Terra's UST Algorithmic Stablecoin Loses Dollar Peg, Triggering $40 Billion Death Spiral and Crypto Market Crash

TerraUSD (UST), the fourth-largest stablecoin with $18 billion market capitalization, began losing its dollar peg on May 7-9, 2022, triggering a catastrophic “death spiral” that would destroy $40 billion in value within days and crash the broader crypto market. The algorithmic stablecoin, created by Do Kwon’s Terraform Labs, was designed to maintain a $1 peg through an arbitrage mechanism with its sister token LUNA—users could always swap 1 UST for $1 worth of LUNA. On May 7, large investors withdrew $375 million UST from Anchor protocol and sold over $285 million on exchanges. By May 8, UST fell to $0.985, then $0.90, triggering panic. As users rushed to redeem UST for LUNA, the algorithmic mechanism created billions of new LUNA tokens, causing hyperinflation. LUNA’s supply increased from 1 billion tokens to 6 trillion in just three days while its price collapsed from $87 on May 5 to $0.0005 by May 13—a 99.99% loss. UST crashed to $0.02, an 98% loss for holders. The total value destruction exceeded $45 billion. The collapse exposed fundamental design flaws in algorithmic stablecoins and catastrophic regulatory failure. Unlike traditional stablecoins backed by reserves (and subject to some regulation), algorithmic stablecoins operated in a complete regulatory void. The SEC, CFTC, and banking regulators all disclaimed jurisdiction, allowing Terraform Labs to market UST as a “stable” dollar-pegged asset while offering unsustainable 19.5% yields through Anchor protocol—a classic Ponzi scheme requiring $6 million daily in subsidies by April 2022. Treasury Secretary Janet Yellen told Congress the collapse demonstrated “the current statutory and regulatory frameworks don’t provide consistent and comprehensive standards for the risks of stablecoins as a new type of payment product.” The SEC began investigating Terraform Labs in June 2022 only after the collapse, examining whether UST violated securities laws—but Americans had already lost billions. The regulatory void allowed Do Kwon to operate an algorithmic stablecoin with no reserves, no audits, no banking oversight, and no consumer protection while it became the 10th largest cryptocurrency. The contagion spread immediately: Three Arrows Capital, heavily exposed to Terra, collapsed. Celsius Network and Voyager Digital froze withdrawals and filed for bankruptcy. The broader crypto market lost 48% of its value. The collapse proved algorithmic stablecoins were fundamentally unstable and that crypto’s “self-regulation” was a fraud enabling massive retail investor losses.