its value if there were a sudden unwanted crash in the $LUNA price. The LFG started buying lots of Bitcoin, in order to ensure the well-being of the Terra ecosystem and having the $UST assets backed by more than just $LUNA. The LFG managed to accumulate roughly $3.1 billion worth of BTC in order to increase trust in the $UST peg. Of course, this was not enough.

The problem about the $UST stablecoin was the Anchor protocol ($ANC). People could effectively deposit $UST into the anchor protocol, and effectively receive 20% APY on their deposits. At its peak, $ANC managed to accumulate $14 billion UST in deposits, which was much less than its collateral at the time (of $3 billion).

If everyone were to start pulling out of the Anchor protocol, then there would not be enough assets to pay everyone out. In many ways, the Anchor protocol was destined to be a Ponzi scheme where the last people who cash out end up not being able to. But if $ANC runs out of $UST to give out to its depositors, that does not necessarily mean that $LUNA and $UST would need to crash. So, why did they crash?

The importance of liquidity 

Although nobody could know for certain what caused the crash, many people believe that it is due to a group of attackers who purchased the entire $UST liquidity on the Curve Pool. The Curve protocol is a protocol that facilitates swaps between stablecoins, effectively helping each stablecoin remain around $1. On May 7th, the Whale Alert bot showed a swap from 85 million $UST for $USDC.

One day later, the price of $UST dropped to $0.985, the first time that the stablecoin has been so depegged. The LFG took action and deployed $750 million of its BTC and 750 million $UST to different arbitrage traders, in order to defend the $UST peg. This actually worked temporarily, bringing the price of $UST back to $1. However, the very fact that $UST was depegged, even if only for a few hours, might have caused a large group of people to lose trust in the project.

One day later, on May 9th, the bank run started. A bank run is when everyone tries to cash out of their assets and get cash, as they fear that their funds might be at risk. The Anchor protocol went from $14 billion in deposits to $9 billion in a single day. People wanted to cash out from their $UST and receive $USDC or $USDT, but the Curve pool reserves were empty. 

Therefore, they needed to cash out of their $UST on exchanges. There was so much selling pressure that $UST dropped to a low of $0.80. The LFG took action and started selling all of its BTC and $LUNA reserves.

It temporarily bumped up the price of $UST, but the trust in the project might have been lost, making more people cash out of the Anchor protocol. $LUNA and $UST kept on dropping.

Part of the algorithmic stablecoin features is that more $LUNA can be printed and immediately sold to keep the price of $UST steady, but as $UST cannot be re-pegged, too much $LUNA started getting printed.

What’s the Blockchain Trilemma? L1 blockchain projects with the biggest scalability issues.

People lost trust in the project leading it to a crash 

$LUNA effectively lost essentially 100% of its value in the span of less than 5 days. The LFG used up all of its assets to try and recover $UST, but it failed. The trust in the project is lost, and today $UST is trading for around $0.0095 per token. A $1.5 million investment would turn into less than $200, in the span of less than 5 days.

 The founder of Terra, Do Kwon, tried to solve Terra’s demise by releasing a brand new Terra, called Terra 2.0, and converting the old Terra coin into $LUNAC, Terra Classic. He does the same with $UST, converting the old $UST into $USTC and making a new $UST. Every $LUNAC owner can receive $LUNA 2.0 airdropped to his wallet.

This had some people able to recover their funds, albeit only a part of it; according to this tweet, people received not even 10% of the original funds that were lost. This created a loss of trust for $ LUNA 2.0. Now, people are chasing Do Kwon in court, claiming their lost assets. But, crypto is overall unregulated, so there’s still a story to tell regarding the consequences for this outcome.  

Wormhole

The Wormhole is a bridge protocol that allows cross-chain transfers. If you had some USDT on the ETH blockchain, and you wanted to bridge it to the Solana ($SOL) blockchain, then you could use the Wormhole protocol. It achieves cross-chain transfers by owning assets on both chains: for the USDT example, the Wormhole protocol has USDT assets on both the SOL and ETH blockchains, and people can switch between both assets for a fee.

As early as January 13th, the Wormhole team updated the code on Github, which had a bug in it and left it vulnerable to exploits. Basically, someone could pretend that they were an admin and manage an admin signature to get the funds transferred out of the Wormhole protocol.

On February 2nd, a hacker found this exploit and transferred $325 million worth of ETH outside of the Wormhole protocol. This made the Wormhole attack one of the top 5 largest crypto hacks in history at the time. 

Since the attack, Wormhole has managed to recover the funds. It is not clear where the funds came from, but it is believed that new lenders managed to bail Wormhole out of its debt. Hopefully the lesson is learned, and Wormhole is more careful when updating the code of its protocol.

BadgerDAO (BADGER)

The BadgerDAO protocol is a Dapp that effectively brings Defi to Bitcoin. Defi allows anyone to lend and borrow in a decentralized manner using collateral. However, as Bitcoin does not support Dapps it mainly remains outside of the Defi universe. Thanks to BadgerDAO, Bitcoin could be used in Defi applications.

On December 2nd, 2021, BadgerDAO got exploited for roughly $120 million. This attack was different from the previous two, as it was not an attack on the smart contracts. Instead of the attacker aiming at flaws in the smart contracts, the hacker noticed a flaw in BadgerDAO’s front-end website, which he exploited. An admin of the BadgerDAO discord channel wrote that one of the Cloudfare APIs that the website was using has been compromised, causing the exploit and attack.  

People that used the BadgerDAO Dapp during this time would unwantedly approve and transfer their tokens to an external wallet, effectively stealing the funds. The odd part of the story is that it could have been easily prevented with better website security. Every element of a crypto project could go wrong; even the website itself can be hacked and cause turmoil. 

Bottom Line

Many crypto projects have gone wrong, and many more crypto projects may go wrong in the future. As the cryptocurrency industry is expanding at a rapid pace, people may not observe some of the bugs and glitches of a protocol that can perhaps be exploited.

Any coded asset is potentially at risk of being exploited. The larger the exploit, the more pressure regulators are given to try and control the cryptocurrency industry. Regulating cryptocurrency may not necessarily be bad for the cryptocurrency industry, as it can help establish trust for large institutions and investors to purchase and own cryptocurrency.

We have highlighted three of the most recent (and largest) crypto projects that went wrong, but there are many more. Now, it seems like Defi protocols themselves are being hacked more often. The reality is that as cryptocurrency gains more attention, more hacks and scams may continue to follow it.

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