LUNA Collapse in May 2022

In May 2022, bearish crypto conditions resulted in the depeg and subsequent collapse of LUNA and UST which crashed from over $80 to $0.69 in the space of five days. UST is the stablecoin which can be minted using LUNA as part of the Terra ecosystem which was founded by Do Kwon.

The collapse wiped over $40b in value from the Terra ecosystem and the wider cryptocurrency market subsequently declined by over 20%.

Background

UST is an algorithmic stablecoin which can be minted by burning LUNA. The redemption mechanism lets a user mint LUNA by burning UST which put further sell pressure on the stablecoin peg. In case of a depeg event, this mechanism adds severe sell pressure on LUNA as more people burn UST to then sell LUNA.

To alleviate concerns about a death spiral, the Terra foundation purchased several billion dollars of Bitcoin that could be used to help stabilize the peg in case of pressure on UST and LUNA.

Timeline

Initial depeg

Over the 7th of May, 9 figures of liquidity was removed from the Curve Finance pool resulting in widespread panic and a depeg of around 2% which was quickly brought under control. Do Kwon implied on Twitter there had been a coordinated attack to create panic and destabilize the peg by simultaneously removing funds from Anchor and Curve Finance. The Luna Guard Foundation also announced it had loaned $1.5b as an additional effort to protect UST.

Rescue efforts and second depeg

As concern for a death spiral kept mounting, The Block reported that the Luna Foundation Guard was raising over $1b to prevent any further damages. The deal would allow several large investment firms to purchase discounted and locked LUNA tokens.

Binance UST Chart

When the price of LUNA kept declining, rumors spread that the deal had fallen apart and that the bailout would not be coming after all and UST further declined to a low of $0.22. LUNA also fell by over 90% to a low of $0.69.

Do Kwon tweeted that Terra would increase the redemption capacity of UST to allow the peg to stabilize quicker. This would result in more LUNA being in circulation, with some crypto twitter users estimating a 6x increase in circulating supply. From May 11th to 12th, it resulted in LUNA’s supply increasing from 1.5 billion tokens to 163 billion tokens. On May 12th, LUNA hit a low of $0.00079.

On May 13th, Do Kwon released a Terra Ecosystem Revival Plan on the Terra forum. If approved, this proposal would reset the network ownership to 1B tokens and have a new distribution plan.

On May 14th, LUNA rebounded over 1,500% from lows and overtook UST market cap for the first time since the beginning of the depegging event. Terra announced over Twitter that a post mortem report would be coming as soon as possible.

On May 16th, the Luna Foundation Guard released a Twitter thread detailing how they sold over $3b in assets to defend the UST peg.

Terra Ecosystem Revival Plan 2

Do Kwon released a Twitter thread and governance proposal detailing the plans to fork Terra. Under this new proposal, Terra would create a new chain and the previous chain would remain active under “Terra Classic.”

UST would no longer be used and the chains would not have new algorithmic stablecoins. Terra Classic would have Luna Classic (LUNC) while the new chain would remain Terra (LUNA).

Under this proposal the newly forked network will be distributed as follows:

1,000,000 LUNA Tokens

• 25% - Community pool, controlled by staked governance
• 1% - Essential Developers emergency allocation, no lockup
• 4% - Essential developers (1 year cliff, 4 year vesting thereafter, granted after launch traction)
• 35% - All bonded / unbonded Luna, minus TFL at “Pre-attack” snapshot
  • For wallets with < 1M Luna: 1 year cliff, 2 year vesting thereafter
  • For wallets with > 1M Luna: 1 year cliff, 4 year vesting thereafter
• 10% - Luna holders (staking derivatives included) at the “Launch” snapshot - 10% unlocked at genesis, 90% vested over 2 years thereafter
• 25% - UST holders at the “Launch” snapshot - 10% unlocked at genesis, rest vested over 2 years thereafter

If passed, the network has a planned launch for May 27th. The official vote on Terra Station went live on May 18th. On May 20th, the vote sat above the pass threshold by a wide margin.

Chainlink Oracle failure

On the 12th of May 2022, Venus on BSC and Blizz Finance on Avalanche were exploited for $13M and $6M respectively. It was revealed the LUNA oracle had a lower limit of $0.10. When the price of LUNA crashed to $0.00005, attackers were able to provide collateral and borrow a lot more than it was worth.

On the 15th of May 2022 Blizz Finance published a post mortem on Medium So far there´s no official communication from Chainlink on the issue, some tweets claim: "Chainlink´s circuit breaker worked as expected". Chainlink´s documentation exposes ways to mitigate risk, though the oldest version of such documentation from November 2021 on Archive.org Wayback machine doesn´t include the suggested steps for risk mitigation.

Aftermath

US Treasury Secretary Janet Yellen mentioned the depeg event to suggest the need for further regulation of stablecoins.

Citadel and BlackRock denied involvement in the attack against Luna after rumors surfaced on Twitter that the two firms were involved in the attack.

Terra TVL went from $35b to less than $3b in five days. TVL for the entire DeFi industry declined by over 50%. From May 7th to May 11th, Anchor’s UST deposits depleted from $17b to $2.6b.

As wider concerns for the health of stablecoins spread in the markets, Curve Finance saw a lot of traders swapping away from Tether's USDT, which made the stablecoin drop slightly to $0.95. Another algorithmic stablecoin called USDN also fell to as low as $0.78.

Crypto markets also declined by over 20% with some currencies tied to the Terra ecosystem falling by over 60% in two days.

It was revealed that Do Kwon was the founder of a previously failed stablecoin project, Basis Cash.

From May 9th to the 12th, LUNA supply has increased 35,000% as that is part of the mechanism to restore peg to UST.

Terra validators have decided to halt the Terra chain to prevent governance attacks following severe $LUNA inflation and a significantly reduced cost of attack. Terra blockchain was officially halted at a block height of 7603700.After patching the code and disabling validators, Terra blockchain resumed block production.

An investor who lost over $2m visited Do Kwon’s house and left after questioning Do’s wife for his whereabouts.

South Korea's ruling party called for Do Kwon to attend questioning at a parliamentary hearing regarding the collapse.

Terraform Labs legal team resigned and the company is using outside counsel.

South Korea’s government is seeking a $78.5m tax payment from Terraform Labs/Do Kwon. Kwon later stated they had no tax liabilities in South Korea.

The Seoul Metro Police sought to freeze Luna Foundation Guard assets after finding clues of embezzlement.

Firm losses

Several investment firms and venture capital funds suffered large losses. The exact amounts are difficult to verify.

• Arca - Published investor letter in May 2022, describing the de-peg as a buying opportunity.
• Delphi Digital - Rumors of $500m loss.
• Arrington Capital - $100m UST yield fund.
• Galaxy Digital - $300m loss (no mention of cause.)
• 3 Arrows Capital - promoted and invested in LUNA. The CIO's Twitter posts implies that they lost money.