When two of crypto’s largest assets — Terra and TerraUSD — collapsed earlier this month, they took a healthy portion of the crypto market with them. Over a trillion dollars worth of market capitalization, of which over $100 billion worth was directly denominated in Terra and associated assets, was washed out.
Terra’s ascent, and demise, had almost everything to do with its power app: Anchor Protocol, which was the steroids that the chain was built on. It offered users the ability to generate a 19.5% APY on funds deposited in $UST. In other words, if somebody bought $100 worth of $UST and then deposited it into Anchor, they’d get roughly $19 in interest in their first year. It was described to the end-user as a “low-risk, high-interest bank account-esque product.”
Using DeFi apps and going on-chain isn’t a specialty that everybody has, necessarily though. Sure, institutions and highly-online retail DeFi speculators know their way around the blockchain, but many don’t. That’s partially to credit for the emergence of institutions representing retail investors through “DeFi apps.” Their pitch is simple: give us money and we’ll find high-yielding DeFi products for you…
Until they don’t.
Users of a Y Combinator-backed DeFi app called Stablegains are now learning that the hard way. They lost more than $47.6 million worth of UST from 4,878 users.
Stablegains, like many custodial crypto apps, lowered the bar to entry for the DeFi-curious. User deposits could be made via ACH or Wire Transfer, which is notably easier than making use of buying crypto, opening a crypto wallet, keeping track of a private key, and then having to file taxes and keep track of their deposits.
The company advertised “15% interest”, which was ultimately the pitch which brought millions worth of deposits to the app. It was prominently displayed on their site, their Product Hunt page, and advertising on social media sites such as Instagram. A supporting cast of VCs and name brand investors such as Pantera, Alameda Research, and Naval Ravikant were displayed on the company’s front page to attest to their credibility (their involvement was/is unclear.)
It was enough for a “crypto-beginner” named Danny to deposit thousands of dollars into the app. He claims that he deposited money based on marketing material that said that his funds would be diversified into different stablecoins, he could withdraw at any time, and his funds would be collateralized.
That claim was corroborated by a swath of marketing material collected by users in a Discord channel called the Anti-Stablegains Club, where over 400 users have gathered screenshots of evidence — advertisements, articles from the company’s Zendesk help desk, the webpages of the site, and the app itself.
They show that, up until a few days ago, Stablegains claimed that “the main stablecoin [they] use is USDC (USD Coin),” along with TerraUSD and DAI. In that statement, they also say that they “allocate funds across a number of stablecoins to not be fully exposed to the potential instability of one stablecoin.”
In separate Zendesk articles and webpages, the company claims that “[Users] will not lose funds because all loans are 100% asset-backed” and that “the company overcollateralized assets by 160%+ to keep the principal safe.” The Wayback Machine even shows that they assured that “Deposits with Anchor Protocol will be fully insured,” just weeks ago on Apr. 17.
But then, Terra began to collapse and the company paused deposits and withdrawals. Danny claims that his deposits were changed from U.S. Dollars to the devaluing TerraUSD stablecoin. Others claim the same happened to them, including an investor named orangecrush on Discord; he shared emails with Stocktwits which were sent out during the depeg incident:
In an email dated May 9, Stablegains informed users that $UST was depegging and that “the only DeFi tool currently supported [was] Anchor Protocol’s deposit side.” This operated in direct contradiction to the company’s earlier documentation, which said that they deposited into a number of collateral-backed coins and insured their Anchor deposits.
Stablegains launched a UST withdrawal feature on May 10, allowing users to remove their UST if they wanted to. However, in another email sent out the same day, the company further detailed the depegging incident and said that there were several scenarios possible for $UST and Anchor: “the most obvious one is that UST returns to its full dollar value as it always did in the past.”
By May 13, the emails had changed tune. The company shares that “when users deposited funds with Stablegains they were converted to UST and deposited with the Anchor Protocol where they earned a yield, as per our terms” and that “the risk of depegging has always been there and it’s something all users have signed up for.”
Members of the Anti-Stablegains Club disagree, including Danny.
“There were definitely not enough disclosures for users to understand the risks, especially regarding the very real risk of depegging,” Danny said. “I think that Stablegains was specifically marketed towards people like me who were not very knowledgeable about how crypto works but willing to try it out in a safe environment.”
