UST is a decentralized algorithmic stablecoin issued on the Terra chain, pegged to the US dollar, with its sister token LUNA being the native token of the Terra project. UST maintains stability through a 'minting and burning' mechanism, meaning that to mint UST, an equivalent value of LUNA must be burned, and users can also exchange LUNA for an equivalent value of UST by burning UST.
On May 8, 2022, the core team of the Terra ecosystem, LFG, withdrew $150 million in UST liquidity from the UST-3Crv pool to form a 4Crv pool. About 10 minutes later, a new address suddenly sold $84 million worth of UST, causing the balance of the UST-3Crv pool to be disrupted. To maintain balance, LFG withdrew another $100 million in UST from the liquidity pool, triggering market panic, leading several whale accounts to continuously sell UST on Binance, causing UST to begin decoupling from the US dollar.
Subsequently, LFG announced it would 'loan out' $700 million in Bitcoin reserves, hoping to maintain UST's stability through exchanges between UST and Bitcoin, but this attempt failed. The price of UST continued to fall, dropping to a historic low of 26 cents on May 11. LUNA also experienced a massive increase in supply due to a large amount of UST being exchanged, leading to a significant price decline and entering a 'death spiral', ultimately resulting in its market cap dropping from $41 billion to zero.
In this event, investors across the network suffered over $107.3 billion in liquidations, and Bitcoin fell below $27,000. UST's founder, Do Kwon, was charged by the U.S. Securities and Exchange Commission (SEC) with conspiracy to commit fraud, commodity fraud, and other charges. On June 14, 2024, the Southern District Court of New York approved a settlement agreement between the SEC and Do Kwon, requiring Do Kwon to pay a $4.5 billion fine to the SEC, along with prepayment of interest and civil penalties. Additionally, on February 21, 2024, a court in Montenegro ruled that Do Kwon should be extradited to the U.S. for trial, and his lawyer stated they would seek to appeal.
The collapse of UST is a far-reaching event in the history of cryptocurrency, with important lessons for understanding stablecoin design, market risks, and the necessity of regulation.
1. The 'decoupling risk' of algorithmic stablecoins is difficult to eradicate.
UST relies on a purely algorithmic mechanism of 'exchange between LUNA and UST' to maintain its peg, lacking fiat reserves or backing by physical assets. This design appears decentralized but is extremely dependent on market confidence—when panic selling disrupts supply and demand balance, the exchange mechanism can trigger a 'death spiral' (UST depreciation → users sell UST for LUNA → LUNA issuance dilutes value → UST further depreciates). This indicates that algorithmic stablecoins lacking support from actual assets are essentially 'naked' in terms of market confidence, with risk resistance far lower than reserved stablecoins (like USDT, USDC).
2. Excessive leverage and ecological centralization pose hidden dangers.
In the Terra ecosystem, UST was heavily used in high-yield lending, liquidity mining, and other scenarios, forming a leverage cycle centered around UST. Meanwhile, the holding and governance rights of LUNA are highly concentrated, and actions by a small number of whales or teams (such as adjustments to the LFG fund pool) can easily trigger market fluctuations. This suggests that the 'centralization risk' and 'leverage dependency' in the crypto ecosystem can amplify the impact of a single asset's collapse, and an excessive pursuit of short-term returns while neglecting risk diversification will ultimately backfire on the entire system.
3. Market confidence is more fragile than 'mechanism design'.
The immediate trigger for the collapse of UST was panic triggered by large sell-offs, rather than technical flaws in the mechanism itself. This reflects that in the crypto market, 'confidence' is a more critical anchor than code. Even if the mechanism appears perfect, once the market questions its stability, it can trigger a 'run' and decentralized mechanisms may struggle to intervene effectively in the face of panic (e.g., unable to force a trading halt or inject liquidity).
4. Lack of regulation exacerbates risk spillover.
At the time of the event, algorithmic stablecoins like UST were in a regulatory gray area, lacking constraints on the issuer's reserves, risk disclosure, and market operations. The aggressive operations by Do Kwon's team (such as opaque decisions to use Bitcoin reserves to stabilize the market) further exacerbated the chaos. This indicates that stablecoins, as key tools connecting the crypto market and traditional finance, must be incorporated into regulatory frameworks with clear reserve requirements, information disclosure obligations, and risk warning mechanisms to prevent risk from spreading to the entire financial system.
5. Investors should be wary of the 'high yield myth'.
UST once provided an annualized yield of 20% through the Anchor protocol, attracting a large influx of funds. This yield, far exceeding traditional finance, essentially relied on the 'Ponzi logic' of ecological expansion (new funds supporting the returns of old users). When expansion stagnates, the yield bubble is bound to burst. This warns investors to remain cautious of promotions for 'guaranteed profits' and 'high-yield stablecoins'; any return is commensurate with risk, and there are no high returns without costs.
In summary, the collapse of UST is a typical case of the collision between the crypto industry's 'decentralized ideal' and 'market reality'. It reveals the limitations of purely algorithmic stablecoins, the destructive power of market sentiment, and the importance of regulation and risk control, also ringing alarm bells for future stablecoin design and industry development.