The UST collapse: seven days that killed algorithmic stablecoins

Terra/UST is the largest collapse in crypto history by speed of value destruction: about $60 billion in one week of May 2022. It was neither a hack nor a scam in the classic sense - the construction worked exactly as designed.

The construction

UST held its peg through arbitrage with a second coin: 1 UST could always be burned for $1 of freshly printed LUNA and vice versa. Demand for UST was stoked by Anchor - a protocol paying ~20% APY on UST deposits (subsidized from the treasury). Tens of billions came for the "risk-free" 20%.

The spiral

Large exits from Anchor and UST sales pushed the peg down. The arbitrage kicked in: UST was burned for LUNA - LUNA's emission exploded, LUNA's price collapsed, and every next dollar of UST redemptions printed exponentially more LUNA. Hyperinflation within days: LUNA from tens of dollars to thousandths of a cent, UST to zero. The contagion killed hedge funds (3AC) and lenders (Celsius, Voyager) - the dominoes kept falling for half a year.

Lessons written in blood

• A 20% "risk-free" yield is risk deferred in time.
• A stable backed by its own volatile token is a death spiral by construction.
• Size is no defense: a top-10 coin died in a week.

Historical collapse breakdowns - in the scam section.