Source-linked AI summary
Anatomy of a Stablecoin's failure: the Terra-Luna case
Antonio Briola, David Vidal-Tomás, Yuanrong Wang, Tomaso Aste
TL;DR
The paper addresses the failure of Terra’s algorithmic stablecoin system and its dependence on Anchor. It reconstructs the collapse using heterogeneous news, market and transaction data, and cryptocurrency network analysis, identifying BTC’s reference role during the first phase and 05 May 2022 as a potential fuse. However, the authors cannot confirm that a coordinated attack or BTC short positions caused the collapse.
Problem
Terra’s failure had not been addressed in the cryptocurrency literature, despite the project’s dependence on Anchor and the collapse of UST and LUNA.
Method
The paper systematically organizes heterogeneous news, analyzes hourly and transaction data for BTC, LUNA, and UST, and studies dependency structures among 61 cryptocurrencies.
Results
BTC had a reference role during the first phase of the collapse, while 05 May 2022 was identified as a potential fuse and the network methods captured cryptocurrency dependency structures robustly.
Takeaways & Limitations
The findings provide quantitative insights into Terra’s collapse and identify intense selling pressure and potential trigger events without establishing a coordinated attack.
Takeaways & Limitations
The authors cannot confirm the existence of a coordinated attack or short-selling positions against BTC described by social media sources.
Abstract
from arXiv · showhide
We quantitatively describe the main events that led to the Terra project's failure in May 2022. We first review, in a systematic way, news from heterogeneous social media sources; we discuss the fragility of the Terra project and its vicious dependence on the Anchor protocol. We hence identify the crash's trigger events, analysing hourly and transaction data for Bitcoin, Luna, and TerraUSD. Finally, using state-of-the-art techniques from network science, we study the evolution of dependency structures for 61 highly capitalised cryptocurrencies during the down-market and we also highlight the absence of herding behaviour analysing cross-sectional absolute deviation of returns.
1. Introduction
Terra’s algorithmic stablecoin design paired UST with LUNA and relied heavily on Anchor’s high-yield demand, leaving the project exposed to severe market stress. In May 2022, a de-pegging event and subsequent selling pressure produced a death spiral, although the alleged coordinated attack remains unconfirmed.
- Terra’s design: UST was stabilized through arbitrage between UST and LUNA, allowing traders to exchange $1 worth of either token regardless of market prices.The mechanism contracted or expanded the UST pool by burning UST and minting LUNA when prices diverged from the peg.
- Terra’s design: Anchor held 75% of circulating UST while offering depositors a 20% annual percentage yield, creating a strong dependence on the protocol.This dependence left Terra heavily exposed to extreme market conditions.
- Collapse mechanism: When UST holders redeemed their positions, UST was burned and LUNA was minted and sold, intensifying LUNA’s decline and encouraging further UST selling.The resulting vicious cycle is described as a bank run or death spiral.
- Collapse mechanism: The reported collapse fuse involved BTC short selling and a 07 May 2022 Curve-3pool liquidity pool attack that pushed UST below $0.99.The Curve-3pool event caused the first UST de-pegging.
- Collapse outcome: LUNA and UST fell from $87 and $1 on 05 May 2022 to below $0.00005 and $0.2 on 13 May 2022, respectively.Potential attacker profits were estimated at over 800 millions.
- Broader fragility: The paper identifies algorithmic stablecoins’ reliance on uncertain demand, arbitrage participation, informational efficiency, and intrinsic economic use as sources of fragility.The authors also note that such factors become tenuous during financial crises or extreme volatility.
- Contribution: The Terra-Luna case had not previously been addressed in the cryptocurrency literature, motivating the paper’s first systematic insights into the project’s failure.The paper organizes heterogeneous news sources to study the collapse.
2. Data and quantitative nature of the events
The paper combines hourly price and return data, exchange transactions, and Anchor statistics to quantify Terra’s collapse and its trigger sequence. The evidence identifies repeated UST de-pegging, strong selling pressure, and Anchor’s severe deposit loss during the failure.
