Not just another crypto-bubble

By Peter S. Kim

Amid stock market woes year to date, the spectacular boom and bust of the "Luna" cryptocurrency surpassed them all. Within a few days, billions of dollars evaporated after an investor frenzy unmatched in the history of asset bubbles. Luna was founded by 30-year-old Do Kwon, who launched the "Terra" U.S. dollar stable coin in 2020.

Terra purportedly holds a value of $1, with its dollar peg maintained by an algorithm program linked to the Luna cryptocurrency. To buy Terra, users need Luna and vice versa forming a symbiotic link. Korean individual investors had been attracted by a scheme in which clients could lend out their Terra for a 20 percent yield. Luna's brief boom-bust is a cautionary tale for investors chasing easy gains based on seductive momentum investing.

With tackling inflation a top priority of central banks worldwide, unproven financial products will be a key target for regulators in the coming months. Every liquidity bubble has a landmark moment, and for the COVID bull market, Luna could be the bubble that marks the end of the liquidity-driven hubris.

Luna attained market credibility from significant investment from institutions like venture capital firms helping Kwon achieve market credibility. Many reports of Kwon's cult-like following, whose followers are "mesmerized by his genius." They found the algorithm model fresh and attractive because there was a growing need for stable coins, and the coins were not linked to the real economy, only backed by each other and by bitcoin.

The symbiotic link is meant to keep the price of Terra stable, but within a week, a "run" took place. As investors dumped Luna, the value of the cryptocurrency collapsed, damaging investors' trust and the ecosystem's delicate algorithmic balance and breaking Terra's peg to the dollar in the process. The spectacular scale of the bubble and abrupt crash matches the legendary tulips bubble many centuries ago.

Korean investors are engaged in an once-in-a-lifetime portfolio reallocation by shifting from property and bank deposits to financial assets. For decades Korean retail investors have been rushing into residential property due to its outperformance over equities and bonds.

With the Korean population falling off the demographic cliff with the lowest birthrate globally with 0.8 children per couple, the demand for residential property will decline over the long term. However, Korean property prices are rising in the short term due to meager interest rates and fiscal stimulus from COVID, especially in the highly popular Gangnam district.

Another demand for financial assets is from bank deposits, which despite the recent jump in interest rates, savers are getting less than 2 percent for one-year fixed deposits. Luna's clever but manipulative promise of a 20 percent yield preyed on the desperate retail investors seeking yields after decades of high single-digit yields.

This month South Korean government appointed the heads of two primary regulatory bodies for the financial industry, the Financial Supervisory Commission (FSC) and the Financial Supervisory Service (FSS). The newly-appointed chairman of the FSC, Kim Joo-hyun, is known for crisis management experience from his role as head of policy for the FSC during the 2008 global financial crisis. One of his first tasks is tackling cryptocurrency regulations after the spectacular crash of Luna.

Notably, the new FSS governor, Lee Bok-hyun, is a former criminal prosecutor, signaling President Yoon Suk-yeol's intent to take a hardline stance over financial activities hurting retail investors. Investors can expect Korea's regulators to introduce measures to clamp down on cryptocurrency creation and trading in the coming months.

The Luna narrative proves many cryptocurrencies as a near-Ponzi scheme, given the investment thesis is built on a pyramid scheme where you hope to buy an asset based on the bet that another investor will buy it for a higher price in the near future. In one of my previous columns, I recommended investors to keep their investments within a small group of proven cryptocurrencies like Bitcoin over other copycat products that prey on the unassuming investors. As the global economy inches toward a recession, prudent investing is required more than ever.

Peter S. Kim (peter.kim@kbfg.com) is a managing director at KB Financial Group.

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