The world’s third-largest stablecoin TerraUSD (UST) de-pegged from the US dollar — trading as low as $0.62 on Tuesday — and lost over $4 billion in market capitalization.
UST’s primary backing asset, LUNA, lost $20 billion within seven days. People using its DeFi ecosystem ⏤ holding $29 billion in deposits just a few weeks ago ⏤ withdrew another $16 billion.
Terraform Labs, founded by South Korean and Singaporean billionaire Do Kwon, claims that UST is able to maintain a peg at $1.00 US dollar using algorithms, rather than holding US dollars in reserve like traditional stablecoins Tether (USDT) or Circle (USDC).
To maintain UST’s peg, it depends on incentivized arbitrage rates for its “balancer” LUNA token and various assets traded by discretionary wealth managers ⏤ all while somehow claiming to be decentralized.
In reality, seven managers make most decisions about transfers, liquidity, and trading its asset reserves.
How Terra’s UST lost its peg
It all started the night of Saturday, May 7 when someone dumped $84 million worth of UST. Users started complaining about suspicious withdrawals from Curve, one of the largest DeFi liquidity pools for UST. Do Kwon later took responsibility for removing liquidity, assuring users that everything was under control. He added, “Obviously, TerraForm Labs has no incentive to depeg UST.”
The situation quickly escalated. Already down $3 billion on Saturday, UST’s LUNA backing shed another $2 billion on Sunday. UST began to consistently trade a couple cents below $1.
Then the major dump arrived. On Monday at 11:45am EDT, $250,000 traded at a UST price of $0.77 on Kraken. Arbitrageurs attempted to regain the peg for a couple hours and failed. A couple hours later, blocks of UST started clearing at $0.90, then $0.87, and then back to the mid-$0.90s. Liquidity cascaded across global exchanges.
Eventually, bears overpowered Terra’s ‘LUNAtics’ community, collapsing UST to $0.62 on some platforms. This time, it would not be just a few hundred thousand dollars but billions in volume.
Do Kwon briefly erred by claiming that a single entity executed 62% of withdrawals from liquidity pools. If accurate, it could have provided some circumstantial evidence of market manipulation. However, he deleted the tweet after realizing that the 62% figure was labeled as “others” on a pie chart.
During the liquidity cascade, a single wallet dumped $84 million in UST on the Ethereum blockchain and $108 million on Binance. Do Kwon said the dump was “not us” and claimed to be hiring a professional market-maker who can prevent UST depegging.
The incident led to speculation of possibly deliberate market manipulation combined with short positions and negative tweets. Others cited simple technical analysis. Kwon chimed in with a reminder to ignore “Crypto Twitter” and poked fun at social media influencers.
How UST became a multi-billion dollar stablecoin
Although Terra advertised a variety of uses for UST, its first successful beachhead was Mirror Protocol. Here, Do Kwon popularized UST as a way to denominate synthetic stock trades. Traders enjoyed placing leveraged bets on “mirrored” versions of US stocks.
Of course, Kwon failed to register any assets on Mirror Protocol with the Securities and Exchange Commission (SEC), which led to an ongoing lawsuit. However, Terraform Labs and Do Kwon decided to fight back in court — they allege irregularities in the SEC’s enforcement efforts, such as violating due process rights by serving Kwon a subpoena on an escalator during a crypto event.
After Mirror, Do Kwon’s next breakthrough for UST utility was Anchor (ANC). Anchor’s primary offering was a 20% yield on UST deposits, subsidized by Terraform Labs. Demand for UST quickly skyrocketed.
Thinking that UST was reliably pegged at $1, investors around the world bought UST and deposited into Anchor. Denominated in UST, they began earning an annualized 20% ⏤ far superior to interest rates from any conventional bond or bank account.
Billions of dollars bought UST, giving TerraForm Labs a multi-billion dollar treasury to manage. Terra voted to allocate $1.5 billion toward stabilizing UST with a new ‘Luna Foundation Guard’ — it bought Bitcoin.
UST has not recovered its $1.00 price peg yet — at press time, UST is trading at $0.91. Tens of billions of dollars have evaporated from its ecosystem. If Terra loses its remaining billions or UST fails to regain its peg, Terra’s collapse could have contagion effects across DeFi for weeks to come.