(Bloomberg) -- The latest twist in the downfall of crypto maven Sam Bankman-Fried is prompting a reexamination of the implosion of the Terra algorithmic stablecoin ecosystem that wiped out around $40 billion in market value earlier this year. 

US prosecutors are said to be investigating Bankman-Fried, the founder of collapsed crypto exchange FTX and its sister trading platform Alameda Research, regarding his possible involvement in orchestrating the death spiral of TerraUSD (UST) and its affiliated token Luna, according to a report in the New York Times citing people with knowledge of the matter. Separately, Bloomberg News reported that FTX’s new CEO and bankruptcy lawyers met this week with Manhattan federal prosecutors investigating the failed exchange. 

The Terra ecosystem was helmed by the symbiotic relationship between the two tokens that was managed by lines of automated code to govern circulation. If the price of UST went above $1, traders were incentivized to swap Luna for UST at a profit, and vice versa, thus in theory keeping UST’s circulation in check. 

But when investors lost confidence in one, the other went down too, and so they were locked in a so-called death spiral that saw their value plummet to near zero in a week’s time in May. 

Whose actions helped precipitate the decline has remained in question. There were two sides to this trade. The first is the side that traders can see on-chain, where wallet addresses were visibly swapping UST for other tokens, and that caused the market to start to panic. The other is on centralized exchanges’ order books, where the “who’s who” is harder to track because user information is not disclosed by platforms.

“People are often seeing half the picture,” Nikita Fadeev, partner at London-based crypto fund Fasanara Digital, said in a message Thursday. “Even blockchain data wouldn’t necessarily tell you the whole picture, and can muddy the water in terms of the ability to interpret the data.”

On-Chain Mismatch

In early May, signs of unease about UST’s stability had begun to emerge. Anchor, a decentralized lending protocol on the Terra blockchain, reduced the yields it offered to clients to 18%, implying that it had started to feel the brunt of offering unsustainable rates to traders willing to lock up their tokens. 

On May 7, UST’s issuer Terraform Labs withdrew $150 million in UST liquidity from Curve, a platform that offered a pool where investors could swap UST for other stablecoins such as USDC at equal value. Do Kwon, Terraform’s founder, said this was a preparatory move ahead of deploying more cash into the pool in a week’s time. 

But one minute later, an unknown wallet swapped $84 million in UST from the pool for USDC. And that wallet wasn’t the only one swapping out their UST, with 12 others also moving tokens between May 7 and May 8, to the tune of $321 million. Seven of those wallets had been withdrawing UST from Anchor as early as January, data analytics firm Nansen said, and as the stablecoin started to spiral in May, the main $84 million perpetrator withdrew around $193 million in UST from Anchor.

Kwon inferred Thursday on Twitter that Alameda had been involved in pushing down the value of UST. 

Suffice to say, all the moves in May imbalanced the Curve pool, which by that point had more UST than any of the other three tokens. Terraform’s Luna Foundation Guard — a fund established to raise money for the sole purpose of keeping UST worth $1 — leapt into action, removing $100 million in UST from the pool. In order to do that, it had to sell Bitcoin it kept in reserves for exactly this purpose, a process which coupled with declining market sentiment, pushed the price of Bitcoin down by 29% that week. 

This was taking place as LFG and Terraform Labs were already in fire-fighting mode, expending a lot of stored crypto cash in a bid to keep UST and Luna from dropping to zero. They weren’t successful either, with panic swapping and $10 billion in withdrawals from Anchor making it impossible for the LFG to balance the scales. 

While most UST activity was happening on decentralized protocols like Anchor and Curve in May, there was also still a bit of action on centralized exchanges like Binance, FTX and others. The only problem was that as UST and Luna’s prices began to come under pressure, virtually all liquidity for UST on major exchanges evaporated.

Data collated by blockchain analytics firm Kaiko at the time showed that on May 8, a huge round of “sell” orders appeared on Binance for a pair that would trade UST and another stablecoin, Tether’s USDT. On the same exchange, the “ask” side of UST’s order book increased, which would have made it really difficult for the token to re-peg to the dollar. 

“Ultimately, the poor liquidity on centralized exchanges likely played a huge role in UST’s depegging, along with a series of events exacerbated by a rush of UST out of Anchor,” Kaiko’s Riyad Carey wrote at the time. 

Kaiko also found that funding rates and volumes suggested that someone was aggressively shorting Luna. But because the LFG was so focused on spending Bitcoin to help shore up UST on Anchor and Curve, there was relatively little left to match the massive sell wall that its price was facing on exchanges.

The bulk of those “sell” orders against UST appeared to be coming from Alameda, the person cited by the New York Times said. US officials declined to comment when reached by Bloomberg News. FTX did not respond to email requests.

“While we can’t prove this was FTX, it could have been them,” said Clara Medalie, head of research at Kaiko, in an email.

--With assistance from Ava Benny-Morrison.

©2022 Bloomberg L.P.