- Data and methods: The analysis uses hourly log-returns and market returns for 61 cryptocurrencies from 01 May through 16 May 2022, including Kraken transaction data for LUNA, UST, and BTC.The market’s descriptive statistics show a negative tendency during this period.
- Hourly data analysis: Hourly closing prices for LUNA, UST, and BTC mark four trigger events between 05 and 11 May 2022.The events occurred on 05 May 12:00, 07 May 22:00, 09 May 14:00, and 11 May 10:00.
- Hourly data analysis: UST first lost its dollar peg on 07 May, briefly recovering to around $0.995 after LFG intervention.The first de-pegging followed the Curve-3pool liquidity-pool attack described in the paper.
- Hourly data analysis: UST lost its peg again on 09 May, producing the main decline in both LUNA and UST prices.The final attempted defense on 11 May briefly lifted UST to $0.8 before the market interpreted it as a signal of Terra’s expected death.
- Transaction data analysis: Transaction data show strong BTC selling pressure on 05 May and markedly greater UST selling pressure after the second de-pegging.The post-second-de-pegging pressure was much higher than after the first, consistent with reported whale-sized UST sales, although the paper cannot confirm a coordinated attack.
- Anchor protocol: Anchor deposits increased 3826% before the collapse, represented 75% of circulating UST, and then fell by around 9.5 billion UST, or 69% of deposits.The protocol maintained deposit interest near 20%, and depositors sold UST once the Terra system and high-interest mechanism appeared at risk.
3. Methodology
The paper models cryptocurrency dependencies with exponentially weighted Pearson correlations and TMFG network centrality, then tests herding through CSAD regressions on market returns.
- Network analysis: The analysis uses Pearson correlations to model linear cryptocurrency relations, with exponentially smoothed weights that emphasize recent observations.The weighting is intended to reduce stress-related sensitivity and distinguish genuine from spurious correlations.
- Network analysis: 24-hour rolling windows advance hourly, and the smoothing factor θ is set to 0.3.The authors report that results are consistent with different θ values.
- Network analysis: TMFG filters the dependency network while retaining meaningful multi-asset interactions under topological constraints, and eigenvector centrality measures asset influence.Higher eigenvector centrality indicates connection to other highly central cryptocurrencies.
- Herding analysis: Herding is assessed with CSAD, whose dispersion is regressed on absolute and squared market returns, including separate up-market and down-market terms.The asymmetric specification uses dummy variables for nonnegative and negative market returns.
4. Results
The Terra collapse produced a sharp, time-localized change in cryptocurrency correlations and network centrality. Despite elevated co-movement, the analysis finds no herding and limited market-wide damage.
- Correlations and network analysis: From 09 May 2022 12:00 to 11 May 2022 10:00, market correlations increased continuously before stabilizing briefly around 0.8.The exponentially smoothed measure weights recent hours more heavily, indicating sustained high co-movement through 11 May.
- Correlations and network analysis: The main market reaction to Terra coincided with the largest decreases in UST and LUNA prices, after which correlations declined across LUNA, UST, BTC, and Kraken.The authors interpret LUNA and UST as effectively excluded from the system after their collapse.
- Network centrality: BTC had higher eigenvector centrality from 05 May 2022 12:00 to 07 May 2022 22:00, potentially indicating influence during the initial down-market.After the first Terra de-pegging, LUNA briefly entered the network core before losing centrality and being completely excluded after 11 May 2022 10:00.
- Network centrality: The first Terra de-pegging temporarily made LUNA central to the cryptocurrency dependency structure.The corresponding TMFG is reported for 07 May 2022 22:00 UTC.
- Herding analysis: The Terra collapse did not produce herding: CSAD results show positive coefficients for absolute market returns and nonsignificant coefficients for squared returns.The absence of herding remains under 7-day rolling windows and after removing stablecoins.
- Herding analysis: BTC and ETH had less negative average performance than the market average of −0.0031, while the authors report limited market-wide damage.They attribute this result to the absence of herding and BTC’s low reaction, while presenting the investor interpretation as a conjecture.
5. Robustness analysis
A Binance-based robustness analysis broadly supports the Kraken findings but reveals exchange-specific pressure patterns for BTC and UST.
