Kevin Zhou on UST's Roller-Coaster Ride and Where It Goes From Here

For months now, Kevin Zhou, the co-founder of hedge fund Galois Capital and former head of trading at digital asset exchange Kraken, has been sounding the alarm on the LUNA and UST issuer, Terraform Labs.

Just today, Terra briefly halted its blockchain, citing inflation for LUNA and the potential for government attacks after the price of the token plunged to less than 2 cents.

And in the span of 72 hours, the Terra ecosystem, which includes the LUNA token and UST, among other algorithmic stablecoins, has been in free fall. LUNA’s price has fallen by more than $80, while UST, the stablecoin pegged to the U.S. dollar, dropped to 37 cents earlier Thursday.

Despite his concerns, Zhou has been taken aback by how quickly things have turned south for the Terra ecosystem. “Even if it happened in slow motion, even if it was something like a bank walk, it was more about this thing not being solvent,” Zhou said on CoinDesk TV’s “First Mover.”

But in the end it was inevitable, according to Zhou, who added that the “mechanism was flawed, and it didn’t play out as expected.”

In the aftermath, Terra has extended a proposal to its users that would burn 1 billion UST (more than $690 million) to save the stablecoin using the community’s UST. It said it would also increase the circulation of LUNA, which supports UST, to 100 million tokens, in an effort to push UST back to $1.

Financial firms including BlackRock (BLK) and Gemini are quashing conspiracy theories that the firms were involved in the collapse of UST. On social media, the companies said they don’t trade UST.

Zhou underscored the sentiment, and pointed to problems with compliance as to why the financial firms would not be able to touch these kinds of assets.

While the markets have been in flux due to UST’s collapse, millions of hundreds of people have been affected. “A lot of people have lost their homes, tons of money and maybe their life savings,” Zhou said.

Sentiment around the Terra ecosystem will further worsen, Zhou added, in part because it's “not even just the mechanical death spiral, but also a psychological one.”

Looking back, the red flags were there, when founder Do Kwon purchased massive amounts of bitcoin (BTC) and began taking in millions of dollars from investors. Though it may not have been a bad move, it did reveal a more important point. “It signaled to the market that they no longer believed in their own narrative,” Zhou said.

Now, as Terra looks to restore UST’s $1 peg, Zhou said it's possible it may be able to do so, but not guaranteed. He noted that Terra should have revalued its currency earlier on and allowed users to take a massive haircut, which may have relieved some of the selling pressure on LUNA.

But at this point, “we’re just undergoing hyperinflation of LUNA in order to support the exit of UST, and now we have to just let it happen.”

Terra’s proposal is good, but not good enough, according to Zhou. “At the end of the day, all of this bad debt has to get flushed out and we’re still in the early innings of that,” Zhou said.