Terra's UST Stablecoin Depegs, Crashing Entire Crypto Market

Terra Was the Blue Chip Algo Stablecoin

Once considered a blue chip algo stablecoin protocol, the $50B Terra ecosystem collapsed in less than a week. The Terra ecosystem uses LUNA as its utility token for maintaining the pegs of its stablecoins, with its US Dollar-pegged UST being the most popular. Before the crash, LUNA traded around $80 and UST was worth $1. LUNA was a top-10 token, and UST was the third-largest stablecoin by market cap. Today, LUNA is essentially worthless, and UST is worth just $0.17.

Anchor Protocol is a lending platform and primitive protocol for the Terra ecosystem with strong ties to Terra's leadership. As crypto traded sideways in 2022, investors poured money into UST and staked it with Anchor at ~20% APY. These yields were not sustainable, as Anchor's actual yield from income generated was closer to 10%. Terra treated these 20% yields as advertising for the Terra ecosystem.

UST is not backed by real assets, just an algorithm that maintains its peg by minting and burning LUNA. In order to backstop UST, the Luna Foundation Guard (LFG) bought ~80k BTC and $100M worth of Avalanche (AVAX). This did not end up helping.

Terra’s UST Depegs

Last weekend, UST began to struggle to maintain its peg to the US Dollar. Almost $3B in market cap left UST as yields on Anchor Protocol decreased. LFG stepped in with $1.5B in loans denominated in UST and BTC to stabilize UST, but there wasn't enough ammo to protect UST's $1 peg.

On Monday May 9, the real collapse started. Institutions and crypto protocols that had integrated Terra and UST were the first to respond, followed by waves of retail exits. As UST holders swapped their UST for other stablecoins on Curve, an exchange with deep stablecoin liquidity, UST continued to fall in value. By Tuesday, UST was trading at $.68 and LUNA at $30.

The panic eventually drove the market cap of LUNA below UST's market cap, meaning there wouldn't be enough value in LUNA for all UST holders to exit at $1 per UST. At this point, most investors lost confidence and LUNA became almost worthless.

What Caused UST to Depeg?

The exact cause of UST's depeg and collapse is unknown, but many–including LFG–believe it was the result of an economic attack on the Terra ecosystem. As investors migrated from Curve's 3pool to its 4pool–the one Do Kwon claimed would kill Maker DAO's DAI stablecoin–UST had very low liquidity. This made it vulnerable to the type of economic attack George Soros used to destabilize the British Pound–something traders noted weeks ago following LFG's Bitcoin acquisitions. On Twitter, Do Kwon dismissed fears of this sort of attack and challenged billionaires to take on the Terra ecosystem.

We don’t know if there was an attack on Terra or if it was just bad luck. We also don’t know if an attack was performed by a single actor or multiple unrelated actors who all saw the same opportunity. What we do know:

• Someone opened a $4B BTC short position, meaning they would profit from a BTC crash.
• At the same time, there was $1B worth of UST in a wallet on Binance.
• During the 4pool migration, $650M worth of UST was sold on Binance, and $350M worth of UST was sold on Curve, draining Curve’s and Binance’s liquidity and making it easier to manipulate the price of UST.

This caused a panic among Anchor users, leading to mass withdrawals and severe Terra network congestion.

All LFG could do to stabilize UST was sell its BTC, driving down the price of BTC in the process. At the same time, someone dumped 100k borrowed BTC, worth over $3B, into the market. LFG didn’t have enough assets to sell or lend to repeg UST, allowing the entire Terra ecosystem to collapse.

It's unknown if the BTC short, the UST dump, and the BTC dump are related, but they certainly worked together to create a predictable result: Terra collapses and Bitcoin crashes, bringing everything down with it. Although many of these moves were made off-chain and it's not yet possible to link them, it looks like the entity responsible for the attack profited over $800M.