This article was written by Dexaran (Callisto Network co-founder) and Vladimir Vencalek (Callisto Network CEO). Part of this article was posted on Medium. Market Data provided by Bulls Investing Club.

A couple of words about Dexaran

Dexaran, is the COO of Callisto Enterprise.

You can find some info about him in this article on Cointelegraph. Long story short — Dexaran witnessed The DAO hack and was among those who drove the creation of Ethereum Classic. After that, he ‘forked off’ from ETC and founded Callisto Network (launched via the airdrop).

Since Dexaran has a unique experience in “forking chains,” we would like to share our own experience that could be potentially helpful for the LUNA community.

LUNA Crisis In A Nutshell

Terra is a blockchain platform that enables its users to create stablecoins. Terra has its own native cryptocurrency traded at the $LUNA ticker. Terra dev team launched their own (stable)coin $UST on their platform.

Typically, stablecoins like USDT are “stable” because users give US dollars to Tether company to receive USDT tokens. At any time, USDT tokens could be converted back at a 1:1 ratio to US dollars by the same Tether company. That’s why they are stable.

$UST was pegged 1:1 to the dollar by a complex algorithm that should have minted/burned LUNA and UST in order to keep the price valid.

This algorithm failed, which resulted in huge amounts of LUNA being printed to the market, which resulted in its price dropping dramatically.

To Fork Or Not To Fork?

Terra’s CEO proposed ” forking” the blockchain and scraping UST altogether.

Notes Regarding The “Forking Plan”

Technically, the proposed solution is not a “fork” (read the explanation of the “fork” term here). Chain Split or Hardfork is a term used for the chain upgrade process where one chain with its history of transactions is split into two chains (with different consensus rules since then) at a certain block. Before that block, the chains had the same history of transactions. Starting from the “fork block,” the two chains have different histories of transactions.

Terra CEO proposes relaunching the chain from scratch (erasing the transactions history), so it is not a fork of the existing chain.

We already have precedents for a similar situation: TheDAO hard fork. Ethereum Foundation proposed an emergency hard fork to redeem TheDAO funds withdrawn by the “hacker.” They gave the community an extremely short time frame to engage in a pseudo-voting process without a proper description and discussion around the topic. Alternative solutions were not discussed widely and a consensus was not built in the community.

As a result, a large group of the community (including myself) disagreed with the actions of the Ethereum Foundation and supported the original chain, refusing the hard fork. The key point here is that in the case of the Ethereum Foundation, this was a time-limited decision. DAO funds were time-locked, and the “hacker” could not use them. Therefore, the decision was rushed as the Ethereum Foundation should have developed a solution before the “hacker” could dump all the funds onto the open market.

Mistakes that must be learned:

  • The lack of consensus within the community & dev team caused the project split — not the proposed solution itself. Investigating alternative solutions and handling a proper PUBLIC discussion of different options is important.
  • A clear process of PROPOSING, INVESTIGATING, and EVALUATING of the solutions must be defined and used.
  • It is important to adhere to the transparency policy when making such critical decisions. The processes must be observable and well-documented. Financial operations must be commented on and documented as well.
  • The consequence of the hard fork (and the chain split) was the value split between the two “projects” and a so-called ETH-ETC race. At this time, it was possible to observe the inverse correlation of prices of $ETC and $ETH in the market, and at the peak point, ETC was worth 0.4 ETH. The trading community was expecting “ETH-ETC flippening” which didn’t happen though. The same happened to the hashrate wars between ETH and ETC. It is clear enough that the split in project governance does not just create the value out of thin air — instead, the “value” of one initial project is split between its two parts.

It is extremely important to note that alternative proposals are presented within the community, most notably this one:

There is another difference. The problem with TheDAO was not the hack. The problem with TheDAO was that it had too much money, and it was a significant part of the ETH supply locked in the hands of one person with no incentives to be a bagholder. So, the solution was to withdraw his stake. In fact, the TheDAO bailout was not solving the problem of TheDAO — it was solving the issue of the Ethereum ecosystem, and the hard fork WAS the solution to this problem.

