The Battle of Water(Luna)

What do Napolean and Do Kwon have in common? They were both on the wrong end of speculative attacks.

As most are well aware, the Crypto world was rocked last week as we watched the Terra ecosystem suffer an incredible and unprecedented devaluation of assets. The events were unfortunate, and there is little I can do other than offer my sympathy to those affected. It might come as little solace, but one comfort I can offer is to say – you are not alone.

Speculative attacks of this type are all too common in history. The famous Napolean nearly lost a war due to a speculative attack before it even started.

The Battle of Waterloo of 1815 was “the nearest run thing you ever saw,” according to the Iron Duke, who observed the battle firsthand. The battle that saw the British defeat the notorious Napolean Bonaparte was undoubtedly one of history's most significant turning points. With that said, and before I get ahead of myself, the main event I want to talk about is not this infamous battle but an obscure one that happened a year earlier. A  battle that didn't play out on a battlefield with cannons and horses but rather one that took place on a financial ledger, a war where the weapon was confidence and (false) information.

So what happened in 1814? Well, the history books will tell you about Napoleon's great success that year. Yet, surprisingly, British bonds, called Gilts, skyrocketed in February of that year. This is a bit of a puzzle. Let me explain why.

War requires states to raise capital. As a famous scholar pined, "War made the state, and the state made war" – Charles Tilly. The link between battlefield success and bond prices is straightforward. If one side wins, they can honor their bonds. If they lose, they can't. The state backs war, and if you win, the war supports the state and the price of bonds.

Logic would suggest that Napoleon's success that year would imply a fall in the price of the British Bond, given a high chance of default if a battle with the French ensued. So why was there an increase in the value of British Bonds? Well, simple, it was a scam.

A few people contacted an elaborate lie to convince everyone Napolean was dead.

“In the early hours of Monday, 21 February, 1814, a man wearing a staff officer's red military tunic adorned with gold star and medal hammered (...) demanded a message (be sent) to Admiral Foley at the Deal garrison. The message was that Napoleon had been slain by Cossacks

This was a complete lie. Many wealthy elites were involved, and it led to long jail sentences. You might ask, is it illegal to claim someone died? Well, no, unless it causes huge swings in the financial markets. And this lie did just that. The plan was simple, sell British Bonds at an inflated price before anyone realized Napolean was, in fact, alive and well.

Now, the interesting question to ask is, suppose everyone believed the scammers? Suppose, by chance, no one was able to uncover the truth that Bonepart was alive and well. The British Gilt would have continued to skyrocket. The French bond would have tanked. The British army could have used this money to build their military might quickly. The French capacity would have withered. The false claim that France's power was on the decline, given the death of their leader, would have become a reality.

After hearing the claims, the French Government and Napolean immediately proclaimed it wasn’t true.  But why were they in such a rush to instill confidence? Wouldn't it make sense for Napolean to pretend to be dead, then surprise attack? Well, yes, if finances weren’t involved, but they were. And when money is involved, confidence is everything. Perception of weakness can lead to actual weakness.

In 1815 after the loss at the Battle of Waterloo, there was again a spike in the price of British Bonds along with a massive sell-off of French ones. This time the information it was based on was correct. Napoleon was indeed defeated (though not dead).

To be precise, Napolean suffered speculative attacks twice. In 1814 based on false information. Then again in 1815, based on accurate information. So what was the attack on Terra UST like? I would argue that it is closer to the second, but, I want to stress – does it matter? Both could have had the same result.

The major problem with Terra UST is that it was backed by Bitcoin and other assets, not actual US dollars. This is fine if Bitcoin wasn’t closely correlated with other Crypto assets, including Terra Luna. This left them susceptible to an attack based on false information.

Consider the following: suppose false rumors run rampant that Terra couldn’t back their peg to the US Dollar. This leads to overall uncertainty in all crypto markets. This leads to the value of Bitcoin and other assets dropping. This means that what was just speculation is reality. Even though Terra might have been able to back the peg before the speculation, the speculation could become a self-fulfilling prophecy. It is possible that entirely false information led to the demise of Terra.

Now, I want to back up. I am only suggesting it is possible. I am not saying it happened. The downfall of Terra might have been legitimate. It might have been true that Terra couldn’t back their peg before speculation. The critical takeaway lesson is the following -- don’t buy stablecoins that could suffer a real devaluation based on false information. Stablecoins shouldn’t need to be like Napolean and have to prove they are alive. It should be the case that even if erroneous information is accepted as accurate, the coin will still maintain its value.

What I suggest is very simple. A Stablecoin needs to have so many resources they aren't dependent on confidence. Even if all trust is lost, they should still be able to win the battle. Meaning if everyone in the world doubts a stablecoin, every person should be able to line up and trade the coin for actual US dollars. If you can't promise this, no one should buy the coin.

Regarding stablecoins, we don't want battles that are "the nearest run things you ever saw." Stablecoins need to offer a certain victory. There is little certainty in Crypto, but stablecoins need to be a zero-risk asset for the entire ecosystem's health.

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