Terra/LUNA: How an Algorithmic Stablecoin Lost Its Peg and $40 Billion
TerraUSD, a stablecoin designed to hold its dollar peg through an algorithmic relationship with a sister token called LUNA, collapsed within days, erasing roughly $40 billion in value and triggering a wave of losses across the crypto industry.
- Combined value erased (approx.)
- $40 billion
- Time from depeg to near-zero
- About one week
- Peg mechanism
- Algorithmic, not backed by cash reserves
What happened
TerraUSD (UST) was a "stablecoin" — a crypto asset intended to always be worth $1 — but unlike stablecoins backed by cash or cash-equivalent reserves, its peg was maintained algorithmically through a relationship with a second token, LUNA. In simplified terms, users could always trade $1 of UST for $1 worth of newly created LUNA and vice versa, a mechanism intended to arbitrage the price back to the peg automatically.
In May 2022, a large sale of UST pushed it slightly below its $1 peg. As traders tried to exit, the mechanism that was supposed to restore the peg instead required minting enormous quantities of LUNA to absorb the selling, which collapsed LUNA's own price — which in turn undermined confidence in the mechanism defending UST's peg, in a rapidly accelerating feedback loop.
Within about a week, both tokens had fallen to a small fraction of a cent, erasing roughly $40 billion in combined value and triggering a wave of forced selling and insolvencies across crypto lenders and funds that had significant exposure to the ecosystem, contributing to a broader crypto market downturn that year.
Why it still matters
The core lesson is that "stable" in stablecoin describes an intended design goal, not a guarantee — the mechanism backing that stability matters enormously, and an algorithmic peg with no hard, liquid reserve behind it carries fundamentally different risk than one backed by cash held one-to-one.
It is also a case study in reflexive collapse: a system where the very act of participants losing confidence directly weakens the mechanism meant to justify their confidence, creating a self-reinforcing spiral that can move from a minor wobble to near-total loss within days rather than the months or years a comparable decline might take in other markets.