What an algorithmic stablecoin is, before the postmortem

A fiat-backed stablecoin like USDT or USDC holds a dollar of real-world assets for every token in circulation. An algorithmic stablecoin tries to hold a dollar by code instead of by reserves. The mechanism varies by design; in the Terra version that produced UST, the rule was:

  • Burn one Luna at the current market price to mint UST worth one dollar.
  • Burn one UST to mint Luna worth one dollar at the current market price.

The arbitrage worked symmetrically. If UST traded below a dollar, an arbitrageur could buy UST below peg, burn it to mint Luna worth a dollar, sell the Luna and pocket the difference. If UST traded above a dollar, an arbitrageur could burn Luna to mint cheaper UST and sell it. The mechanism was elegant, fully on-chain, and required no off-chain collateral. It also required Luna to have enough market value to absorb the burns.

The single sentence that summarises the design risk. An algorithmic stablecoin that uses a sister token as its absorption mechanism is solvent only as long as the sister token has more market cap than the stablecoin. When that ratio inverts under pressure, the design enters what people later called a "death spiral".

How Terra grew · 2020 to early 2022

Terraform Labs launched the Terra blockchain in 2018. UST went live in 2020. For the first eighteen months, UST was a small experiment with a market cap below 1 billion. The growth came from a single feature inside the Terra ecosystem: Anchor Protocol, a savings product that paid roughly 20% APY on UST deposits.

The yield was not generated by lending UST out at 20% — Anchor's borrow-side income was substantially smaller than its deposit-side payout. The gap was filled by a "Yield Reserve" subsidised by Terraform Labs and later by the Luna Foundation Guard (LFG), the foundation behind Terra. Anchor was, in effect, a paid-marketing programme: deposit UST, receive a yield that the foundation paid for, which encouraged holders to mint more UST and grow the network.

The model worked. UST market cap grew from roughly 1 billion in early 2021 to 19 billion at the April 2022 peak. Anchor held roughly 14 billion of that 19 billion — more than 70%. The system was reliant on Anchor not just for growth but for steady-state demand.

19B
UST market cap peak
(April 2022)
14B
UST in Anchor
at the peak
20%
Anchor APY
subsidised

The Bitcoin reserve, and why it did not save them

By early 2022, the Terra team had recognised that an algorithmic stablecoin with no exogenous reserves was structurally fragile during stress. The Luna Foundation Guard began accumulating Bitcoin as a reserve. By early May, LFG held roughly 80,000 BTC, worth about 3.2 billion at the time. The plan was to deploy BTC reserves to defend UST during depeg events.

The reserve was not large enough to defend a 19 billion stablecoin against a coordinated run. When the run came, LFG sold the Bitcoin into a falling market, which itself contributed to the broader May 2022 crypto downturn. The Bitcoin sales recovered some of the UST peg briefly but did not arrest the decline. The reserve was depleted within seventy-two hours.

The collapse · day by day

Saturday, May 7, 2022
A large UST holder — later identified as a single wallet but never definitively attributed to any one actor — withdraws 375 million USDC from Anchor and swaps to UST on Curve, then unwinds the position by selling UST into the Curve 3pool. The Curve pool composition shifts. UST trades to 0.9850. This is unusual but within historical range; the depeg recovers partially within hours.
Sunday, May 8 · evening
A second large position exits Anchor and sells UST. Anchor TVL falls from 14 billion to 11 billion in 24 hours. UST trades around 0.99 across exchanges. Twitter discussions of a possible "depeg attack" begin to circulate. The Terra team publishes a statement reassuring holders that the system is operating normally.
Monday, May 9
UST trades through 0.985 and reaches 0.95 during US hours. LFG announces it is deploying Bitcoin reserves to defend the peg, transferring 1.5 billion of BTC to a market maker for OTC sales. UST recovers to 0.92 then 0.94 intra-day. Luna falls from 64 to 31 during the same period — the burn mechanism is starting to mint Luna at scale to absorb UST sales.
Tuesday, May 10
UST falls below 0.70. Luna falls below 15. The death spiral is now visible: as UST holders exit, Luna is minted to absorb the burns, which dilutes Luna supply and drops the price further, which means each subsequent UST burn produces more Luna, accelerating the dilution. The mechanism that was meant to stabilise UST is destabilising it.
Wednesday, May 11
Binance halts Luna and UST withdrawals temporarily for "technical reasons". UST trades through 0.30. Luna falls through 1.00. The two tokens are now in free fall together. Anchor's TVL has collapsed to under 2 billion. Tether USDT briefly trades to 0.95 on contagion fear before recovering.
Thursday, May 12
Luna's supply expands from 350 million tokens to over 6 trillion tokens within 24 hours as the burn mechanism continues to mint. The price falls to fractions of a cent. The Terra blockchain is halted by validators to prevent further governance-attack risk. UST is effectively worthless on most exchanges; price quotes are nominal.
Friday, May 13 onward
Binance, Coinbase, Bybit, OKX and most major exchanges delist or suspend Luna and UST. Terra announces a fork plan: a new Luna ("Luna 2.0") will be issued via airdrop to holders of the original Luna and UST. The fork ships in late May. The original chain is renamed Luna Classic (LUNC) with UST renamed USTC. Neither recovers in any meaningful sense.

