Terra Money collapses amid market FUD and rumours of a coordinated attack

Gabriel V. Gabriel V.
14 May 2022
5 min read
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Terra Money collapses amid market FUD and rumours of a coordinated attack

As the markets are tanking and fear, uncertainty and doubt dominate the emotions all around, Terra Money collapses in a liquidation cascade. Will this be the end of UST and LUNA?

This week we have seen one marking event in crypto space, one of those that shift people's thrust and set a precedent for tech development, the Terra collapse. This is by far, the biggest threat to crypto right now, as it has massive ramifications across the entire industry. The potential impact of the collapse of an $18b market cap decentralized stablecoin and a $40b market cap layer one network put this event in the top 3 worst events in crypto history: 

  • Mt. Gox Hack
  • The DAO Hack
  • Terra Collapse

Understanding the event

The main factor for the collapse started with the de-peg of the UST from the USD value. Every stablecoin suffers de-pegging daily, this is usually a good thing, when it has small deviations, it makes arbitrage opportunities possible to the players, and projects.

To understand why a de peg is possible, let's explore the different types of stablecoins:

  • Algorithmic: Backed by an algorithm, not assets. 
  • Fiat-backed: Backed by tangible assets

Algorithmic stablecoins like UST are valuable because they are: 

  • Scalable, ideal for facilitating DeFi 
  • Decentralized 
  • Improved capital efficiency 

Unfortunately, this also creates risks, which can result in de-pegging. The AvaLabs founder and CEO, Emin Gün Sirer, recently said in a tweet:

"We need a decentralized stablecoin. Fiat-backed stables are subject to legal seizure and capture. A decentralized economy needs a decentralized stablecoin whose backing store cannot be frozen or confiscated. For the algorithmic side of the stablecoin to work, the underlying chain has to offer high capacity and resilience under load. Few chains have the right mempool, fee and API infra to handle high loads. 
 Remember that every single stablecoin has, at times, de-pegged, including fully-collateralized fiat-backed stablecoins. All of them that have a real team behind them have bounced back. The bounce back is a great arbitrage opportunity. The dynamic that gives rise to a bank run executes in reverse on the way back."

UST stabilizes its peg by allowing you to redeem $1 UST for $1 worth of LUNA, or 1 LUNA for its equivalent value in UST. To incentivize the arbs, UST must possess true utility, which was happening fast, being used in multiple protocols, and exchanges pairing with major other cryptocurrencies. The main LUNA utility so far was to serve as collateral for borrowing and burning mechanism for UST minting. 


Coordinated attack

The rumours around the collapse of Terra are spreading, suggesting some involvements from Gemini, Blackrock Capital and Citadel. All of them stated publicly that they had no part in the events.

But let's break down the events(supposed) that led to it:

  • Blackrock and Citadel borrowed 100k BTC from Gemini;
  • Swapped 25k BTC into UST;
  • When the time was right, they called up Do Kwon at Terra Foundation saying they wanted to sell a large chunk of BTC for UST;
  • Do took the bait and did the trade, lowering significantly the UST liquidity;
  • At that point, Blackrock/Citadel dumped all the of the UST and BTC causing massive slippage and triggering a cascade of forced selling in both assets;
  • Blackrock and Citadel knew that this crash could lead to more and more withdrawals, surpassing the capacity that Anchor Protocol could repay;
  • These forced withdrawals and selling would trigger a massive selloff in LUNA potentially breaking the UST peg, which happened.
  • After this de-pegging, the LUNA price dropped significantly, and as the protocol works, the emission of LUNA started to pump to regain the UST peg, pushing the price further down, making more emissions and turning into a death spiral leading to what we are seeing today;


Again, we are stating what is supposed, not pointing out or accusing any actor in this well-orchestrated act.

The solution

As this happens, TerraLabs tried out to stop the crash by sending a proposal as stated in their tweet:

"The prevailing peg pressure on $UST from its current supply overhang is rendering severe dilution of $LUNA. The primary obstacle is expelling the bad debt from UST circulation at a clip fast enough for the system to restore the health of on-chain spreads. To expedite this goal, several measures are being taken. First, the current Prop 1164 will expand the base pool size and accelerate the burn rate of UST – helping deflate on-chain spreads. 
1. Proposal to burn the remaining UST in the community pool. 
2. TFL will burn the remaining 371 million UST cross-chain on Ethereum. 
3. TFL just staked 240 million $LUNA to defend from network governance attacks."

As we have seen by now, it didn't end well, as the price continued to fall reaching unimaginable values.

Their defence continued until the validators decided to halt the network.

"The Terra blockchain was officially halted at a block height of 7603700. https://lcd.terra.dev/blocks/latest Terra validators have decided to halt the Terra chain to prevent governance attacks following severe LUNA inflation and a significantly reduced cost of attack."


By the time of writing, LUNA still sits in the 32 spot by market capitalization, and their TVL has drastically evaporated as seen below:


This event will undoubtedly be marked in the history of crypto as one of the more catastrophic ones.

Its reasons or motivations are still unclear, but in time, the truth will pop out independently if this was a design flaw or a coordinated attack. In a tweet Do Kwon said:

What we should look to preserve now is the community and developers that make Terra’s blockspace valuable – I’m sure our community will form consensus around the best path forward for itself, and find a way to rise again.

The good thing is that it was exploited now, and not in 2 years when it was much larger and of course, this left a lot of things to be considered by all the builders out there and will lead to mature development in the crypto ecosystem.

Anyway, to all the players out there, always remember to trade responsibly, make good risk management, only invest what you can lose, and never put your eggs in the same basket. For more information on trading systems and psychology to prevent yourself from being wrecked in events like these, check out this article.

Don't forget to follow us @cryptonezo to stay updated with the latest blockchain and cryptocurrency news

Gabriel V.
Gabriel V.
About the Author

Crypto researcher, investor and trader. Technical and data analyst.

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