Terra and Luna: The Fragility of Endogenous Stability

The collapse of TerraUSD, or UST, and Luna in May 2022 demonstrated that targeting a stable price is different from possessing robust redemption capacity. UST used a conversion relationship with Luna to support its dollar peg. If confidence in both the peg and the related token weakens, the stabilization mechanism can amplify selling instead of absorbing it.^[1]

The BIS analysis describes how burning UST in exchange for a dollar value of newly created Luna could accelerate issuance and selling during a run. The SEC's June 2024 announcement addressed the civil fraud verdict and settlement and described approximately $40 billion of market value erased. Market capitalization lost is not interchangeable with every investor's realized cash loss, misappropriated funds or court-ordered amounts.^[1][2]

The legal discussion here is anchored to those identified 2024 civil materials, not a claim that every later proceeding in every jurisdiction has the same status. Structural vulnerability and legally established conduct should be evaluated separately.

Our analysis emphasizes circular dependence. Where redemption delivers another token whose value depends heavily on confidence in the same ecosystem, a wave of redemptions can become a wave of sales of that token. A lower token price requires more units to represent the promised dollar value, potentially adding further selling pressure. This differs from access to sufficient independent external redemption resources.^[1]

Arbitrage can narrow deviations in normal conditions, but it still requires counterparties and executable liquidity. Receiving tokens with a quoted value of one dollar is not necessarily equivalent to receiving one dollar in cash during distress. A stabilization model must therefore examine the ability to sell or redeem at scale, not only its conversion arithmetic.

A high advertised yield does not demonstrate sustainable economic profit. Researchers should identify whether payments come from operating cash flow, subsidies, token issuance or new funding. High yields alone do not prove that every product is fraudulent, but an unexplained source of return should trigger analysis of cash flows and loss allocation before attention turns to the headline rate.

Price stability and an investment contract also involve different risks. A token designed to trade near one dollar can be deposited into a product that introduces borrower, platform, collateral and redemption risks. The denomination of the initial contribution does not guarantee the principal of the entire arrangement.

It is incorrect to assume that every stablecoin has the same failure mechanism. External reserves, overcollateralization, algorithms and issuer redemption obligations create different structures. None should be treated as risk free without examining reserve liquidity, custody, redemption eligibility, processing times and legal priority.

Even apparently liquid reserves may not prevent a market discount where the holder lacks a reliable redemption route. The relevant question is how value reaches the claimant under stress, not merely what appears on a reserve list.

A practical process begins with a cash-flow diagram: who supplies funds, who generates returns and what is sold to meet a large redemption request? Stress analysis should test whether supporting assets and customer confidence deteriorate together. For Bitcoin holders, the episode also demonstrates that the stablecoin used as trading cash introduces a separate exposure from Bitcoin itself.

Test whether users would remain without subsidies or elevated rewards. Deposits seeking incentives differ from demand for payment or storage utility. If reserve value and token value depend on the same confidence, both can weaken together. Holding instruments with different names does not establish independent risk diversification.

Imagine a voucher promising that a 1,000-won claim can be exchanged for 1,000 won of shares in the same shop. If customers stop trusting the shop, redeem their vouchers and sell the shares, the share price falls and more shares must be issued. Both promises depend on the same confidence and can weaken together.