According to Stablegains, users will have to ultimately have to withdraw what’s left of their UST in UST, USDC, ACH, or Wire by the end of June. The company indicated that “there is a possibility that no UST will be accessible/usable on any blockchain following May 27, 2022” because of Terra’s ongoing reconstitution. The company is also closing its doors as a result.
The Anti-Stablegains Club claim they’ve also observed a change or two in the company’s marketing material and Zendesk articles. The company says that the updates were meant to be clarification which already existed in the company’s terms.
“We thoroughly disclosed the risks associated with decentralised finance overall, as well with Stablegains in our Terms of Use,” said Emil Dalgård, the co-founder of Stablegains, in response to comments furnished by Stocktwits. “We have not changed our Terms of Use since December 28, 2021. The document referred to is an article from our Learning Center, which we updated as soon as the crisis hit to discuss an unprecedented situation and help users navigate.”
That matters little to users who feel wronged by Stablegains. A channel called #losses on the Anti-Stablegains Club Discord features stories from users who lost thousands. Their only hope for getting back their funds is an uncertain airdrop for Terra’s new chain and a purported class action lawsuit which is expected to be brought by the law firm Erickson, Kramer, and Osborne on behalf of users.
The firm sent a letter, dated May 14, to Stablegains demanding that they preserve and maintain records of customer accounts, marketing and advertising, and internal and external communications regarding the Terra stablecoin.
We reached out to Stablegains for comment on the alleged losses and damages. They responded that they had seen the May 14 letter, indicating that “To the extent a lawsuit is filed, we intend to defend against it.” They added that, “As a broader matter, our priority right now is to guide customers through the situation and encourage them to recoup as much of their funds as possible through making withdrawals.”
YCombinator, which hosted Stablegains as part of their venture accelerator and wrote a follow-on check, did not return our request for comment either.
Stablegains was not the only crypto custodian to go up in flames as a result of Terra’s collapse. Another app called Alice also utilized the Anchor Protocol to fetch its 20% yields for users. The company raised $2 million from Arrington XRP Capital, Terra founder Do Kwon, Accomplice, and Mechanism Capital in May 2021. They did not return our request for comment regarding how they plan to compensate users and whether they understood the risk of Anchor.
The two apps cumulatively represent a nine-figure loss for users.
Alice and Stablegains are just two out of hundreds of crypto custodians which are helping users intermediate with DeFi, often in ways that they don’t understand. However, they can be reassured that they won’t be the last to lose.
Before the Terra incident, $180 billion worth of assets were locked (TVL) in tracked DeFi protocols according to DeFi Llama. That figure is now a fraction of what it was before the depeg, but even if institutions and speculative retail investors on-chain continue to own the majority of that pie — a portion of that pie will start to be made up of smaller institutions representing retail such as the apps. The amount they’ll command will be smaller, but not insignificant.
The failure of these two DeFi apps prove that credible compatriots and promises of “insurance” and “overcollateralization” might not be enough to safeguard funds. Unlike the on-chain speculators, the everyday crypto-curious might be unaware of the risks they’re taking.
“If a retail investor wanted to do research into a retail-facing DeFi app, they would likely have little visibility into who they’re working with,” said Johnny DeMaddalena, who runs his own eponymous bitcoin-based investment firm, DeMaddalena Capital. “Even if they’re overcollateralized and have an attestation to being so, you can’t underwrite the risk and how much risk you’re exposed to.”
That means that even if companies make claims, retail investors who deposit will often be at the whims of the honor system; depositing is tantamount to placing trust in a firm. “[These apps] putting 100% in Anchor are recklessly yield chasing. These companies make money on a spread, so they are going to push the risk where they can,” DeMaddalena says.
That implies that these glamorized intermediaries and money managers might pursue yield recklessly (or opaquely) in order to maximize their cut of it. After all, such is the business of DeFi for many self-professed degens on-chain; they don’t have risk departments or models. It’s all about feel, high APYs, and maybe a little bit of Do Your Own Research (DYOR.)
Maybe crypto will learn from the failings of these two apps, but crypto is in a volatile state. Rugpulls and hacks are common, collapses are not abnormal, and crypto itself is still finding that even “stable” assets are unstable at times. Maximalists relish in all its complicated complexity.
Unfortunately, that complexity is often wielded as a weapon against those who don’t know better.
“The apps are a black box of yield generation that is making money,” DeMaddalena said. “It could make money, or it could all blow up.”