Analysis of the Terra Ecosystem Crash

Adam Tracy
8 min readMay 20, 2022

The crypto market experienced a shock when the stablecoin UST and LUNA of the Terra ecosystem fell flat to zero. On the 10th of May, the price of LUNA started falling, this made a lot of traders see the asset as a good deep to buy — not knowing it was a falling knife to be avoided. Anyone who has been in the crypto market since five years ago should be familiar with the 80% market crash that happened in 2017. But while that might have looked like the worst, the LUNA crash has been the most brutal so far.

Without question, this historic event is beclouded with a lot of lamentations and takes which may not allow people to know the exact cause of the crash. One thing is worthy of note, the LUNA crash is not just the peril of an ecosystem, there is a lot more to it than what is visible on the surface. This therefore raises a lot of questions regarding the crash, but this can only be answered through a thorough analysis. Indeed, there are a lot of lessons to be learned from this occurrence.

Against this backdrop, we shall roll up our sleeves and take a thorough dive into the LUNA crash.

Background and Tokenomics of The Terra Ecosystem

In the year 2018, Do Kwon — a South Korean crypto whale — founded Terraform Labs in Seoul. Since the computational Proof-of-Work consensus mechanism has become inefficient in today’s world, Kwon adopted the proof-of-stake mechanism for its blockchain — Terra ecosystem. The ecosystem has two tokens: LUNA and UST. While the latter is a stablecoin, the former is a volatile one. Nonetheless, both of them are linked together. It behoves to note that UST is fundamentally different to other stablecoins like Tether and USDC which are claimed to be backed by real-world assets such as bonds. In the case of UST, it indeed has no real-world reserves, but it works through a complex system of minting and burning tokens to maintain price stability. A UST token is created by destroying some of the related cryptocurrency LUNA to maintain the dollar peg. When UST’s price is too high (>$1), the protocol incentivizes users to burn (destroy) LUNA and mint (make) UST. When UST’s price is too low (<$1), the protocol incentivizes users to burn (destroy) UST and mint (make) LUNA. That is how it works. But the extreme market volatility has put UST to the test, and it has been unable to maintain the peg.

Do Kwon’s Confidence In The Tokenomics of UST

Ever since the rise of the Terra ecosystem, Do Kwon has always displayed enormous confidence in the infallibility of both UST and LUNA. He once tweeted that those anticipating the depegging of UST might have to “wait until the age of man expires.” Two months ago, he even struck a bet with a crypto personality known as GCR to the tune of $10 million over the future price of Terra (LUNA). Both parties have sent $10 million in stablecoins (USDT for Kwon and USDC for GCR) to an escrow account, which is simply an Ethereum wallet held by a veteran crypto trader known as Cobie. GCR sent their funds over yesterday, Kwon has also sent his own Payment confirming the bet. The bet is founded on whether the price of Luna will be increased or decreased in one year. Kwon made a bet in favour of the price of LUNA, which is his project, while GCR is betting against it. The price of LUNA as of the time the of betting was accepted at $88. After acknowledging the escrow account had been filled for both bets, Cobie tweeted, “May the best degen win.”

The Story of The UST Coordinated Attack, How It Happened

On the 9th of May, the UST chart started diving below the $1 peg. But this didn’t arouse attention early enough since some other stablecoins do go a little bit below the value of their attached fiat currency at times. But it started getting serious when UST dipped below to $0.6 on the 10th of May. At this point, most investors and holders caught the FUD and were panic selling. While that was going on, some investors unfortunately mistook the crash to be a dip and pumped funds into it. But the crash became more evident on the 13th of May when its price action ridiculously dropped to $0.07.

Prior to this time, Terra has been planning to launch the Fourth Pool with Frax, USDT, and USDC. This is important to compromise and mitigate the curve war of liquidity among stablecoins. To participate in the curve, among other things, the Terra team bought a reserve of Bitcoin worth over $3.5 billion. Ahead of the Fourth Pool, the LUNA Guard Foundation were gradually draining the Third Pool; they started by scooping off $150 million. Of course, this caused a sharp decline in the pegging of UST, but the foundation sold a few BTC to ensure balance.

Meanwhile, the attacker had earlier borrowed 100,000 BTC from Gemini and then bought $1 billion of UST over the counter. During the transition to the Fourth Pool, the attacker started shorting its UST positions causing a noticeable decline in the market, coupled with the FUD on socials, the crash was getting more glaring. As the LUNA foundation was selling its BTC to balance the peg, the attacker was also selling UST aggressively as well. At the end, the attacker didn’t only drain the Third Pool Curve, [s] he also dumped UST on Binance. The attacker eventually went away with around $800 million, as analyzed by Onchain Wizard. While commenting on this massive dump, Caetano Manfrini — a Brazilian blockchain business lawyer — clearly called it a “Coordinated Attack” because a single entity dumped $285 million worth of UST on Binance. Looking at the way Bitcoin is still in a terrible downtrend despite its use in dumping UST, analysts have speculated that the attacker most likely took the proceeds of the attack off-chain.

