http://doi.org/10.65281/660912
Pr.Yousfate Ali
Spatial and Environmental development Laboratory Studies (SEDLAB), Adrar University, Algeria.
Dr.Ben Abedelkabir Hassen.
Spatial and Environmental development Laboratory Studies (SEDLAB), Adrar University, Algeria.
Pr. Mostéfaoui Sofiane
Spatial and Environmental development Laboratory Studies (SEDLAB), Adrar University, Algeria.
Reception : 12.02.2025
Acceptance:14.09.2025
Publication:12.12.2025
Abstract :
The cryptocurrency market witnessed an unprecedented expansion during the 2020 2021 period, culminating in Bitcoin reaching an all-time high of USD 68,789. This surge was driven by expansive monetary policies, heightened risk appetite, and increased institutional participation. However, the macroeconomic environment shifted sharply in 2022 as the global economy faced stagflationary pressures. Aggressive monetary tightening by the U.S. Federal Reserve, successive interest rate hikes, and the appreciation of the U.S. Dollar Index collectively triggered a severe contraction in risk assets, leading to a collapse of approximately 68% in the overall cryptocurrency market capitalization. Within this context, the failure of the Terra Luna ecosystem represents one of the most significant systemic shocks in the history of decentralized finance. Launched in 2019 by Terraform Labs, Terra aimed to establish a decentralized payment infrastructure through an algorithmic stablecoin, TerraUSD (UST), designed to maintain parity with the U.S. dollar and compete with dominant stablecoins such as Tether. The project facilitated capital flows between crypto assets and fiat equivalents, thereby playing a central role in the broader digital financial system. Nevertheless, structural vulnerabilities embedded in its stabilization mechanism ultimately led to a loss of confidence, triggering a death spiral that resulted in the evaporation of nearly USD 45 billion in market value. This paper examines the mechanisms underlying the collapse of Terra Luna, identifying its fundamental causes, analyzing its repercussions on the cryptocurrency market and investor confidence, and extracting key lessons for the design, regulation, and risk management of stablecoins and decentralized financial systems.
JEL E32 E49 E59
Keyword: Cryptocurrency, Stablecoin, Terra Luna, Collapse, Blockchain .
- INTRODUCTION :
The crypto market is one of the promising and polarizing markets for many individual and institutional buyers, which witnessed a great boom, especially between 2020 and 2021. At this period, Bitcoin reached its highest peak on November 10, 2021 at 68,789 USD, a period during which the crypto market witnessed a great boom and many projects had been launched. In the same context, the new and the existing currencies flourished; and the market value of the crypto reached a maximum on November 10, 2021 at 3,048 billion US dollars. However, the stagflation crisis that the world is experiencing during 2022 and the tight policy of the Federal Reserve, raising interest rates and the rise of the US dollar index led to the collapse of global financial markets and the Crypto market is not the exception. The latter fell by 68%, when the market value of the crypto market reaches $972.47 billion only by September 28, 2022. (de-Best, 2022).
During the declines that the Crypto market suffered, there was a failure that put the reputation of this market at the stake and led to the evaporation of $ 45 billion of market value during the irreversible days (Miller, 2022). This fact was due to the Terra Luna project. This project was established in 2019 by the developers of Terraform Labs whose boss was Do Kwon (who will be responsible to the US and South Korean courts for the collapse (Cha, 2022) (Court, 2022)). The creation of a Stablecoin that competes the most powerful Stablecoin Tether (USDT) equivalent to 1 US dollar and thus a tool for money transfer from Crypto market to US dollars (Fiat Money) via Stablecoin (Ledbetter, 2022).
In this paper, we try to study Terra Luna, its mechanisms of action, the causes of its collapse as well as the repercussions of its downfall, and the learned lessons.
- STABLECOIN DEFINITION:
Stablecoins are intended to trade at the same value as a reference asset. (Dollar-pegged stablecoins are envisioned to trade for around $1.) Tether, the first stablecoin, was established in 2014, and there are presently at least six other dollar-linked stablecoins in circulation with over one billion coins (USD Coin, Binance USD, Dai, TerraUSD, Paxos Standard, and TrueUSD). Stablecoins were originally designed to compensate for the lack of efficient fiat on and off ramps on crypto exchanges, but they are now primarily used by traders to move in and out of cryptocurrencies, arbitrage price differences between exchanges, and within decentralized finance (DeFi) applications ((Catalini Christian and de Gortari Alonso, 2021)).
