The Collapse of LUNA and TerraUSD (UST) – How Did This Happen?

The historic collapse of Terra's LUNA and its sister token UST in 2022 shook the crypto market. What began as one of the most ambitious experiments in the field of decentralized finance quickly became one of its most catastrophic failures.

In a matter of weeks, a project valued at over 60 billion dollars ( equivalent to the current market cap of Solana ) has collapsed, breaking years of trust, billions of dollars in savings, and a vision that promised to reshape finance. Here is the timeline of events – from the rapid rise to the design flaws in the system that caused a domino effect that no one could stop. The remarkable growth of LUNA – From 66 cents to 104 dollars in 14 months The Terra blockchain was designed by Terra Labs, based in South Korea and led by Do Kwon, a computer scientist graduated from Stanford. The system includes two main tokens: LUNA and TerraUSD (UST). These digital currencies are designed to work together. LUNA is designed to keep UST, a stablecoin pegged to the US dollar, stable through a delicate balancing act of minting and burning. This is not just another cryptocurrency project. This idea has attracted serious attention. By March 2022, UST had increased from $180 million at the beginning of 2021 to a market capitalization of nearly $15 billion. At the same time, the price of LUNA surged from $0.66 to a peak of $104.58 on March 9, 2022. Even when other markets were declining due to geopolitical tensions, Terra remained strong. In February 2022, the Terra DAO signed a $40 million sponsorship deal with the Washington Nationals baseball team. There was talk of UST being accepted at stadiums. This is no longer niche finance – it has become mainstream. How is the model supposed to work? The core of the Terra system is an algorithm unlike traditional stablecoins such as USDT and USDC, which are backed by real-world assets; UST maintains its peg through LUNA. When UST trades above $1, users can swap $1 worth of LUNA to mint UST and profit from the difference.

It has been effective for a while, and UST has become the fourth largest stablecoin in the world. LUNA has become one of the top 10 cryptocurrencies. The Anchor Protocol, the platform where UST can earn about 20% interest, has attracted billions of dollars from users seeking passive income. By early 2022, critics began to warn about this fragility. An article from the University of Calgary noted that algorithmic stablecoins are "already fragile" and "always in a vulnerable state." When the 20% yield of Anchor became unsustainable and began to decline, fear emerged. Confidence – the only glue that holds everything together – started to weaken.

Singapore-based Luna Foundation Guard (LFG) has attempted to restore trust by securing $1 billion in Bitcoin reserves to protect the fixed rate. But that's too little, too late. In May 2022, it happened. A large sell-off of UST began. As its price fell below $1, investors rushed to exit. To maintain the peg, more and more LUNA had to be minted. But minting more LUNA meant diluting its value. The price of LUNA plummeted. As it fell, the system printed more LUNA, causing a hyperinflationary spiral. The numbers have become astonishing. The supply of LUNA skyrocketed from 345 million to over 6.5 trillion in just a few days. Its price plummeted to nearly zero. UST, once a proud asset worth 15 billion dollars, could not maintain its peg and fell below 10 cents.

Investors witnessed their lifelong savings disappear. Billions of dollars were wiped out from the market overnight. The entire Terra ecosystem – with all its projects and partnerships – collapsed. What Remains After the Fall By June 2022, Terra had officially died. Exchanges had delisted both UST and LUNA. Major DeFi protocols built on Terra had been abandoned. Anchor, Chai, and Mirror – all beloved children of the Terra dream – had become useless. The U.S. Securities and Exchange Commission has stepped in. The commission has issued a subpoena to Do Kwon regarding the Mirror Protocol, which allows users to trade synthetic stocks like Apple and Tesla. Meanwhile, Kwon and Terraform Labs have challenged the SEC's authority in court. Public opinion has shifted dramatically. The idea of algorithmic stablecoins, once hailed as an innovation, is now seen as reckless. The collapse of Terra has caused a ripple effect throughout the entire crypto market, eroding investor confidence and attracting closer scrutiny from regulators. What does the collapse mean for the future The collapse of LUNA was not just a single cryptocurrency losing support. It was the explosion of an idea – that decentralized algorithms could replace traditional centralized systems without causing consequences. The collapse forced investors, developers, and regulators to rethink how to build these systems. In the months following the collapse, global regulators began tightening oversight of stablecoins. Questions about transparency, reserves, and accountability became the focus of any new project. And algorithmic stablecoins have yet to recover their reputation since then.