The fall of Terra may feel like ancient history now. Two more major crypto ventures — Celsius and Three Arrows — have seized the attention of investors as they struggle to avoid Terra’s fate.
Yet fathoming precisely what went wrong at Terra is still under way, and earlier this month Chainalysis, a blockchain intelligence firm, says in a June 9 report that just two traders were responsible for the initial break of UST’s peg that precipitated the death of UST and the entire Terra Classic chain.
The report notes that on May 7, Terraform Labs, the company behind Terra, withdrew 150M UST from Curve’s 3pool — a liquidity pool comprising various stablecoins designed to facilitate efficient exchange between the tokens — making it susceptible to volatility.
One trader then swapped 85M UST for USDC 13 minutes later, with a second wallet trading 100m UST for USDC in 25M increments over the following hour. Terraform Labs responded by withdrawing a further 100M UST in a bid to “rebalance” the pool.
“These large trades – and a number of much smaller ones – had already broken UST’s peg. Investors panicked, the sell-off began, and many holders with their UST deposited in Anchor started to withdraw their funds,” Chainalysis said.
Chainalysis notes that three wallets swapped a combined $480M USDT for UST between May 7 and May 9 in an apparent bid to restore its parity with the dollar. LFG also offloaded billions in BTC for UST on May 9. But LFG’s were depleted and UST’s had broken for the last time by the following day.
The report asserts that UST’s failure drove surging stablecoin redemptions. “Redemptions peaked across all stablecoins — both algorithmic and asset-backed. This suggests that UST’s collapse scared investors away from stablecoins altogether, not just those of a certain class,” Chainalysis wrote.
This series of events marked a shocking fall for one of DeFi’s most beloved darlings. The network’s growth appeared unstoppable, increasing 244% to $31.3B in early April from $9.1B in late November as deposits to its leading dapp, Anchor — which represented more than half of Terra’s total value locked (TVL), soared.
Anchor billed itself as a simple savings protocol and promised annual returns of nearly 20% to depositors of Terra’s native stablecoin, UST. UST maintained its peg algorithmically by allowing hodlers to redeem $1 worth of Terra’s network token LUNA regardless of its value on exchanges, and Anchor’s yields were subsidized by a reserve fund.
In February, Anchor’s reserve fund was on track to be completely emptied by the end of the month, but was shored up by an OTC token worth $1B by the newly formed Luna Foundation Guard (LFG) that was led by Jump Crypto and the now-embattled Three Arrows Capital. Anchor claimed the reserve would maintain its high yields until a forthcoming v2 iteration would deliver self-sufficiency in November, and Terra and UST resumed absorbing billions in TVL.
But in early May, UST and LUNA suddenly and spectacularly collapsed. On May 7, UST’s peg began to falter, with the token’s price violently crashing by 40% two days later. With LUNA having tumbled 50% over the month leading up to UST’s depegging, the incident indicated that the incentives it’s algorithmic design offered to arbitrageurs were no longer sufficient to maintain UST’s parity to the dollar.
With UST holders rushing to secure whatever exit liquidity they could — whether that be by selling UST on the open market or redeeming it for LUNA — the ostensibly stable token’s value cratered down to $0.08 by June 13, with LUNA’s price also crumbling to just a fraction of a cent.
LFG’s enormous offloading of BTC is also attributed as a factor pushing down the price of Bitcoin at the time, as is the broader macroeconomic downturn that was impacting stocks.
While Chainalysis asserts that UST’s failure likely poses “a threat to consumer confidence in the short term and serves as a legislative catalyst in the long term,” the report adds that “responsible innovation” will not be hampered by the incident.
“Fortunately, thanks to blockchains’ transparency, we can learn from these incidents, educate others, and continue to build trust in cryptocurrency,” the report concludes.