The Terra/Luna Collapse: A Stablecoin Failure Case Study

In a single week in May 2022, an algorithmic stablecoin called TerraUSD (UST) and its sister token Luna went from a combined market value in the tens of billions of dollars to functionally worthless — wiping out roughly $45 billion in market capitalisation and triggering a chain reaction that brought down several major crypto lenders and funds within weeks. It remains the largest algorithmic stablecoin failure on record.

What happened

UST was designed to maintain a $1 peg not through cash or bond reserves, as conventional stablecoins do, but through an algorithmic relationship with a companion token, Luna. Users could always exchange $1 worth of Luna for 1 UST, and vice versa — a mechanism intended to arbitrage the price back to $1 whenever it drifted. The system also relied heavily on Anchor Protocol, a lending platform associated with Terra's founder Do Kwon that offered an unusually high, roughly 20% annual yield on deposited UST — a rate widely flagged by analysts as unsustainable without an external subsidy, and one that drove much of UST's rapid growth in the months before the collapse.

The collapse began on 7 May 2022, when large UST sell orders — including over $285 million sold on Binance — pushed UST's price below its $1 peg. As confidence eroded, the Luna Foundation Guard attempted to defend the peg with a $1.5 billion loan to buy back UST, but the intervention proved far too small against the scale of the panic. Within a week, UST had crashed to around 10 cents and Luna, whose supply expanded massively as the algorithm tried and failed to restore the peg, collapsed from roughly $116 to effectively zero.

The numbers at a glance

• ~$45 billion — market capitalisation wiped out within a single week in May 2022
• ~20% — annual yield Anchor Protocol offered on UST deposits, widely seen as unsustainable
• $40 billion — total scale of losses prosecutors attributed to the broader fraud scheme when Do Kwon was later sentenced
• 15 years — prison sentence given to Do Kwon in December 2025 after his guilty plea

Do Kwon's prosecution

Terra founder Do Kwon fled after the collapse and was arrested in Montenegro in March 2023 while reportedly attempting to travel to Dubai using falsified travel documents. He was extradited to the United States at the end of December 2024 to face charges including securities fraud, commodities fraud, wire fraud, and conspiracy. In August 2025, Kwon pleaded guilty to two counts of fraud and agreed to forfeit $19 million; he was sentenced to 15 years in prison in December 2025.

Why this matters for accounting and finance students

Terra/Luna is essential material for anyone studying financial stability, valuation, or emerging asset classes, because it demonstrates a structural weakness specific to algorithmic — as opposed to fully collateralised — stablecoins: a peg maintained by market confidence and a companion token's supply mechanics, rather than by verifiable reserve assets, can unwind in a self-reinforcing spiral once that confidence breaks. The roughly 20% Anchor Protocol yield is also a useful teaching example of a classic warning sign — a return meaningfully above what the underlying activity could plausibly sustain — that deserved far more scrutiny than it received at the time from investors, and one echoed in several of the fraud cases explored elsewhere in this series.

The start of a wider chain reaction

Terra/Luna's collapse didn't stay contained to its own ecosystem. Numerous crypto funds, lenders, and trading firms had built up direct exposure to Luna or UST, or had extended leveraged credit to counterparties who did, and the sudden loss of tens of billions of dollars in value exposed those interconnections within days. The resulting stress rippled through the wider crypto lending and trading sector over the following weeks, contributing directly to the subsequent collapse of both the hedge fund Three Arrows Capital and the crypto lender Celsius Network — making Terra/Luna's failure a useful case study not just in stablecoin design risk, but in how quickly contagion can spread through a tightly interconnected, lightly regulated financial ecosystem once a single large node fails.

Frequently asked questions

Why did the UST stablecoin lose its dollar peg?
UST was an algorithmic stablecoin backed by a mint-and-burn relationship with the Luna token rather than cash reserves; a wave of large sell orders overwhelmed that mechanism and the Luna Foundation Guard's rescue attempts, triggering a self-reinforcing collapse in both tokens.

What happened to Terra founder Do Kwon?
He fled after the collapse, was arrested in Montenegro in 2023, extradited to the US in December 2024, pleaded guilty to fraud in 2025, and was sentenced to 15 years in prison.

Did the Terra/Luna collapse affect other companies?
Yes — it directly triggered the collapse of crypto hedge fund Three Arrows Capital and contributed significantly to the subsequent failure of crypto lender Celsius Network, both covered in companion case studies.

Terra/Luna is valuable, recent material for ACCA and CIMA coursework on emerging asset classes and financial stability risk. Learnsignal's CPD courses also cover ongoing risk and cryptoasset training for qualified professionals.