You will be able to explain how TerraUSD lost its peg and why it took Luna down with it.
Early in 2022, Mei Ling, a 31-year-old accountant in Tampines, kept some savings in TerraUSD on a crypto app. Her reasoning sounded careful. It was a stablecoin, so its price stayed at one US dollar, and it paid a far higher yield than any bank. She thought of it as a high-interest savings account with a crypto label. By the middle of May, the coins she held were worth almost nothing. Mei Ling is a made-up example, but plenty of real people were in her position, many of them in Singapore, where the company behind the coin was based.
This module looks at five failures from 2022 that cost retail investors money. Terra comes first, because its collapse set off much of what followed.
TerraUSD, often shortened to UST, was an algorithmic stablecoin, the type you met in lesson 2.2, Stablecoins: what holds the peg and what breaks it. It was created by Terraform Labs, a company based in Singapore and co-founded by Do Kwon. There was no pile of dollars or treasury bills behind UST. Its peg rested on a link with a second token, Luna.
The rule was that anyone could always swap one UST for one US dollar's worth of Luna, newly created for the swap, and the other way round. If UST traded at 98 cents, a trader could buy it cheaply, swap it for a full dollar of Luna and sell the Luna for a two-cent profit. That buying was supposed to lift UST back to a dollar. If UST traded above a dollar, the trade ran the other way. The UST that came in through these swaps was destroyed, and so was the Luna.
As long as Luna was worth a lot in total, and people believed it would stay that way, the mechanism worked. That is the condition to hold on to.
Mei Ling did not hold UST for the technology. She held it because of the yield. A lending application built on Terra, called Anchor, paid depositors of UST a yield far above what banks or most other crypto platforms offered at the time. That yield drew in large amounts of money, and much of the UST in existence ended up deposited there.
Ask the question from lesson 2.3, Tokens, DeFi and the questions to ask any of them: where did the yield come from? Anchor did earn interest from borrowers, but not enough to pay what it promised depositors. The gap was covered by reserves that had to be topped up. A yield that the underlying activity could not pay was a warning sign in plain view.
In May 2022, large amounts of UST were withdrawn from Anchor and sold. UST slipped below a dollar. The mechanism kicked in as designed: traders swapped UST for newly created Luna and sold it.
That selling pushed Luna's price down. A lower Luna price meant each swap had to create more Luna to deliver a dollar's worth, and more Luna for sale pushed its price lower still. As holders saw both tokens falling, more of them rushed to get out of UST before it fell further, which meant more swaps, more Luna and more selling. Efforts to defend the peg by selling reserves held for that purpose did not stop the slide.
Within days, the supply of Luna had multiplied enormously and both tokens had lost almost all their value. UST, the coin that was supposed to be worth a dollar, traded for a few cents. The whole process is often described as a death spiral, and it is the failure that lesson 2.2 warned algorithmic designs are open to: a mechanism that works while confidence holds can feed on itself once confidence goes.
Do Kwon later faced criminal charges in South Korea and the United States. For retail holders like Mei Ling, the legal outcome made no difference to what they had lost.
Put plainly, the design flaw was that UST's only backing was the value of another token, Luna, issued by the same project. When people lost confidence in one, they lost confidence in both. Nothing outside the system held value that a holder could fall back on.
The warning sign a holder could have seen was the yield. Mei Ling could not have predicted the date, but she could have asked three questions. What backs this stablecoin? A mechanism, with no reserves. Where does the yield come from? It was more than the activity could pay. What happens if many people want out at once? The swaps would create more Luna, which is exactly what happened.
Nobody needed inside knowledge for this. They needed to treat "stable" and "yield" as claims to check, the way you would check a bank's advertised rate against its conditions in lesson 1.2 of How money works, How a bank earns the interest it pays you. And check harder as the yield climbs.
The best test of whether you understand a collapse is whether you can explain it briefly to someone who has never heard of it. Aim for an account that Mei Ling could have read in early 2022 and acted on: what the coin was, how it was supposed to work, what broke, and which sign was visible beforehand. Keep it short, and name the flaw and the warning sign plainly.
Write a five-sentence account of the Terra collapse in your own words, naming the design flaw and the warning sign a holder could have seen.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).