The Crash of Terra Luna and Looming Lawsuits: Is This the Price of Innovation?

A South Korean law firm is representing investors who lost millions of dollars due to last month’s $40 billion crash of algorithmic stablecoin TerraUSD and its sister token Luna.

Founders of Terraform Labs, Do Kwon and Daniel Shin, who created Luna, have become targets of the crypto industry’s ire after the stablecoin lost its peg to the dollar. Its stabilization mechanism failed and caused Luna to undergo hyperinflation, reducing its value to virtually zero.

Seoul-based LKB & Partners told local media it will be filing a complaint against the Terraform founders, bringing two charges, including fraud. The firm also told local newspaper Munhwa Ilbo that it filed an attachment order to the Public Prosecutors’ Office of the Seoul Southern District to seize Kwon’s properties.

The claimants are believed to include LKB & Partners lawyers themselves. The firm did not respond to a request for comment.

More potential lawsuits may be on the way. Investors who suffered losses from the Luna crash have joined movements against Kwon and Shin. A community called LUNAscam, hosted on the South Korean online platform Naver, has gathered more than 1,700 members since it was created in mid-May.

It is unclear if Terraform has engaged external counsel for legal advice. Last year, Kwon was represented by Dentons when the U.S. Securities and Exchange Commission accused him of violating its own rules and the due process clause of the U.S. Constitution.

The crash of Luna has also caused an implosion within Terraform. The company’s legal team, including chief corporate counsel Lawrence Florio, general counsel Marc Goldich, and regulatory counsel Noah Axler, resigned shortly after the stablecoin’s colossal collapse.

According to South Korean media reports, Kwon may be summoned to appear before the local government to testify. National politician Yun Chang-Hyun has requested that Kwon and other executives of local crypto exchanges explain their actions while the de-peg was taking place. Local police have also launched an investigation for criminal action against Do Kwon.

Lawyers point out that any lawsuit against Kwon and his companies will be significantly impacted by the conclusion of police investigations.

“If the police investigation bears fruit, the civil lawsuits would be able to proceed likely on much better evidentiary footing,” said Daniel Lai, a former in-house counsel at Uber, and Airwallex. “If the investigation does not bear fruit, I’d expect there to be a private and confidential settlement.”

Until then, Luna investors have little to fall back on. In fact, it is even unclear at this stage which, or who, would be the right entity to sue, lawyers say.

Potential legal action against Kwon or his companies has been likened to securities class actions in the U.S.: most do not make it to trial or settle out of court. Especially for crypto investments, investor protection is thin on paper.

“Generally speaking, in many countries, crypto-assets do not yet have the status of financial products or securities. So victimized investors would unlikely be able to claim securities fraud,” said Lai.

South Korean regulators have said that they are keeping a close eye on any potential fallout from the Luna collapse but also added that there is little they can do about it.

“It’s difficult to take specific measures because there aren’t laws on protecting investors” in cryptocurrencies, Koh Seung-beom, chairman of South Korea’s top regulator, the Financial Services Commission, told local media, adding that regulators are closely observing the changes in price and transaction volume.

Misrepresentation, fraud and embezzlement have been listed as possible charges against Do Kwon. The possibility that the setup could have been a Ponzi scheme has also been suggested but that is hard to prove, particularly as the coding for Luna was transparent to the public and its investors, even though the coding eventually failed.

“The stablecoin, in its ‘death spiral,’ appears to have operated exactly as what the coding had intended, given that there were articles and warnings that have previously articulated online about such issues; and there appears to be no specific ‘user protection’ regime applicable to stablecoins in relevant jurisdictions,” said Hoi Tak Leung, a Hong Kong-based counsel at Ashurst.

Issues with “bad coding” are unlikely to be a basis for a successful fraud or misrepresentation claim, without additional factors involved, he explained.

“Oftentimes, businesspeople are just bad businesspeople. They’re guilty of being too bullish on their own businesses and tend to ignore or neglect the risks, even though they are aware of the risks,” said Lai. “Drinking one’s own Kool-Aid does not necessarily amount to fraud.”

One possible recourse would be for claimants to argue that Terra’s latest whitepaper on Luna did not specify a threshold for the issuance of new coins. The whitepaper is a comprehensive document that discusses the theory and plan for cryptocurrencies including the technology behind it. Luna’s initial drafts capped the distribution of Luna coins at 800 million but more than 6 trillion Luna tokens were issued in May alone.

Growing Pains?

While speaking at the Asia Tech x Singapore summit earlier this week, Singapore Deputy Prime Minister Heng Swee Keat used the stablecoin collapse to warn retail investors against investing in cryptocurrency. But he also conceded that digital dollars could transform finance.

The conundrum is part of crypto’s growing pains, some lawyers say.

Regulators are now facing more pressure to impose robust rules and frameworks for digital asset and crypto trading.

“At a wider level, Luna’s failure and subsequent fallout illustrates the difficult balance between innovation and decentralization, and regulation and consumer protection,” said Leung.

But he added that regulators are unlikely to favorably view projects and technologies that cause the loss of such massive amounts of money that can then be “revived” without consequences for the founders or compensation for the impacted users.

On the other hand, it’s good news for lawyers, as investors are now more likely to engage legal advisers to help them assess risks relating to their crypto investments.

“Regardless of the outcome of these actions, business promoters always need to be careful and balanced about disclosing risks to their investors, and this should be done with the advice of lawyers,” said Lai.

Those complex legal risks and ramifications may surface sooner than expected. On May 16, Kwon proposed revival plans that included the creation of a new blockchain and issuing new LUNA tokens. According to data from Terra Station, the official wallet of the Terra blockchain, 65% of all voters support the proposal. But looming legal actions will inevitably complicate the response and reception to Terra 2.0.

“The fact that holders of Luna will receive and presumably accept Terra 2.0 tokens—what does this mean for the legal position of Terra 1.0 holders?” asked Lai.

An investment in Terra 2.0 may mean that investors in Luna have unconsciously waived their rights to any potential claims from the financial debacle that took place in May.

Lawyers Still Bullish on Stablecoin

Nevertheless, some believe strongly in the resurrection of the algorithmic stablecoin, Even lawyers are bullish on the revolutionary yet risky form of finance.

Benjamin Bai, chief legal officer at digital asset firm Amber Group, bought some LUNA coins in 2021. Bai was until recently vice president and chief IP counsel at Ant Group, which operates China’s largest digital payment platform.

“I thought highly of the algorithmic stablecoin,” said Bai. “They had a unique product that failed, but it still doesn’t change the fact that it was a great invention.

“Luna was used in some e-commerce platforms so it had some use cases,” he continued. “It’s a great experiment that failed, but that’s what innovation is about – failures.”