Class Action Lawsuit Against TerraForm Outlines Fraud Allegations After UST Collapse

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A recently revealed lawsuit against TerraFormb Labs over the collapse of USDT and other tokens gives a glimpse into how the ecosystem could have fallen, resulting in losses for investors and possibly the beginning of the “Crypto Winter.”

In a 72-page class action lawsuit against TerraForm, 3 Arrows Capital, and TerraForm chief executive Do Kwon, attorneys for Scott+Scott argue Terra Tokens were promoted as a stable way to grow wealth but was set up to be unsustainable in the end.

Attorneys Allege TerraForm Misled Investors

The lawsuit was filed in U.S. District Court for the Northern District of California on June 16, 2022, but announced by Scott+Scott on Sunday, July 24 – over one month after the filing. The complaint tells a story about how UST and the Anchor Protocol were sold to investors, only to come crashing down.

Their allegations state problems can be tied back to April 2019, when the LUNA whitepaper was released outlining the goal to create an algorithmic stablecoin. One year later, the company’s head of research published the Anchor Protocol whitepaper, describing it as a savings protocol accepting Terra deposits and paying out a yield from lending “…deposits to borrowers who put down liquid-staked PoS assets from major blockchains as collateral.”

“In plain English, Anchor offered depositors a fixed annual return of 20% by redistributing fees from borrowers and rewards from other assets staked in Anchor,” the lawsuit reads. “The whitepaper repeatedly refers to this 20% interest rates as ‘stable.’”

Importantly, the complaint claims both TerraForm and the Anchor Protocol continued to advertise the “stable” yield rate. On March 17, 2021, the lawsuit claims the Anchor Twitter account sent a message stating: “The protocol offers stable, 20% APY interest to depositors and only accepts liquid staking derivatives as posted collateral by borrowers.” A similar message was sent in April and May 2021, with the penultimate message reading: “Anchor is the gold standard for savings – 20% yield for all.”

Trouble begins to brew under the surface for Anchor and UST

Despite the positive language, the lawsuit claims trouble was brewing under the surface. The complaint claims that an unnamed researcher at crypto-related venture capital firm Hashe warned the Anchor Protocol at their own governance forum that their yield reserve would only last through February 20, 2022. Afterwards, the fund would need another $436 million to sustain their yields through November.

After the meeting, the group ultimately voted to capitalize the Anchor Yield Reserve by 450 million UST, followed by a private sale of $1 billion of Bitcoin and other cryptocurrencies to “provide a further layer of support using assets that are considered less correlated to the Terra ecosystem.” Afterwards, the positive messaging continued, with executives of 3 Arrows and others tweeting about burning LUNA to make the coin more valuable, while making UST more accessible. Calls to reduce the yield payments were ignored and voted down, in hopes that the protocol would continue to grow and attract more borrowers.

“Both the size of the deposits in Anchor and the ballooning interest payments owed to investors became too much for the Terra ecosystem to bear,” the lawsuit reads. “In early May 2022, the house of cards came tumbling down after structural vulnerabilities within the Terra ecosystem precipitated a massive selloff of both UST and LUNA.”

Crash drives price of UST down over 90%

The lawsuit claims that the defendants knew that the growth of UST was not only unsustainable, but the continual payout of 20% did not allow for defense mechanisms to be built for the protocol. Even with this information, the lawsuit alleges that leaders at TerraForm and 3 Arrows continued to encourage retail investors to purchase and take out loans to take advantage of the yield.

Once the crash began, the lawsuit claims the total value locked in the Anchor Protocol dropped by $11 billion between May 9 and 11, 2022. This ultimately caused the price of UST to drop by 91% and de-peg from the U.S. Dollar, while LUNA tokens dropped in value by 99.7%. The court filing notes that Luna Foundation Guard Governing Council member Remi Tetot admitted that his entire cryptocurrency portfolio was in LUNA, and he could do nothing but watch as he “watched it melt from 8 digits to 0.”

The complaint is seeking to recover money from the LUNA and UST collapse on behalf of the class, as well as post-judgement interest on any recovered funds. The complaint is currently in front of the court, and hearings are ongoing – no decisions have been rendered.

Neither TerraForm nor 3 Arrows Capital have publicly commented on the pending litigation.

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