One of the advantages of Stablecoins is that they have a fixed value around the currency they are pegged to (e.g. the US dollar) so that they can be a more reliable store of value for investors, unlike the extreme volatility of Ethereum, Bitcoin and other cryptocurrencies.
Another benefit of stablecoins is that they are on a blockchain that is accessible to global users, so users do not need multiple international bank accounts to send cryptocurrencies to individuals in other countries; they only need one crypto wallet with stablecoins (Tan, 2022).
There are four main types of stablecoins (Iredale, 2021):
Figure. 1 : Types of Stablecoins
- FIAT-COLLATERLIZED STABLECOINS :
It is the stablecoins backed by fiat money such as the US dollar or the euro or others at a ratio of 1:1. The 1:1 ratio indicates that one stablecoin will be equal to one unit of fiat currency, and therefore the currency has liquidity in banks to respond to the needs of investors.
- COMMODITY-BACKED STABLECOINS:
Other stablecoins backed by assets such as real estate, oil, and precious metals aside from gold, the owners of the stablecoins backed by commodities primarily exercise ownership of tangible assets of real value. This is a huge advantage over the majority of cryptocurrencies.
- CRYPTO-BACKED STABLECOINS:
They are stable currencies supported by cryptocurrencies, which are the most private and decentralized. They are not associated with any one entity that controls your money, but the problem of cryptocurrencies is the high volatility that can rise more than 100% and vice versa. These problems can be solved by diversifying the encrypted currencies in its portfolio and every dollar of stablecoin is accepted by $2 of cryptocurrency so that if it goes up, the stablecoin stock will strengthen further and if it goes down up to 50%, the break- even point is reached.
- ALGORITHMIC STABLECOINS: THE NON-COLLATERALIZED STABLECOINS:
Algorithmic stablecoins might provide stability based on market supply and demand. It is also worth noting that algorithmic stablecoins have the maximum amount of decentralization and independence. Such algorithmic versions of blockchain, on the other hand, rely on continuous expansion to ensure success. You should be aware that there is no collateral involved with algorithmic stablecoins for liquidity, and anybody can lose money in the event of a crash.
This type of stablecoin will be the focus of this paper through the Terra Luna project
2. THE MECHANISM OF TERRAL LUNA MODEL:
Terra Luna is a blockchain protocol and algorithm-based payment platform for a stablecoin known as TerraUSD (UST), with its backing currency Luna, where the price of TerraUSD (UST) is fixed at one US dollar by raising or lowering the unit value of the Luna.
The TerraUSD is linked to the US dollar using a simple arbitrage mechanism: a 1:1 peg of UST to USD (Viswanath Natraj, 2019)
Cryptocurrency for the Terra Luna project was established in 2019. The Terra platform uses a “proof-of-stake blockchain” and features much faster cryptocurrency settlement than Bitcoin (Ledbetter, 2022). The project also provides the Blockchain for new cryptocurrency projects (Tokens) and the conclusion of a smart contract on it.
The working mechanisms of the Terra Luna model are as follows:
A sibling token, Luna, whose value was determined by the market, was connected to TerraUSD. A holder of $1 in UST would always receive $1 in value back since one UST was set to be equivalent to $1 worth of Luna, even though the quantity of Luna given over in an exchange for UST would fluctuate. This gave traders arbitrage incentives that were intended to maintain the value of UST at or around $1. (Shen, 2022).
Anytime, a floating quantity of Luna with a market value of $1 can be traded for one UST. The smart contracts set up to sustain the system remove the money from circulation once any of them is exchanged.
There is an incentive to swap $1 worth of Luna for one UST, which is worth more than one dollar. The fact is generating an immediate profit when the market value of one UST is more than one dollar. Consequently, this lowers the price of UST by increasing the supply of UST.
Inversely, there is an incentive to sell one UST, which is currently worth less than $1, for $1 worth of Luna in order to make an immediate profit while the market value of one UST is less than $1. By removing some UST from circulation, this raises the cost of UST. (Shen, 2022).
The Luna coin was also designed as a shock absorber for UST price fluctuations, and for this price-fixing mechanism to work, users could redeem1 UST for one USD from Luna, even if the UST was worth less than one USD. However, this mechanism would later lead to one of the biggest crashes in the crypto market (Tan, 2022).
- THE DEVELOPMENTS OF THE COLLAPSE OF TERRA LUNA PROJECT:
The following chart shows the price of Terra USD, which is supposed to be worth ± 1 US dollar (slight difference), as it is noted that the value of Terra USD was maintained equivalent to 1 US dollar since it is from Stablecoin with daily trading volume (24 hours) that reached $2.81 billion (9-5-2022). (A market value of about $18 billion see Figure A-2). The same day that preceded the beginning of the gradual massive collapse of the currency during the next two weeks, the daily trading volume has increased, reaching 7.68 billion US dollars, because many investors and traders believed that the decline of the Terra USD currency and the Luna currency is an emergency and will return to the parity point. The trading levels recorded only by the leading currencies in the crypto market Bitcoin (BTC), Ethereum (ETH) and Tether (USDT). However, 1USD = 0.7994 UST, that is, it lost 20%, which is a critical value and unacceptable volatility in Stablecoin, (acceptable volatility ±0.5percentage). After it became clear to traders and investors that the Terraluna project was in bad shape. Trading on Terra USD currency as the volume of daily trading on it $ 78.64 million, a decrease of 97%, and the value of one USD = 0.05753UST decreased (5-22-2022), the collapse continued as the daily trading volume was only $ 8.4 million, a decrease of 99.7%, i.e. a total collapse where 1USD=0.008UST (See Figure A-1).
Figure A-1: The chart of TerraClassicUSD USTC (Price)
Source: Coinmarcketcap, available at link: https://coinmarketcap.com/currencies/terrausd/
Figure A-2: The chart of TerraClassicUSD USTC (Market cap)
Source: Coinmarcketcap, at link: https://coinmarketcap.com/currencies/terrausd/
On the one hand, the Luna currency, which was the darling of traders, was marketed as a currency with a promising and strong project; and that it would compete with Ethereum and Bitcoin. It rose from about one dollar to reach the highest price of 116 dollars with a daily trading volume of 2.48 billion dollars (4-5-2022) within a year and a half, an increase of 8800%, and the maximum market value of the Luna currency reached about 41 billion dollars (4-4-2022). However, after the collapse of the Terra Luna project algorithm, the value of the Luna currency reached a few cents, as its price amounted to 0.00009591 dollars with a daily trading volume of only 99 million dollars (4-6-2022). Knowing that it witnessed a collapse of significant daily trading volumes amounting to 15.9 billion dollars (12-5-2022), its collapse rate reached 99% (see Figure A-3, A-4).
Figure A-3: The chart of Terra Classic Lunc (Price)
Source: Coinmarcketcap, at link: https://coinmarketcap.com/currencies/terra-luna/
Figure A-4: The chart of Terra Classic Lunc (Market Cap)
Source: Coinmarcketcap, at link: https://coinmarketcap.com/currencies/terra-luna/
With the spread of news about the bad situation of the Luna currency and the attempt of the Terra Luna developers team to rescue it and sell them their stock of Bitcoin (see Figure A-5) of about 71,000 bitcoins supporting the Terraluna project. In addition to the attack of large traders and their forging in the future on the currency Luna and investors selling their stocks of the Luna currency and the deteriorating situation of Bitcoin during that period after its great descent from its historical peak of 67.54 thousand per grain (9-11-2022). This which eventually led to the largest collapse in the history of Crypto and the loss of approximately $ 45 billion of investors’ money (Miller, 2022), and the loss of the Crypto market is a large part of its reputation, which harmed other promising and strong projects in the crypto field.
Figure A-5: The volume of bitcoin sold by Terra Luna project.
Source: It is possible to search for Terra Luna transactions on the smart contract network at the following link: https://bitinfocharts.com/bitcoin/address/ bc1q9d4ywgfnd8h43da5tpcxcn6ajv590cg6d3tg6axemvljvt2k76zs50tv4q
The collapse of Luna led to a huge hit to the crypto market, and with the number of coins that had its origins in Luna as a reserve or invested as a supporter of their currencies or working on Terra Luna’s own blockchain, the sale of bitcoins that supported Terra Luna by its project team (see Figure A-5). Ultimately, Bitcoin led to a major fall during that period, and while Bitcoin was the leader in the crypto market, it dragged the rest of the currencies towards the fall. This crisis has affected the further deterioration of the Bitcoin price, as it lost during this crisis over a period of 45 days 52.34% (see Figure A-6). Due to the volume of liquidations that were taking place to get rid of the Luna beads stored by the investors, as well as the shorts in the future on Luna, eventually led to the UST and Luna being stopped trading on the largest crypto trading platform Binance (13-05-2022), ( Binance Team, 2022).
Figure A-6: BTC and Luna cryptocurrencies movements.