In the case of LUNA, the relaunch/rebranding of the project is NOT a solution to the problem. LUNA is a system of stablecoins. The root of the problem was the algorithm that could lead to such a collapse and the loss of USD peg of the core stablecoin. However, removing the stablecoin does not solve the problem of this stablecoin platform. Instead, it simply removes its core part. There were funds allocated to “insure” the collapse like this. Take it and use it on purpose.

  1. The algorithm must be re-investigated, and the stablecoin must be reworked. There are time-proven examples of working stablecoins (such as USDT). Possibly, it is worth sticking to a more traditional approach.
  2. There were funds allocated to “insure” the collapse like this. Take it and use it on purpose.
  3. There is absolutely no need to split the value of the network between its parts (if there will be $LUNA and $LUNC as per Do Kwon’s proposal) — this will only lead to a further decrease in the overall value of any of the system parts.

Technical Analysis – What The Market is Telling Us

LFG reported buying 2,684,727,990 USTs by selling USDTs, USDCs, and BTCs on May 8 and 10. Details of the amount that was spent can be found in their tweet.

These transactions can be performed in two ways: on the open market or over the counter (OTC). From an essential standpoint, OTC is an exit of liquidity. In terms of using the open market, we will discuss this in detail as follows:

A) LFG reported having purchased (2,684,727,990 UST), representing 23.8% of the total UST supply. Purchasing such an amount in two days should appear on the chart as a spark, even if there was a sell-off, it should absorb it, yet the chart shows a drop in this bar followed by a red bar, “the bar after such a purchase should be green”.

The following four charts show the evolution of the liquidity of the four main UST exchanges:

From a technical analysis perspective, the red bar after these bars means there was no such a buy.

B) Regarding the sale of BTC “to buy UST,” the first purchase occurred on the 8th of May. Technically, the bar doesn’t show any particular volume change. The increase in volume in that bar was due to the break of the “34413$” support. Each bar that breaks support has an increasing volume due to Stop Loss execution. The next chart shows the normal volume on both volume profile and classic volume for that date:

Selling 80,000 BTC within two days from a single part should significantly drop the chart, yet on May 8 and 10, the total amount of BTC sold worldwide in every exchange was 199.65k BTC. LFG has stated that they have sold half of that volume.

The selling volume on May 8 on all exchanges was 62.02k BTC; the previous days, the volume was 56.4k, 73.77k, and 45.17k. Therefore, there was no volume increase, representing a sell of 50k BTC from a single account. The next charts show these data:

Finally, if we look closely at the total UST chart, we can see a larger drop than the 8th of May drop, yet LFG didn’t move any of their reserves at that time, which leads to the question of why they acted quickly this time. The following charts compare both drops:

In conclusion, the technical analysis and volume do not show massive buying in UST or a huge BTC selling.

Some Questions That Need to be Clarified

After analyzing the blockchain, it appears that the LFG should explain some transactions for transparency for the community and investors.

First of all, the transfer of 25012 BTC on May 9, 2022, with a value of 842 million USD:

Then, a series of transfers on May 9, 2022, totaling 70752 BTC and valued at 2,380 billion USD:

Given the off-chain nature of these transactions and their amount, we strongly recommend the LFG to communicate their purpose and intent.

Furthermore, it is unclear how much funds LFG currently has; the dashboard indicates that 1.5 billion were allocated to maintain the UST peg and accumulate BTC. However, it is unclear if these funds are available and how they were used during the crash.

What The LFG Should Do

Considering the abovementioned elements, we recommend not proceeding with the blockchain hard fork. This action will not solve the current issues and will, instead, lead to split a strong and united community.

We would suggest LFG publish the actions taken to maintain the UST peg and the reports of the transactions made on the exchanges. Given the circumstances and the amount involved, the highest level of transparency is required for the project’s and its community’s sake.

About Callisto Network

Founded by Dexaran,  co-founder of Ethereum Classic, Callisto Network is a blockchain platform that prioritizes security. We’ve conducted over 330 smart contract audits across platforms like Ethereum, Ethereum Classic, and EOS. In addition to our audits, we’ve developed the ERC 223 token standard and CallistoNFT standard, enhancements over existing standards that address flaws and offer new capabilities, further establishing us as industry leaders in crypto-security.

Trust The Blockchain, Audit Your Smart Contracts.