Vitalik and CZ Have Some Thoughts on Terra’s Demise

Vitalik Buterin, the creator of Ethereum, critiqued the entire premise of UST, citing it as, from inception, intentionally misleading and inherently flawed. “‘Algostable’ has become a propaganda term serving to legitimize uncollateralized stables by putting them in the same bucket as collateralized stables like RAI/DAI,” Buterin tweeted on 14th of May. Changpeng Zhao, CEO of Binance, the world’s largest cryptocurrency exchange expressed his disappointment in the way Terraform Labs handled the recent LUNA and UST collapse. Zhao said that the team behind the Terra network hardly responded to Binance’s request to help them restore the network. “We requested their team to restore the network, burn the extra minted LUNA, and recover the UST peg,” he tweeted. “So far, we have not gotten any positive response or much response at all” He compared Terraform’s response to that of Axie Infinity’s, the project that was hacked for $622 million in March 2021, lauding the latter for its accountability at that time. “This is in sharp contrast to Axie Infinity, where the team took accountability, had a plan, and were communicating with us proactively” added Changpeng Zhao. “And we helped.”

Two Popular Plans to Bail Out UST and LUNA holders

Currently, two Terra governance proposals appear to be favoured for returning some value to stakeholders. They are the Revival Plan and the FatMan Plan. The Revival Plan calls for a hard fork in the Terra blockchain, resulting in the creation of 1 billion Terra 2.0 tokens, which will then be distributed among developers, holders and investors in the project. The FatMan Plan calls for the LFG to distribute its $1.5 billion reserves to all UST holders before the de-pegging- helping them recover at least some value on their investment. But the community is yet to vote on either proposal. Terraform Labs and Do Kwon have also shared a few details on the path forward.

What Next For LUNA and UST?

A high-ranking member of the Luna Foundation Guard (LFG) said on Monday that the foundation’s reserves are almost ready to be deployed, barring a few technicalities. Luna Foundation Guard (LFG), the non-profit organization holding Terra’s bitcoin reserves, confirmed on Monday morning that it had sold over 80,000 BTC over the past week to acquire TerraUSD (UST) in an attempt to defend its crumbling U.S. dollar peg.

As of May 16, LFG holds 313 bitcoin in reserves, out of 80,394 BTC it held on May 7. The foundation also holds a handful of other assets, including UST and LUNA. The majority of its LUNA is staked (locked up) “across a range of validators to protect against a possible governance attack” as the token’s price kept dropping near zero and the amount of LUNA in circulation skyrocketed. “The Foundation is looking to use its remaining assets to compensate remaining users of $UST, smallest holders first,” LFG said in a final tweet. “We are still debating through various distribution methods, updates to follow soon.

Final Remarks

This unprecedented incident has caused a lot of ripple effects. After the fall of UST, Bloomberg announced that DEI — another stablecoin that its value was attached to the United States Dollar — had also lost its peg. Sequel to the progressive decline of major stablecoins, there was also FUD that the same might soon be the tale of USDT. To guard against this, various regulators are on their toes to give clear-cut directives towards the reserves of stablecoins and protect their citizens from unfortunate incidents of crash. At the moment, the Treasury Secretary of the United States — Janet Yellen — has set the motion for the regulation of stablecoins in the US. Similarly, the South Korean government has formed a committee to investigate the crash and have further summoned Kwon for questioning.

With the look of things, the crash of Terra might trigger regulators to be more vigilant within the crypto space.

A former professional rugby player, Adam S. Tracy brings over twenty years’ experience as an attorney, consultant and dealmaker with a particular focus on cryptocurrency, digital products, payments and immersive corporate structures. As an accomplished executive and advisor to blockchain merchants and stakeholders, Adam has proven himself as a results oriented, decisive leader with proven success advising early market entrants, technology adapters, as well as established participants across a wide range of blockchain verticals. Adam Tracy’s attack-first personality allows him to excel in dynamic, demanding environments including complex corporate negotiations, distressed environments and regulatory investigations.

In addition, Adam S. Tracy also has a successful track record co-founding blockchain industry ventures, building & leading cross-functional teams, and spearheading diverse corporate transactions. A serial entrepreneur, Adam has successfully started and created exits across a wide swath of markets, including various mobile SaaS ventures, cryptocurrency, peer-to-peer payment systems, and numerous token generation events. Moreover, as a recognized expert in the payments field, Adam Tracy has been a blockchain and digital currency evangelist and influencer since the early days of Bitcoin.

Utilizing his proprietary “Pre-Event Driven™” strategy for decision making, Adam S. Tracy further leverages his over twenty years’ experience to create cost-effective, value-add solutions for each client. A data-driven acolyte, Adam continually refines his strategies based on field studies and data collection. Moreover, Adam Tracy further augments his range of solutions by actively networking with regulators, liquidity providers, legal and compliance experts, deal-flow brokers, investors and management of leading high risk industry ventures.

Adam S. Tracy earned his Bachelor of Science in Computer Applications and Bachelor of Science in Finance from the University of Notre Dame. He subsequently earned his Masters in Business Administration from the DePaul Kellstadt Graduate School of Business, while concurrently earning his Juris Doctorate from the DePaul College of Law. Adam lives outside Los Angeles with his with his wife, son, four dogs, and two cats.

On the Web:
Instagram: @theadamtracy
Telegram: @adam_tracy
Skype: @adamtracyesq
Email me: