Terra was one of the crypto market’s most high-profile disasters. In a number of days in mid-2022, the network spiraled out of control, crashing headfirst into the ground and snuffing out about $60 billion of investors’ money. The fallout wiped out hedge funds like Three Arrows Capital and contributed to the bankruptcies of lenders like Celsius and BlockFi. Oops! But what happened? 

How Terra Worked

First, the rise: Terra’s innovation was to create a US Dollar stablecoin that wasn’t backed by, you know, actual money. 

That’s a big departure from the way that stablecoins like USDC or USDT (Tether) operate: tokens that are issued in return for (at least, according to their websites) deposits of real deposits of US dollars. The tokens are therefore always worth a dollar, and the dollars are invested in safe assets like US treasuries and other cash equivalents. 

Terra, launched by Do Kwon and Daniel Shin, operated quite differently. The network was comprised of, principally, two tokens. The first was a stablecoin called USD Terra (or UST for short) and the second was a volatile token called LUNA. The two tokens were linked and, crucially, could always be traded for each other. 

Whenever UST fell below a dollar, traders could buy it up in exchange for any LUNA they had spare in order to kick the price back up to dollar parity. And if UST’s value rose above a dollar, traders could sell it for LUNA and knock it back down to its dollar peg. Anyone participating in this kind of arbitrage could net a tiny profit that, over time, could result in big returns.

Huh? So How Did Terra Work?

As you may have guessed, the stability of UST was wholly dependent on traders being able to sell it for LUNA, whose value was pretty much arbitrary and grounded merely in “confidence” in the Terra LUNA project. (Unlike, say, dollar reserves or an underlying productive enterprise.) If people lost confidence in LUNA, then UST would have no mechanism by which to stabilize its price. This was common knowledge but for some reason, people didn’t mind. 

In any case, Kwon confidently batted away his critics on Twitter, going so far as to tell the world that he refused to debate with “poor” people. Other would-be naysayers benefited by staking their UST on Anchor, one of Terra’s many DeFi (decentralized finance) protocols, for a 20% annual return.

Others were placated by Terraform Labs’ links to Chia, a major Korean payments network. However, it later emerged that these links were overblown and that Chia did not run on Terra.

Oh, Right, It Didn’t Work

Finally, one day in May 2022, the whole thing came crashing down. The reasons are murky—perhaps the appetite for US stablecoins had soured in a high-interest rate environment, perhaps too many people rushed for the exit, or perhaps people just lost interest in crypto. The important thing is that it failed—and fast.

Critics called it a “death spiral.” LUNA lost 99.99% of its value in a number of days. And because people no longer cared about LUNA, UST didn’t rebound in the way that people hoped, so it careened downwards, too.

In the meantime, Kwon practically disappeared. He remained active as CEO but couldn’t be found; Korean authorities, among many investigating Kwon and his company, Terraform Labs, for innumerable crimes, thought he had fled to Serbia. 

Nope! Totally Just Didn’t Work

TFL even relaunched Terra under the same name—minus the failed stablecoin—and renamed the original chain Terra Classic. Few people are using it, as of April 2023. And in March 2023, authorities in Montenegro arrested Kwon, who had been traveling using false documents. 

Whether Terra will rebound remains an open question, but it’s clear that it’ll be an uphill struggle. Meanwhile, other decentralized stablecoins, like Frax and MakerDAO, remain solvent and reliable. They are both backed in part by crypto but cautiously so, and with plenty of actual assets in the mix.