When (if ever) is blockchain-state manipulation justified?

Pretty much never--unless, as in the case of USTC, you are burdened with an otherwise-unpayable debt.

Thoughtful contributors to Terra Classic such as StrathCole/@ColeStrathClyde and TCB/@THORmaximalist, among others, have raised a conscientious objection to Terra Classic proposal #11675 on the grounds that it manipulates blockchain state. The idea that “state is sacred” is very fundamental to blockchains, and this position is an intellectually honest one. In 99.99% of circumstances, I would agree with them without a second thought.

But in the case of USTC, I think this principled objection is fatally wrong, and it’s really important for the community to understand why.

USTC as defaulted debt

What happened to UST/USTC has a strong parallel in the world of traditional finance: a debt default.

UST was an IOU algorithmically programmed to be something pretty close to $1 a large majority of the time that somebody wanted to cash in the IOU, unless the person redeeming the IOU (swapping UST for LUNA) was trying to do so at the same time as lots of other people were trying to do so.¹

Today, of course, USTC is a very long way away from $1, and nobody thinks it will just magically get there and stay there on its own without drastic changes. A return to $1 would require an investment of billions of dollars—$9,795,903,377 to be exact—, with no upside from there, buying up every USTC token for $1 - current USTC token price ($.015ish).

It’s not going to happen.

Now, in traditional finance, when a big debt default happens, it’s “restructured” a very large majority of the time. What does that mean?

A debt restructuring happens because a “creditors’ multisig” (a committee of individuals representing owners of the defaulted debt) gets together, goes through the wreckage of a failed enterprise like Lehman Brothers, takes over the remaining business and subsidiaries of the defaulted business, and executes a series of financial maneuvers (laying off people, selling off profitable subsidiaries, finding underappreciated assets buried within the wreckage, renegotiating unpaid invoices due to suppliers, and so on) to rebuild what can be rebuilt and liquidate for scrap what cannot be rebuilt.

They also agree, if the debt default is severe enough, to completely write-off a big percentage of debt owed. (This is especially common in the case of sovereign defaults, eg, Argentina.)

In other words: the governance of the failed entity agrees to alter the state of the previously-agreed contracts.

But why would anyone do that? Why surrender the free option billions of money owed them, in exchange for nothing?

Because everyone ends up making a lot more money that way.

If a defaulted entity has infinite debt relative to its plausible earnings power, no employee will want to spend years rebuilding it. No rational person wants to be a creditors’ slave for mistakes that weren’t their fault.

Furthermore, counterparties won’t take the entity in question seriously. They’d understand that anybody competent would leave at the first opportunity, and whatever equilibrium the entity tried to present to the world was mathematically doomed to crumble under its own debt-weight. They’d charge a risk premium for things like waiting 30 days for an invoice to be paid, if they did business with the entity in question at all.

For USTC, pretending $9.55 billion of debt will be magically repaid is not a viable future. The state must be altered.

If “state is sacred,” USTC is dead

Those who support USTC re-peg efforts, yet object to altering LUNC’s state to void zombie USTC debt, are effectively saying:

“The LUNA/LUNC blockchain ($535m market cap today) made a promise when it borrowed $9.7 billion. A promise is a promise. We cannot, under any circumstances, break any promise—even one which is already completely shattered. I feel so strongly about this that I wouldn’t do it even if it were to help creditors ultimately get MORE than they would in today’s status quo.”

Which they might object to by saying, “I see where you’re coming from, but that’s a strawman argument! I’m just hopeful that Multisig XYZ will voluntarily extinguish its debt by sending its funds to the burn address on its own.”

While I agree that it would be nice if other people Did the Right Thing and solved our own problems for us, it’s hard to take that objection seriously, because:

1. That’s not how the world works.

2. All the funds being considered for this kind of blockchain-state-altering extinguishment are, by any legal or moral standard, community assets which happen to be in a particular multisig’s custody. Thus, the community should have absolute control over how those assets are used.

3. The entities in question have already had an entire year to voluntarily do whatever they want to do to extinguish debts, etc.

4. The entities in question—all legally recognized entities with off-chain as well as on-chain assets—have very strong legal incentives to do nothing: anything constructive they do will be twisted to maximum defamation by ambulance-chasing grifters like “FatManTerra”, which will embroil them in more litigation and make their offchain assets more vulnerable to legal attacks.

5. As much as it’s a bad approach in life to wait for someone else to solve your own problems for you, it’s an even worse attitude re: blockchain governance. Decentralized governance is already extremely slow and inefficient compared to the centralized alternative.

USTC is dead if the vast majority (at least 90%, imho) of its $9.6bn bad debt can’t be extinguished.

Extinguishing bad debt isn’t a crime. It’s a rational reaction to drastic changes in circumstances, to turn wreckage into something greater than wreckage. In the real world it happens all the time. (Donald Trump even became a US president after a debt restructuring of his failed business, and the restructuring had a happy-enough ending for his creditors that the lead creditor in that restructuring deal, Wilbur Ross, became Trump’s Commerce Secretary).

Also, defaults on promises happen all the time in crypto. They’re called rugpulls. Chain state isn’t altered, but the team quits, nothing gets done, and the token devolves to zero.

Is a default less bad because it happened in a way that the blockchain’s computers were unable to memorialize? Maybe, just because respecting usually-good norms is better than disrespecting usually-good norms, all else equal. But substantively it’s the same end-result for the investor.

So, agreed: blockchains have different rules and cultural norms that deserve enormous respect. Unfortunately, the financial severity of USTC’s debt default puts it way beyond that event-horizon. To suggest otherwise is unrealistic and not pragmatic.

BTW: this argument was THE reason why, 9 months ago, I proposed a “USTN airdrop to mirror existing USTC distribution, minus certain mega-accounts” approach to the problem of eradicating excess USTC supply. I saw the blockchain-state objection coming from miles away. An airdrop of a new token would’ve elided the blockchain-state issue to achieve the exact same result.

Unfortunately, something else changed in the past 9 months that I didn’t foresee: the regulatory environment for stablecoins got a lot worse, and for algorithmic stablecoins, horribly worse.

So much so that listing a new algorithmic stablecoin on major CEXs is an extremely unlikely prospect. So USTC’s CEX listings have become much more valuable insofar as LUNC is interested in resurrecting an algostable in some better form in the future. Therefore: USTC is now a much better instrument to execute a debt restructuring than it used to be.

USTC’s debt restructuring has a long way to go. We’ll have to alter LUNC’s state multiple times to get there. If one party or another wants to help things along with voluntary actions consistent with that path, great. If they don’t, we should put ourselves in a position to not care. Most parties in question are not in a position to help us on this issue, even if they wanted to.

The future’s up to us. For many of us, the wait has been long enough.

1. LUNA was designed to exact an exit tax that parabolically increased to 100% (but which was force-reduced to 40% during LUNA’s crash, because arbitrageurs wouldn’t take on arb-related risks at higher tax rates than 40% when volatility was very high).