Source: Updated by Researchers
- THE CAUSES OF COLLAPSE:
The trading price of UST reached roughly 98 cents on Saturday, May 7, and remained there for a longer period than arbitrage theory would have predicted. This is comparable to a money market fund “breaking the buck” broadly speaking. Large amounts of UST (worth billions of dollars) were removed from a number of protocols, indicating either a general lack of confidence in the coin’s value or, as some have speculated, a planned attempt to capitalize on a sharp decline in its value. UST has drastically declined; as of May 13 at noon, it is selling at around 15 cents. A worse outcome befell LUNA, which has been trading for less than a cent since May 12 and caused Terraform Labs to reset its blockchain (Ledbetter, 2022).
One of Terraform Labs’ most important projects is the Anchor project (ANC) which is based on storing the UST liquid at 20% per annum, and it is an attractive return far higher than the interest rates of any traditional bond or bank accounts. In addition to the confidence of investors around the world in UST, billions of dollars have entered into Anchor, and this is one of the reasons for the rise in value UST logistic and Luna at the short time.
Given the money received by Terraform Labs., (Vote) Terra has voted to allocate $1.5 billion to stabilize UST through a new “Luna Foundation Guard” to buy Bitcoin to support the currency project. (Protos-Staff, 2022). Terra decided to spend $1.5 billion to purchase Bitcoin in order to stabilize UST with a new “Luna Foundation Guard”.
- DISCUSSIONS:
After failing to save their project from collapse, the Terraform Labs team created a new coin LUNA 2.0 and separated it from the Terra stablecoin, keeping the old coins called TerraClassicUSD (USTC) and Terra Classic (LUNC) (Shukla & Nicolle, 2022) (Muyao). , 2022). These coins are still operating on the largest Binance trading platform and are achieving some heights, but not with the momentum and levels that were known previously.
– The collapse of the Terra Luna project led to a reconsideration of the way to invest in the crypto market, after it was based on staking or holding coins for a period of up to 6 months or a year or more and benefiting from increases that may reach 1000% and more. Unfortunately starting from 2022, all cryptocurrencies collapsed by 70%-100% and there are many currencies that collapsed completely and trading on them was stopped.
– Since the Crypto market is not subject to any official or regulatory body, it increases the possibilities of the emergence of Ponzi cryptocurrencies and the waste of more investors’ money.
– Most of the trading platforms are institutions registered in tax havens, and a few of them are registered in the United States such as the largest registered Binance platform Cayman Islands, and the branch of the platform Binance.us is registered in the United States.
– The Crypto market is still a profitable market and full of opportunities. However, this stage with the collapse of the markets which is due to the global economic crisis 2022 and the prevailing state of uncertainty, we must stay away from investment and long-term storage and be satisfied with only speculation in all its forms (Scalping, , Day trading, Swing trading, position trading).
– The Crypto market is still a profitable market and full of opportunities. However, this stage with the collapse of the markets which is due to the global economic crisis 2022 and the prevailing state of uncertainty, we must stay away from investment and long-term storage and be satisfied with only speculation in all its forms (Scalping, , Day trading, Swing trading, position trading).
– Since Stablecoins are important for trading, you should choose Stablecoins backed by real liquidity or real assets such as Tether to some extent, BUSD backed by the world’s largest trading platform Binance, and USDC, the stablecoin of the big American platform Coinbase.
– Stablecoin fears have only grown since the TerraUSD crisis. At a Senate Banking Committee hearing on May 10, 2022, Treasury Secretary Janet Yellen said: “The stablecoin known as TerraUSD has seen a stampede and depreciation.” “I think this simply shows that this is a fast-growing product and that there are risks to financial stability and we need a framework A proper job.” (Ledbetter, 2022).
6. CONCLUSION:
Crises are a natural part of the movement of global financial markets in general and the crypto market in particulars as it is a highly profitable and a high-risk market. The Terra Luna crisis was one of a number of many crises, but what is distinctive about it is that it led to the collapse of a leading currency that surpassed the leader currency such as Cardano (ADA), Ripple (XRP) and its performance was close to that of Ethereum and Bitcoin. In light of the uncertainty witnessed in 2022 by the stagflation and the strength of the US dollar, liquidity dried up from the markets and the cost of borrowing rose, this fact led to an increase in the market contraction Crypto, although there are still opportunities for traders to profit from declines in the volatility of cryptocurrencies. However, as a precaution, it is necessary to withdraw part of the profits and invest them in reality.
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