- Data and robustness: Binance is used only for robustness analysis because its BUSD-denominated cross-rates may create inconsistencies in comparative studies.The remaining results are described as consistent with Kraken and are available upon request.
- BTC and UST pressure: On 05 May 2022, Binance shows a high positive BTC imbalance, consistent with possible short-selling positions opened against BTC.The authors describe this as potentially occurring on that date.
- BTC and UST pressure: During the Terra collapse, Binance shows considerable buying pressure for UST, unlike the pattern observed on Kraken.The finding could imply that LFG or other market actors used Binance to defend the UST peg.
- BTC and UST pressure: The Binance imbalance figures encode positive values as selling pressure and negative values as buying pressure for LUNA, UST, and BTC.The figure reports hourly imbalances across the three assets.
6. Implications and future research
The paper frames Terra’s failure as a stablecoin and financial-stability concern despite limited herding in this episode. It calls for stronger scrutiny, standards, transparency, redemption processes, and risk management.
- Future research and policy: The Terra project’s dependence on Anchor and the fragility of decentralized-finance frameworks motivate closer analysis of stablecoin ecosystem dependencies.The paper identifies stablecoins’ role as crypto bridges as potentially destabilizing once they become systemic.
- Implications: Stablecoins are critical to crypto markets because they support trading, liquidity in DeFi, and activities including exchanges and lending protocols.The paper reports that stablecoins were involved in almost 75% of total trading.
- Implications: Although UST’s collapse did not generate relevant herding, the failure of larger stablecoins could create systemic effects across the crypto universe.The paper also notes possible implications beyond crypto through growing links with traditional finance.
- Future research and policy: The authors argue for a Global Stablecoin Standard and continuously updated regulation covering redemption claims, reserve-asset transparency, and risk-management frameworks.They also advocate scrutiny of third-party protocols connected to stablecoins.
- Implications: The Terra episode highlights neglected questions about stablecoins as exchange media, their crypto-market role, regulation, and financial-stability risk.The authors connect these gaps to the rapid growth of decentralized finance and the nascent research field.
7. Conclusion
The paper reconstructs Terra’s collapse through news, hourly and transaction data, and cryptocurrency dependency networks. It identifies breakpoints and market mechanisms while finding BTC’s reference role, rapid marginalisation of LUNA, and no detectable herding behaviour.
- 7. Conclusion: The authors systematically organise heterogeneous news and identify four main breakpoints for the crash.They combine news review with quantitative analysis to reconstruct a reliable collapse timeline.
- 7. Conclusion: Hourly data for 61 cryptocurrencies and smoothed weighted correlations are used to characterise dependency structures during the collapse.Transaction data additionally detect relevant micro-structural market events.
- 7. Conclusion: BTC played a reference role during the first phase of the collapse, while exchange-level comparisons examined buying and selling dynamics across Kraken and Binance.The comparison highlights how market actors could have used multiple exchanges to attack or defend the Terra ecosystem.
- 7. Conclusion: 05 May 2022 is identified as a potential fuse for the process that led to Terra’s failure, amid intense selling pressure on the crypto asset.The paper states that the evidence cannot establish that the event and collapse formed part of a coordinated strategy.
- 7. Conclusion: After 07 May 2022, LUNA was quickly marginalised by the rest of the network’s components.The paper links this finding to the conjecture that investors considered the collapse a non-structural shock.
- 7. Conclusion: The absence of detectable herding behaviour supports the conjecture that investors considered the collapse a non-structural shock.The paper also notes that broader economic weakness could have contributed to a “perfect storm,” while Terra’s dependence on Anchor increased exposure to simultaneous speculative strategies.
Supplementary Material
The supplementary material lists the 61 cryptocurrencies analysed in the paper and assigns each a sector using the taxonomy adopted by Kraken.
- Supplementary Material: The supplementary material lists 61 cryptocurrencies with their symbols, names, and corresponding sectors.The sector mapping follows the taxonomy proposed by Messari and adopted by Kraken.
- Supplementary Material: The listed assets span sectors including decentralized exchanges, smart contract platforms, data management, derivatives, and stablecoins.Examples include 1inch Network, Ethereum, Covalent, dYdX, and Frax Share.