The Terra LUNA Crash

$60 billion wiped out in 5 days

WTF happened?

The Terra LUNA Crash: A Deep Dive into the Cryptocurrency Nightmare

The crypto realm is known for its volatility, with the Terra LUNA crash of May 2022 standing as one of the most dramatic collapses in crypto history. Deciphering the complex web of events leading to the implosion provides key insights into the risks inherent in the burgeoning cryptocurrency sector. Here we take a closer look at the Terra LUNA catastrophe, charting critical dates, statistics, and events that offer a roadmap of what went wrong.

Genesis of the Terra Ecosystem

Before delving into the infamous Terra crash, it's crucial to understand what Terra LUNA is. Terra, a blockchain platform, aimed to create a more stable and user-friendly crypto ecosystem. It leveraged the LUNA token to stabilize the price of its algorithmic stable coin, UST (TerraUSD), which was pegged to the US dollar. The innovative concept behind Terra attracted a significant following, leading to a thriving ecosystem of decentralized applications (dApps).

Do Kwon and Daniel Shin: Founders of Terraform Labs

Terra was created in 2018 by Terraform Labs, a South Korean startup that was co-founded by Do Kwon and Daniel Shin. They dreamed big: they believed that decentralized economies needed decentralized money. And the best tool crypto had to offer was an algorithmic stablecoin. A token that had consistent value, UST, along with 21 other stablecoins in Terra's ecosystem, were pegged to the price of their fiat currencies. 1 UST = $1 USD.

But a key difference between Terra and traditional finance (Trad-Fi), is that you were your own bank. It was cheap and fast to transfer, with no boundaries across borders, and no governments gate-keeping the monetary policy or inflation rates. The rules of Terra, and its future, were to be governed by the community. Not only is this a big dream, but it was well-intentioned and transparent due to Terra's community governance system.

Do Kwon on a couch, probably thinking about crypto, or Starcraft

Sparking the Powder Keg

Fast forward to 2022: Terra was a top 10 crypto project by market cap. LUNA price soared from $0.12 in 2019, to an all-time-high (ATH) of $119.18, reaching a market cap of $41.03 billion USD. This was bolstered by the explosive growth of UST, Terra's flagship algorithmic stablecoin, which reached a peak market cap of $18.77 billion USD. Combining these two, Terra was worth a combined total of $59.8 billion USD.

The growth of UST was largely due to the attractive yields offered by Terra's DeFi protocol, Anchor, promising 20% interest rates on UST deposits. This was the best interest rate you could find, anywhere. And it attracted a lot of capital.

And outside of Anchor protocol, Terra had a booming economy of dApps, decentralized exchanges, domain names, arbitrage players and so much more. But the underlying mechanisms that kept UST's price stable would eventually become its undoing.

The Beginning of the Bank Run

On May 7, 2022, the market witnessed initial tremors as several large UST withdrawals took place on Curve, a defi stablecoin automated market maker (AMM). The first swap was $85 million UST for $84.5 million USDC. This started causing the UST dollar-peg to wobble.

At first, UST fell to $0.93 cents on the dollar, then to $0.74. The Luna Foundation Guard (LFG) intervened, pledging $750 million USD worth of its Bitcoin reserves to stabilize UST's price. The UST price rebounded back to $0.93, but as more and more UST swaps were made on-chain, and UST selling pressure increased off-chain, the peg couldn't be recovered.

The markets were spooked, and people wanted out.

A Week of Mayhem

Between May 8 and May 12, the situation rapidly deteriorated. The Terra LUNA crash gained momentum as the de-pegging of UST triggered a negative feedback loop, known colloquially as a "death spiral." Investors lost faith, leading to a mass-exodus from both UST and LUNA. In an effort to save their investments, people were selling their UST on centralized exchanges (CEX's), decentralized exchanges (DEX's), and using Terra's platform to burn their UST and mint new LUNA.

Do Kwon and the Terraform Labs team did their best to stop the bank run. The LFG committed their remaining Bitcoin to defend the peg.

This is, perhaps, one of Do Kwon's most famous tweets:

But despite having 80,394 Bitcoins in the LFG war chest, which at the time was worth nearly $3 billion USD, it wasn't enough to stop the bank run. Investor confidence was shattered.

The Numbers Tell a Grim Tale

The LUNA price plummeted from its all-time high of nearly $120 to mere fractions of a penny in less than a week, with its market capitalization vanishing into thin air. At the zenith of the crash, both LUNA and UST experienced a free-fall, losing up to 99.99995% of their value, leading to catastrophic losses for investors and shaking the entire crypto market.

A Closer Look at Key Events

The Anchor Protocol's Part

The Anchor protocol's unsustainable promise of high yields was a ticking time bomb. It created excess demand for UST, which had a higher risk of capital flight. Simply reducing the yields on Anchor could cause UST supply to meaningfully contract, and possibly impact the peg. It would have also slowed Terra's explosive growth. And when the peg finally did wobble...

The De-Pegging Dilemma

UST de-pegging from the dollar marked the beginning of the end. The mechanism that minted new LUNA to absorb the excess UST could not cope with the sheer volume of UST being burned, leading to hyperinflation in LUNA tokens and the subsequent crash of both assets.

Just how bad was the hyperinflation?

Before the crash, Luna supply was 726 million tokens. And in a matter of days, 6.9 trillion LUNA were printed and people rushed to exchange their UST for LUNA. But once the market cap of LUNA was below the market cap of UST, the inflation soared to astronomical levels.

