Today, we will review a collapse that is destined to be recorded in financial history, a textbook-level failure. It was not a hacker theft, nor a project team running away, but a 'belief' worth $40 billion, built on a clever mathematical formula, which was completely shattered by the most primal human panic in just three days. This is the story of the collapse of LUNA and UST, an 'epic stress test' for algorithmic stablecoins, and the result of the test was an explosion on the spot.
I remember very clearly that before May 8, 2022, UST was the star of the crypto world. It claimed to be a 'decentralized dollar', supported by algorithms (rather than dollar cash), forming a 'dual currency nesting doll' structure with LUNA. Countless people invested their life savings in the Anchor protocol, enjoying nearly 20% 'stable' annual returns. The entire ecosystem was thriving, and founder Do Kwon was hailed as a genius, with unwavering faith from the community.
Then, the entire collapse began with a seemingly small crack, evolving into a black hole that swallowed everything under the resonance of panic.
1. The 'magic' of UST: A clever 'trust game'
To understand the collapse, one must first understand how it operates. The design of UST is a masterpiece of intellect:
Core mechanism: Dual-coin minting and destruction arbitrage.
Pegged at $1: UST's goal is to always be worth $1.
LUNA is the 'spring': When UST > $1, the system allows you to mint 1 UST with LUNA worth $1 (then you can sell UST for profit). This increases UST supply, bringing its price down.
Arbitrage maintenance: When UST < $1 (for example, $0.98), the system allows you to destroy 1 UST in exchange for LUNA worth $1. You buy UST at a low price to destroy it, exchanging for high-value LUNA to sell for profit. This reduces UST supply, causing its price to rise.
The core assumption of this model is: arbitrageurs always exist and have enough profit to drive them to maintain the peg. It completely outsources the responsibility of maintaining stability to the profit-seeking instincts of the market.
2. The death spiral: When 'trust' is devoured by 'panic'.
In early May 2022, several seemingly independent events overlapped, igniting the fuse:
Macroeconomic environment: The Federal Reserve raises interest rates, global liquidity tightens, and risk assets are under pressure.
Massive withdrawal from UST: Hundreds of millions of UST were withdrawn from the Anchor protocol.
Precise targeting suspicions: Some whales began to sell off UST on a large scale while establishing short positions on LUNA in the market.
Then, the classic dominoes fell:
First card: Decoupling and arbitrage failure.
UST's price first slightly decoupled, dropping to $0.985. As designed, arbitrageurs should enter here, buying UST to destroy for LUNA, pushing up UST's price. But the problem arises: to complete this arbitrage, you need to first believe that this system can recover, and have sufficient liquidity to sell the LUNA you acquired. During the initial panic, confidence wavered.
Second card: Panic selling and 'stampede arbitrage'.
As UST further declined, a terrifying 'arbitrage' emerged: people were no longer trying to maintain the peg, but rather to 'escape'. They frantically sold UST and immediately sold the acquired LUNA in the market for any stable asset (like USDT, USDC). This led to:
UST supply surged (all selling), causing prices to drop further.
LUNA supply surged (due to arbitrage + panic selling), causing prices to plummet.
Third card: The death spiral officially started.
This is the most fatal link: LUNA's price plummeted, meaning the 'collateral' (LUNA itself) used to support UST's value was shrinking rapidly. The market began to question: 'If LUNA is nearly worthless, how can it support UST's value?' This skepticism led to more UST being sold, requiring more LUNA to be minted for exchange, further crushing LUNA's price... a perfect, self-reinforcing death spiral formed.
UST decouples → More LUNA minted → LUNA plummets → Confidence collapses → UST further decouples.
In just a few days, LUNA's price plummeted from over $80 to less than $0.0001, erasing $40 billion in market value. That clever mathematical balance was as fragile as a piece of paper in the face of full-blown panic.
3. The 'bloody' lessons for ordinary investors.
The collapse of LUNA was not accidental; it taught all investors the most expensive lesson:
Lesson one: Beware of complex financial engineering that 'fights magic with magic'.
The more complex and reliant a mechanism is on multiple dynamic balances, the greater its vulnerability under extreme pressure. When a system requires the constant introduction of new faith and funds to sustain itself, it is essentially close to a 'faith-supported Ponzi structure'. Simplicity trumps complexity, transparency trumps sophistication.
Lesson two: High 'risk-free' returns are the biggest red flag.
The Anchor protocol's nearly 20% stablecoin yield is the 'hook' attracting massive capital to the ecosystem. But we must ask: where does this yield come from? In the traditional world, yields over 6% raise questions. In the crypto world, those promising double-digit 'stable' returns must be assumed to be either taking risks (investing in high-risk assets) or that the principal of later investors is paying your interest. When you stare at high returns, high returns are also staring at your principal.
Lesson three: Understanding 'correlation risk' and 'systemic risk'.
Many people think, 'I only bought UST, not LUNA, so I'm safe.' But they fail to realize that UST's survival completely depends on LUNA's price and the confidence in the entire system. In a tightly coupled system, there are no islands. The failure of one component will destroy the entire system through the designed transmission mechanisms.
Lesson four: In a collapse, liquidity is the only 'lifeboat'.
When the death spiral started, liquidity instantly dried up. Sell orders hanging on the limit down could never be executed. This teaches us: never invest a position you cannot afford to lose in a single asset or a highly correlated ecosystem. And, be clear about the 'liquidity depth' of the asset you invest in.
4. How do we identify the next 'LUNA'? (Observation checklist)
While precise predictions are impossible, we can establish an observation checklist:
Economic model examination: Does its value capture and system stability rely on 'infinite growth expectations' and 'continuous new capital inflows'?
Questioning revenue sources: Do the high returns it offers have clear, sustainable, and transparent sources? Or do they come from 'treasury subsidies' or 'token inflation'?
Correlation assessment: Are the assets within this ecosystem highly coupled, thriving together and suffering together?
Stress test imagination: In your mind, conduct a 'bank run test' or 'confidence collapse test', imagining whether its defense mechanisms would become a catalyst for accelerated collapse under extreme conditions?
The collapse of LUNA was a painful, global deleveraging experiment. It taught us at the cost of $40 billion: in the financial world, the most powerful force is not mathematics, but human nature; the strongest fortress is not algorithms, but simple values that have stood the test of time and ample collateral.
Do not be blinded by complex designs and dazzling returns. The essence of investing is always to pursue simple, understandable, and risk-reward matching value. When something seems too good to be true, it often isn't.
If you have been paying attention to or involved in the LUNA/UST ecosystem, I hope this review leads to deeper reflection.
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