The Terra Blockchain Project and the stunning collapse of its two tokens, the UST Stablecoin and the Luna Utility Token, were unprecedented events in the short and extremely turbulent history of cryptocurrencies. It reportedly vaporized billions of dollars with crypto wealth, leaving thousands of investors virtually penniless.
So many people lost so many, many brows were raised a few weeks later when Do Kwon, founder of Terraform Labs, announced a bold plan to revive the Terra blockchain via forks.
What happened to Teralna?
Terra Blockchain was one of the most ambitious cryptocurrency projects ever launched, with the goal of becoming a decentralized finance hub. The key to this plan was also known as Terra's unique algorithm, Stablecoin Terrausd, aka UST.
Kwon's idea was that having a Stablecoin is absolutely fundamental to the success of any Defi Ecosystem. Crypto traders and speculators don't like to cash out to Fiat Dollars as they are time-consuming, expensive and inviting a lot of hassle and problems. For this reason, Stablecoins are extremely popular. On decentralized exchanges, stub coins such as tethers and USDCs are used to resolve transactions and create trading pairs.
However, not everyone trusts stubcoin. Both Tether and USDC are asset-backed stubcoins run by centralized companies that have the ability to effectively maintain control over these tokens and freeze their wallets at any time. That goes against the very idea of decentralization. In addition to concerns, particularly in the case of tethers, there is a recognition of the lack of transparency in the exact nature of the assets used to support the USDT token.
Do Kwon created UST as a decentralized alternative to these stubcoins, but he had no billions of dollars worth of cash or other liquid assets. To that end, he instead created the UST as a “algorithm” stablecoin that uses complex mathematical algorithms to keep a 1:1 peg in US dollars.
How UST was supposed to work
According to Terra's Whitepaper, the goal of this project was to create a truly reliable and scalable peer-to-peer electronic cash system. The plan included two coins whose fate was closely intertwined with each other. It's a UST price-stable and a growth-driven Luna that helps you maintain PEG without the need for cash reserves.
Terra's mechanism relied on smart contracts designed to lock UST prices to US dollars. It worked by encouraging Luna holders to burn and build new tokens to earn arbitrage rewards. Therefore, if the UST price exceeds $1.00, Luna owners can benefit by replacing $1.00 worth of Luna and minting a new UST token. After that, these tokens could be sold for a small profit. Just as more people did this, it had the effect of diluting the UST supply and reverting its value to $1.00.
On the other hand, if the UST price falls below $1.00, UST holders can earn a risk-free profit by swapping USTs at a 1:1 ratio of Luna. The UST was then burned by Terra, reducing the supply of tokens and reverting its value to $1.00.
The UST worked well, but until the beginning of 2021 it was really popular with the launch of Anchor. This is a Defi protocol designed to help people invest in its ecosystem for 20% APY that will stand out. After the launch of Anchor, the price of the Luna rose 100 times, but $10 billion worth of UST was minted. Luna has become the top 10 cryptocurrency token in terms of market capitalization, with UST emerging as the fourth-largest stubcoin behind Tether, USDC and Binance USD.
At the autopsy of Terra's collapse, Aax Academy, research unit at AAX Exchange, explained the importance of anchor protocols and its role in UST/Luna's growth. It was noted that the compensation offered is orders of magnitude better than any bank offers. Therefore, anchors have collected a huge amount of money that was traditionally allocated for low-risk investments.
“Demand for UST has increased rapidly, leaping the market capitalization of stubcoins, backed by more established Fiats, including TUSD, GUSD and Algo Cousin Dai,” Aax Academy said. “Most of that demand came from an unusually high 20% APY that was rewarded by UST's stakers in anchor protocols.”
How it fell apart
Despite some wobble and many critics labeling the anchor protocol as “fraud” or “Ponzi scheme,” UST was able to hold a 1:1 peg in USD for over a year. On May 9th, UST was suddenly removed, but in exchange for regaining the pegs the same way that many did, its value continued to collapse to just 7 cents within 48 hours. Meanwhile, Luna collapsed even more spectacularly, dropping from its peak in April from $116 (if its market capitalization exceeds $40 billion) to just a few cents by May 11th.
The crypto industry has seen this kind of collapse before, but it only happened to small cap memokines – for large tokens like Luna, it was simply unprecedented.
“Luna's price has now gone to zero, registered and relisted in a major exchange, and its supply has increased by 20 times. “Millions of people have risen in smoke. Both cash parked in the anchor's 'safe' option and money held in Luna. ”
The actual cause of the Terra crash remains unknown, but there was speculation that the ecosystem was targeted in some kind of attack launched by hedge funds.
