Terra and LUNA Collapse (2022): How an Algorithmic Stablecoin Failed
In May 2022 TerraUSD lost its dollar peg and LUNA fell to almost nothing within days. A clear account of how the system worked, how it broke and the fallout.
In the first half of May 2022, a stablecoin called TerraUSD, or UST, lost its peg to the US dollar. Its sister token LUNA, which was meant to support it, collapsed in value over the same few days. Tens of billions of dollars of market value disappeared, and the event helped trigger a wider downturn across the crypto industry.
What Terra was
Terraform Labs, founded in 2018 by Do Kwon and Daniel Shin, built a blockchain called Terra. Its flagship product was UST, an algorithmic stablecoin. Unlike USDC or Tether, UST was not mainly backed by cash. Instead, it relied on a mechanism linking it to LUNA, the network's volatile native token.
The mint and burn mechanism
The design allowed anyone to exchange one dollar's worth of LUNA for one UST, and vice versa. If UST traded below one dollar, traders could buy cheap UST, swap it for one dollar's worth of LUNA, and make a profit, which should push UST's price back up. If UST traded above one dollar, the reverse applied. The system therefore depended on traders believing that LUNA would keep enough value to absorb the shocks.
The weakness is circular. The stablecoin is supported by a token whose value in turn depends on demand for the stablecoin. When confidence drops, supply of LUNA must expand sharply to absorb redemptions, which pushes its price down further.
The Anchor Protocol
A large part of UST demand came from Anchor, a lending application on Terra that offered a yield of close to 20 percent on UST deposits. The rate was supported in part by reserves and subsidies set by the project, not only by borrower interest. This attracted many depositors, and by early 2022 a large share of UST was deposited there. Critics noted that a fixed rate that high was hard to sustain.
The week of the collapse
- 7 to 8 May 2022. Large withdrawals from Anchor and big UST sales in a major liquidity pool pushed UST slightly below one dollar.
- 9 to 10 May. The price slid further. The Luna Foundation Guard, a non-profit set up to defend the peg, used its bitcoin and other reserves to buy UST, but the selling continued.
- 10 to 13 May. Redemptions created enormous amounts of new LUNA, whose supply grew from hundreds of millions of tokens to trillions, and its price fell to a tiny fraction of a cent. UST fell far below one dollar. The Terra blockchain was halted for a period.
Fallout
- Investors. Many retail holders lost savings, including people in South Korea, where the project was popular.
- Wider contagion. Firms that were exposed to Terra or that had borrowed heavily faced difficulty. In the following months, the crypto hedge fund Three Arrows Capital and the lenders Celsius and Voyager Digital all filed for bankruptcy.
- Legal action. South Korean prosecutors opened investigations, and Do Kwon was arrested in Montenegro in March 2023. In the United States, the SEC sued Terraform Labs and Kwon in 2023. In 2024 a jury found them liable for fraud in that civil case, and Terraform agreed to a large settlement as it moved through bankruptcy. Kwon was extradited to the United States at the end of 2024, pleaded guilty to fraud charges in August 2025, and was sentenced in December 2025 to 15 years in prison.
Earlier algorithmic attempts
Terra was not the first algorithmic stablecoin. NuBits lost its peg during 2016 and 2017 and never fully regained it. The project Basis, which raised a large sum in 2018, shut down and returned money to investors, citing regulatory concerns. In June 2021 Iron Finance's partially backed stablecoin, IRON, lost its peg and its companion token TITAN fell to almost nothing in a day, in a pattern that resembled a bank run. Terra was larger than any of these, which is why its failure had much wider effects. The recurring feature is a reliance on a volatile companion asset, and designers have been cautious about repeating the model. For more background on hosting questions, visit the knowledge base.
What it showed
| Lesson | Explanation |
|---|---|
| Reserve quality matters | A stablecoin backed by its sister token has no independent asset to fall back on |
| High yields need explanation | A returns promise with no clear source deserves scrutiny |
| Confidence is a dependency | Designs that rely on market belief can fail quickly under stress |
Regulatory impact
The collapse added urgency to stablecoin regulation. The EU's Markets in Crypto-Assets rules include provisions for stablecoins, and other jurisdictions started or sped up their own rules. Authorities generally distinguished between asset-backed stablecoins and algorithmic ones, with the latter treated more cautiously.
What this article does not claim
There was much speculation at the time about whether coordinated trading triggered the initial depeg. Investigations and legal cases have examined this, but this article sticks to the established outline of events and does not attribute motives beyond what court findings have established.
A practical lesson for site owners
If you accept crypto payments, the choice of what you hold matters. A payment processor can convert to a stable asset or fiat so you are not exposed to price swings. Zebra Hosting accepts many coins, including USDT, via Cryptomus; see our hosting plans for how checkout works.