The contagion chain

The collapse did not stay contained. Three Arrows Capital, the largest crypto hedge fund at the time, had concentrated exposure to Luna and to UST-related positions. 3AC could not meet margin calls and entered insolvency in June 2022.

3AC was a major counterparty to Voyager Digital and to Celsius. Both lenders had been borrowing from 3AC, lending to 3AC, or both. Voyager filed for bankruptcy in July 2022. Celsius froze withdrawals in mid-June and filed for bankruptcy soon after. The chain extended further: BlockFi was forced into a credit facility with FTX (later collapsing with FTX), Genesis Capital experienced severe losses (and would eventually file for bankruptcy in January 2023 after FTX), and the broader crypto-lending sector contracted by more than half within six months.

The cleanest way to think about Luna's role is as the detonator. The collapses that followed were already fragile counterparties; Luna was the event that exposed the leverage and the cross-lending that had built up in the bull market.

Who lost what

The market-cap erasure is the headline number — roughly 60 billion combined for Luna and UST at the peak. The retail loss numbers are harder to estimate and more painful. A few categories:

  • Anchor depositors. Anyone holding UST in Anchor for the 20% yield. Many were retail savers in jurisdictions where local currency inflation made the Anchor yield genuinely attractive. The total deposit base was 14 billion at the peak; recovery was effectively zero.
  • Luna stakers and validators. Anyone holding Luna for staking yield or governance participation. Includes a substantial validator infrastructure community that had built tooling on Terra.
  • Exchanges' margin and lending books. Lenders who had Luna as collateral or as borrow exposure faced rapid liquidations during the death spiral. Some had to write off positions.
  • Indirect contagion. Holders who had no Luna or UST exposure directly but who lost funds at Celsius, Voyager, FTX, BlockFi or other lenders that failed in the contagion chain. The total here is harder to pin down; legitimate claims still being processed in some bankruptcy cases in 2026.

The Do Kwon extradition

Do Kwon, the co-founder and public face of Terraform Labs, left South Korea in early 2022 before the collapse. He was charged in South Korea after the collapse with violations of capital markets law. The US Department of Justice and the SEC also filed charges, the SEC alleging that Terra's marketing and structure of UST and Luna had constituted unregistered securities sales.

Kwon was arrested in Montenegro in March 2023 at Podgorica airport on a separate charge of using a forged passport. He served a Montenegrin sentence for the passport offence through 2023 and into 2024. Both South Korea and the United States filed extradition requests; the Montenegrin courts and government went through a prolonged decision process before granting extradition to the United States in December 2024.

The US case (Southern District of New York) is ongoing in 2026. Kwon faces multiple counts of securities fraud, wire fraud and commodities fraud. Earlier in 2024 the SEC's civil case against Terraform Labs went to trial in New York; a jury found Terraform and Kwon liable, with a judgment of roughly 4.5 billion dollars later that year. The criminal case is the more consequential remaining proceeding.

What the regulators wrote into law

Luna's collapse directly shaped the stablecoin frameworks that followed.

MiCA (EU, fully in force June 2024)

The EU's Markets in Crypto-Assets regulation defines stablecoins as either e-money tokens (referenced to a single fiat currency) or asset-referenced tokens (referenced to a basket). Both categories require reserves of high-quality liquid assets, with strict redemption rights and disclosure obligations. Pure algorithmic designs that maintain peg only through code do not qualify and cannot be marketed as stablecoins in the EU. The exclusion was a direct response to Luna.

US discussions · GENIUS, STABLE, Clarity Act

The US has pursued several stablecoin frameworks since 2022, most prominently the GENIUS Act (Guiding and Establishing National Innovation for US Stablecoins) advanced through 2024-2025. The draft text requires payment stablecoins to be backed by high-quality reserves — short-dated Treasuries, cash, certain repos — and explicitly excludes "endogenously collateralised stablecoins" (the Luna design). The framework has not been enacted into law as of mid-2026 but the exclusion language has been consistent across drafts.

Hong Kong, Singapore, UAE

The Hong Kong Monetary Authority, the Monetary Authority of Singapore and several UAE regulators each published stablecoin guidance in 2023-2024 that follows the same outline: reserve-backed stablecoins with high-quality assets only, algorithmic designs excluded.