Just a week before the collapse, Do Kwon knew of plans to buy $10 billion worth of Bitcoin, intended to be used as a reserve asset to protect UST's PEG. In theory, Bitcoin is a bearer asset, completely decentralized and unlike Tether's commercial paper reserve, it was a solid idea because it wasn't built into the TradFi system.
However, critics of the move, including the AAX Academy, warned that in doing so, Kwon effectively targeted UST. Aax only took a few whales (holders of a large amount of BTC) to unstable UST PEG and create a bank run.
It seems that it happened. This Twitter thread features a very popular theory, which has since been retweeted over 10,000 times and has received over 31,000 likes. One cryptocurrency wallet is claiming it is suddenly dumping over $350 million UST, pushing it out of its peg and trying to force the price to under $1.00. This led LFG to aggressively sell Bitcoin Holdings to maintain UST's PEG.
The theory wants to see Bitcoin prices drop as the attackers also held a major BTC short position. That's exactly what happened as LFG sells almost the entire BTC reserve. Bitcoin prices collapsed, earning an estimated profit of over $800 million for attackers.
For Terra, the running was absolutely miserable. By mid-May, over $6 trillion in Lunacoins had been circulating, with the price being $0.0002. It was still theoretically possible to redeem UST and repaint the Stablecoin for a huge amount of Luna worth $1.00, but the system fell apart due to a lack of buyers. Luna was worthless and no one wanted to touch it. Therefore, ust remained only a small part of the value of its pegs.
Terra's collapse sent shockwaves through the world of cryptocurrency. Anchor's native token fell more than 70%, and even Tether temporarily lost pegs to the US dollar.
Will the resurrection be successful?
The Terra ecosystem was more than just UST. In fact, the Terra blockchain has had dozens of highly successful Defi projects, including the popular Defi protocol and video games and NFTs with different ears. To save this ecosystem and return some of the lost value to Luna and UST holders, Do Kwon quickly announced a reboot of Terra via a Terra 2.0 fork.
With forks, Terra revives the blockchain and Luna tokens, but realizes that it has lost all trust and obsoletes UST Stablecoin. When the community voted to move on, Terra quickly implemented the plan, and Terra 2.0 was born before the moon came out.
The Luna 2.0 is no surprise, and has seen a lot of volatility since its launch. Within minutes a new token came out, and its value quickly rose. The UST holders who received the new token via airdrop then decided to cash out during the good time, causing the price to just take. However, the price of the Luna 2.0 has since been rebounded due to demand from people who believe Terra still has a future.
Ju-dean is still out on the possibility of rebuilding the Terra. As AAX explained, on the one hand there was still a strong developer community with many successful projects, the network ran smoothly, and many of its Dapps had a large user base. However, on the other hand, Terra lost the main driver of the original Meteoric Growth, as 20% of the APYs have not won the APY offshore.
The problem with Terra is that you need to bounce back from the most sudden and epic loss of confidence that has ever been a hit with a cryptocurrency project. It's not easy to regain that confidence. Terra took at least the most important step, choosing community governance rather than led by Do Kwon himself. However, cryptocurrency crowds are hard to please, and Terra will need more than decentralized leadership to restore lost fame.
FAQ
What causes the collapse of Terra Luna and UST?
The collapse was caused by UST's loss of Dollar Peg, leading to a death spiral with sister token Luna. Both tokens crashed in value as the algorithmic system failed to maintain stability, especially under pressure from large withdrawals.
How did Terra's UST Stablecoin work?
UST was a stable coin of algorithms supported by Luna through mint and burning mechanisms. Users can swap Luna for UST and vice versa, allowing them to maintain a 1:1 peg in USD. However, the system relies heavily on market trust and failed during liquidity crunch.
What is Terra 2.0?
Terra 2.0 is the original Terra blockchain fork that excludes failed UST Stablecoin. The goal was to reboot the ecosystem under the new token, Luna 2.0, and rebuild trust with the community and developers into affected owners through decentralization and airdrop.
Is Luna 2.0 working well in 2025?
Luna 2.0 has experienced volatility since its launch. Despite the renewed interest from developers, the project is still recovering from a major crisis of confidence. Its long-term success depends on ecosystem growth and restoration of user trust.
Was Terra's collapse caused by an attack?
Unconfirmed, widely distributed theory suggests that large traders may have misused Terra's reserve mechanics by shortening and shaking Bitcoin and forcing back-selling. This caused a cascade effect that led to downfall.
