defi mechanics
How a $18B Stablecoin Hit Zero in Days: The Depeg Spiral
A 'stable' coin worth $18 billion went to near-zero in days
In May 2022, the third-largest stablecoin on Earth went to zero. TerraUSD — ust — carried an eighteen-billion-dollar market cap. It was supposed to hold one dollar. Always one dollar. That was the entire promise. Inside a single week, that promise evaporated, and the wreckage took roughly forty billion dollars of value down with it across the Terra ecosystem. Not a slow bleed. A vertical drop. Holders who believed they owned cash equivalents watched their balances melt in real time. The word 'stable' did a lot of quiet work in that name — and it was a lie. To understand why a stablecoin can detonate this fast, you have to understand what was actually holding the peg up. The answer, it turns out, was almost nothing. And nothing scales beautifully — right until it doesn't.
How the peg was supposed to hold — mint-and-burn arbitrage with LUNA, not cash
Most stablecoins hold a dollar by holding a dollar — cash in a bank, treasuries in a vault. Terra held nothing. ust was algorithmic. Its peg ran on a swap: anyone could always trade one ust for exactly one dollar's worth of its sister token, luna. That's the whole machine. If ust slipped to ninety-nine cents, arbitragers would buy it cheap, burn it, and mint a full dollar of luna — pocketing a clean penny. That buying pressure was supposed to drag ust back to one dollar. Burn ust, mint luna. Mint ust, burn luna. A balancing loop, fueled by greed, with zero cash behind it. On paper, elegant. In practice, the entire structure depended on one fragile assumption: that luna would always be worth something. Take that away, and the loop doesn't stabilize anything. It accelerates the fall.
The lure: a 20% yield drew deposits that made the system top-heavy
Now, why would anyone hold a dollar that pays nothing? They wouldn't. So Terra built a magnet. Its Anchor Protocol advertised a fixed yield of roughly nineteen-and-a-half percent on ust deposits. Nineteen-point-five. On something marketed as a stable dollar, in a world where banks paid almost nothing. Capital did exactly what capital does — it flooded in. By early 2022, around seventy-five percent of all ust in existence was parked inside Anchor, chasing that rate. Nearly fourteen billion dollars sitting in one protocol. But that yield wasn't earned from real lending — it was subsidized, paid out of a reserve that was visibly draining. So the system became dangerously top-heavy: most of the demand for ust wasn't belief in the peg. It was rate-chasing. And rate-chasers don't stay loyal. They leave the instant the math turns. That exit door was about to get very crowded.
The trigger: large withdrawals broke the Curve pool and snapped the peg
Every reflexive system needs a first crack. Terra's came in the trading pools where ust swapped against other stablecoins. On May seventh through ninth, 2022, hundreds of millions of dollars of ust were pulled out of the Curve liquidity pool in a short window. That pool was the shock absorber — the place ust proved it could trade at a dollar. Drain it, and the balance tips. ust slipped first to ninety-eight-and-a-half cents. A small number. To a peg, a catastrophic one — because a stablecoin's only job is to never move. Once it moved, the seventy-five percent sitting in Anchor for the yield did the rational thing: they ran for the exit. Selling begat selling. Within days ust broke through seventy cents. The peg wasn't bending anymore. It was snapping. And now the arbitrage loop — the supposed safety mechanism — was about to be pointed straight at the system's own heart.
The cascade: the death spiral — redeeming UST mints unlimited LUNA
Here's where the design turns lethal. The protocol still honored its promise: hand in one ust, get a dollar's worth of luna. But luna's price was now falling. So to pay out one dollar, it had to mint more luna tokens. More tokens meant more supply. More supply crushed luna's price further. Lower price meant even more luna minted for the next redemption. That is the death spiral — a self-feeding loop where the rescue mechanism is the poison. luna's supply exploded from roughly three hundred fifty million tokens to over six-point-five trillion. Read that again: trillion. Its price collapsed from around eighty dollars to fractions of a cent. ust, the thing all this was supposed to protect, bottomed near ten cents. The absorber token absorbed nothing. It just amplified. Once confidence broke, the math had only one destination — and it got there in days.
Aftermath: contagion spread to funds, lenders, and even reserve-backed coins
Forty billion dollars doesn't vanish quietly. It pulls others down with it. The hedge fund Three Arrows Capital, heavily exposed, blew up owing creditors around three-and-a-half billion. The lenders Celsius and Voyager followed it into bankruptcy. Terra's founder, Do Kwon, was later arrested. That's the contagion of an algorithmic failure. But here's the part people misread: even fully-reserved stablecoins can wobble. On March eleventh, 2023, usdc — issued by Circle, backed by real cash — slid to about eighty-seven cents. Why? Three-point-three billion dollars of its reserves were trapped at Silicon Valley Bank, which had just failed. The cash existed. It was simply frozen, and for a weekend nobody knew if it would come back. Same symptom — a broken peg — but a fundamentally different disease. One was missing money. The other was just locked away. That distinction decides everything about what happens next.
Lesson: the backing model decides whether a wobble heals or spirals
So why did one coin recover and the other die? Look at what stood behind each. usdc re-pegged to a dollar within days — once regulators backstopped svb's depositors and the three-point-three billion was confirmed safe. Real dollars existed. The peg was scared, not insolvent. ust had nothing behind it but a reflexive token that the panic itself destroyed. There was no floor — so it found zero, and stayed there. Permanently. And this wasn't even new. In June 2021, Iron Finance's iron stablecoin and its titan token ran the exact same algorithmic spiral — DeFi's first true bank run — vaporizing roughly two billion dollars, with Mark Cuban publicly caught in it. The pattern was a year old when Terra repeated it at twenty times the scale. The lesson is brutally simple: when a stablecoin wobbles, the only question that matters is what's actually behind it. Cash heals. Reflexivity spirals.
Sources
- Reuters, Terra/Luna collapse, May 2022
- CoinDesk, The Fall of Terra timeline
- Bloomberg, Anchor/Terra collapse
- Reuters, Luna/Terra collapse, May 2022
- Reuters, USDC depegs after SVB exposure, March 2023
- Bloomberg, Iron Finance/TITAN collapse, June 2021
- Reuters, USDC depegs after SVB, March 2023
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