Algorithmic stablecoins in 2026 · what survives, what does not

The pure algorithmic category is effectively dead at scale. Several hybrid designs exist; most have learned the Luna lesson and added meaningful collateral:

  • Frax (FRAX). Originally a partially-algorithmic design backed mainly by USDC and other reserves. In 2023, the protocol governance voted to move FRAX to fully collateralised. The token continues to operate as a reserve-backed stablecoin in 2026.
  • USDD. Tron's USDD launched after the Luna collapse with the same mint-and-burn architecture but with substantial collateral reserves (BTC, USDC and TRX). Has experienced depegs in 2023 and 2024 but has not fully collapsed. Trades below peg as of mid-2026 by 1-3% in most quotes.
  • Various small experimental designs. Several research projects exist on smaller chains. None has crossed 100 million in supply at any stable peg as of mid-2026.

The market does not seem to want pure algorithmic stablecoins in 2026. The combination of regulatory exclusion, retail trauma and the lack of demonstrated stress survival has kept the category small. Whether a future design will prove the category survivable remains an open research question; the desk's view is that without a credible exogenous reserve, the answer is likely to remain no.

Five lessons every stablecoin holder should keep

Lesson 1 · Subsidised yield is a marketing programme, not a return

Anchor's 20% was paid for by Terraform Labs and LFG, not by Anchor's underlying borrow market. Any yield meaningfully above the risk-free rate is being paid for by someone, somewhere, and that someone has a finite budget. The desk's working filter: a stablecoin yield above 6% in 2026 needs an explanation of who is paying for the gap above Treasury rates and how long they can sustain it.

Lesson 2 · The peg holds in calm weather; pricing risk requires bad weather

UST traded near a dollar for two years. The mechanism worked. Inferring from two years of calm that the mechanism would work under stress was a category error. The same point applies to any new stablecoin: the question is not whether the peg holds today but how it behaves on the worst day of the year.

Lesson 3 · Reserve composition matters more than reserve existence

LFG had Bitcoin reserves. The reserves existed. The reserves were not large enough to defend a 19 billion stablecoin against a coordinated run, and the act of deploying them into a falling market accelerated the decline. Reserves help only if the size, composition and deployability match the stress they are meant to absorb.

Lesson 4 · Cross-pool concentration is contagion risk

UST liquidity was concentrated in a small number of Curve pools. A determined large seller could distort the entire on-chain price by emptying one side of one pool. The same risk applies to any stablecoin with thin off-exchange liquidity: a single venue's order-book depth is not the same as ecosystem-wide depth.

Lesson 5 · "It cannot happen here" is the most expensive sentence in crypto

The desk heard versions of "Luna will not be UST" right through the May 2022 collapse. The mechanism, the team's credibility, the reserves, the academic backing — none of it was decisive. When the run started, the design failed in seventy-two hours. The same sentence is now being applied to other categories of crypto product; the lesson from Luna is to read each new "it cannot happen" claim with the May 2022 framework in mind.

If you want to act on this

The most actionable lesson is the simplest: hold stablecoins that have demonstrated stress survival. In 2026 that effectively means USDT and USDC, with smaller positions in MiCA-compliant tokens like EURC and FDUSD where the use case applies. The desk's working venue for global users is Binance; the referral link opens a Binance registration page pre-filled with code BN16188. Full disclosure on the disclaimer page.

If you held Luna or UST and lost capital, you are not alone; the loss number is in the tens of billions across hundreds of thousands of holders. The bankruptcy proceedings for the contagion chain (Celsius, Voyager, FTX, Genesis, BlockFi) continue to produce small distributions in 2026 — check those proceedings if you were an affected creditor.

Reading list for the Luna postmortem

  • Terraform Labs governance forum and on-chain Anchor data, archived versions on Wayback Machine for 2021-2022.
  • Curve.fi 3pool subgraph data, May 7-13 2022.
  • SEC v. Terraform Labs PTE Ltd and Do Kwon, complaint filed Feb 16 2023; trial verdict April 2024.
  • US Department of Justice indictment of Do Kwon, March 2023, Southern District of New York.
  • Korean Financial Services Commission notice, May 2022 and subsequent.
  • EU Markets in Crypto-Assets Regulation (Regulation (EU) 2023/1114), Articles 36-58 covering stablecoin requirements.
  • Three Arrows Capital liquidation filings, BVI Eastern Caribbean Supreme Court, June 2022 onward.
  • Celsius Network bankruptcy filings, Southern District of New York, July 2022 onward.

Anything you can verify yourself, you should. Corrections to this article live on the corrections page; email [email protected] if you spot an error.