5.89 trillion LUNA were minted in the final hour before the chain was temporarily shutdown. UST only contracted 23.6 million 😲

Hyperinflation of LUNC During the Terra Crash

6,906,651,533,238 new LUNC printed

Meanwhile, UST was only able to shave 7.4 billion from it's 18.7 billion token supply.

Supply Reduction of USTC During the Terra Crash

-7,434,538,501 USTC burned

The Failed Salvation Attempts

In desperate attempts to restore stability, the LFG used nearly all of its 80,000 Bitcoin reserves, but to no avail. The trust in the Terra ecosystem had suffered a fatal blow. Even proposals to shutdown the chain, fork the blockchain or to execute buybacks of LUNA tokens came too late.

The Aftermath

The collapse reverberated through the crypto world, prompting introspection and calls for more stringent regulations. The terms LUNA crypto and LUNA crash quickly became synonymous with risk and failure in the DeFi space.

Lingering Tokens: LUNA Classic and LUNC

In the weeks following the LUNA crash, a proposal was made by Do Kwon and the Terra team to fork the chain. The "old chain" would be renamed to Terra Classic, with all the tokens adopting similar nomenclature: LUNA Classic (LUNC) and UST Classic (USTC). On May 25th, the Terra Validators and community voted to move forward with the fork. On May 28th, Terra 2.0 was launched.

Terraform Labs and independent teams are now working to rebuild the Luna ecosystem with a new LUNA token. Shares of the new token were airdropped to users who held the old tokens during the crash. They believed this was the best way forward, and the only thing they could do to make this right to the community who lost everything.

However, some factions of the community still believe LUNA Classic can be revived. Originally led by a group called the Terra Rebels, and later joined by various teams, validators, and developers, along with old and new members of the Terra Classic community, a war cry to revive the old chain was born. Even CZ, CEO of Binance, supports the burn movement by burning Binance transaction fees from LUNC trades.

It's no easy task to revive the LUNA Classic chain. The bad UST debt, approximately 10 billion tokens worth, needs to be burned or offset somehow. It's not an easy task, but this sparked the LUNC burn movement, and Do Kwon provided the address to the famous LUNC burn wallet. Any Terra tokens sent to this address are instantly removed from supply. You can follow the burn stats on our LUNC burn tracker and USTC burn tracker.

Ripple Effects on the Crypto Market

The Terra LUNA crash sent shockwaves through the entire crypto market. Confidence waned as the overall crypto market cap saw significant pullbacks during the same time, as well as a rise in inflation around the globe. Investors everywhere started to risk-off and pull out if burgeoning asset classes like crypto.

Regulatory Attention

Authorities worldwide watched the Terra LUNA disaster unfold, with Celsius and FTX also collapsing later that year. These catalysts renewed the push for cryptocurrency regulations. Stablecoins, in particular, have come under the scrutiny of financial watchdogs eager to prevent a similar crisis.

FAQ's about the Terra Crash

Is Do Kwon Guilty?

This may not come as a surprise, but warrants were issued for Do Kwon's arrest. For months after the crash, his whereabouts were unknown. Rumors emerged he had fled South Korea for Singapore and Serbia, but he was eventually arrested in Montenegro, along with his former CFO Han Chang-joon, while boarding a flight to Dubai. He was found guilty of forged documents (passports), and sentenced to 4 months jail. At the time of writing this, the US SEC is pursuing a fraud case against Do Kwon. South Korean courts have also issued arrest warrants.

Was Terra LUNA attacked?

Many people in the Terra LUNA and other crypto communities allege Terra was attacked by a third-party. Some unfounded allegations include:

  • FTX / Sam Bankman-Fried
  • Alemeda Research (FTX affiliate)
  • Digital Currency Group (DCG)
  • Citadel, a US market maker

At this point, there is no clear evidence to affirm if it was an attack, or just a run-of-the-mill death spiral. Although it's not hard to imagine how other companies in the crypto space would benefit and profit from Terra failing.

Some smart folk in the crypto community even proposed it was a Soros-style attack:

Luckily, crypto blockchain ledgers are public and transparent. The crypto sleuths at Nansen completed a forensic audit of all Anchor protocol withdrawals before the Terra crash. This is an in-depth and technical read, but their analysis shows 7 different wallets making large withdrawals from Anchor Protocol, which likely had major impacts to UST depegging. While not 100% clear how many people are involved, or if this was an orchestrated attack, it would suggest multiple parties were involved in moving large sums of UST.

Nansen's research clearly refutes the idea that it was a single attacker, or wallet, which caused the LUNA death spiral.

LUNC $1?

The LUNC $1 movement is very real. Many smart and talented people are working on ways to overcome the bad UST debt. Can LUNC ever reach $1? It's too early to say, and frankly, we don't provide financial advice, but... time will tell. We hope the future of LUNC is very bright.

But if the chain was able to mint 5.89 trillion LUNA in the final hour of the crash, then it's possible to burn that many tokens... however, it will take a significant catalyst to drive that demand.

Lessons to be Learned

The Terra LUNA crash serves as a sobering case study in the rapid rise-and-fall cycle of crypto assets. It accentuates the importance of due diligence, the ethics of crypto entrepreneurship, and the need for a measured approach to innovation in financial markets.

Final thoughts on the Terra Crash

While the Terra crash led to significant losses, which were truly devastating to many, it has also spurred important discussions on resilience and regulation in the crypto realm. As the industry continues to evolve, the lessons from the Terra LUNA crash will undoubtedly shape the future of decentralized finance.