Luna's Death Spiral: The Rise and Fall from a Trillion-Dollar Ecosystem to the Abyss

In mid-May 2022, a storm capable of reshaping the crypto market landscape quietly arrived. When Luna’s price fell below $42 and triggered widespread liquidations, the entire market realized that the ecosystem once hailed as “the hope of algorithmic stablecoins” was experiencing an irreversible death spiral. This was not only a de-pegging crisis for UST but also a profound interrogation of the fundamental nature of crypto financial models.

The Crypto Bloodbath Under Global Tightening

The timing of the event was no coincidence. Entering 2022, with inflation pressures remaining high, central banks around the world announced rate hikes—ranging from 25 basis points, 50 basis points, to 75 basis points—filling markets with fears of tightening. As these policies took effect, global financial markets plunged into their worst downturn in recent years. Stocks suffered heavy losses, and the VIX index hit levels unseen since the COVID-19 pandemic.

Against this backdrop of a global asset drought, a phenomenon called “correlation unity” began to emerge—when large positions faced exposure, traders were forced to sell other assets to cover losses, causing a collective decline across various asset classes. Mainstream crypto assets like Bitcoin and Ethereum were not spared. This panic-driven sell-off across the industry ultimately pushed Luna to the edge of the cliff.

The Trap of High-Yield UST: $18 Billion Concentrated Risk

The real crisis in the Luna ecosystem was not the price itself but the close coupling between UST and Anchor Protocol.

As of May 5, the total value locked (TVL) in Anchor Protocol had reached $18 billion, nearly accounting for the entire market cap of UST. In other words, most of the circulating UST was locked in Anchor, offering users a 20% annual yield (APY).

This ultra-high yield was a deadly attraction. When traditional finance and crypto markets both faltered, both institutional and retail investors converted their funds into UST and deposited them in Anchor to earn a stable 20% return. Many users even engaged in loop operations—borrowing UST to buy Luna, then staking Luna to borrow more UST, repeatedly amplifying their leverage.

For Luna Foundation Guard (LFG), this appeared to be a marketing success: attracting massive capital inflows into the ecosystem. But in reality, this highly concentrated liquidity structure became a ticking time bomb inside the ecosystem.

Whales Detect Danger and the Launch of the Death Spiral

Warning signs appeared on the evening of May 8. Whale monitoring accounts on Twitter began to sound alarms, reporting new large-scale UST sell-offs every hour, with transaction sizes in the millions of dollars. These savvy whales had already sensed the abnormality—the high liquidity in Anchor was facing a run risk.

Between May 8 and May 9, LFG launched a series of emergency rescues. They deployed $750 million worth of Bitcoin via OTC trading to maintain the peg of UST to the dollar. Subsequently, they announced the deployment of $1.5 billion in liquidity (comprising $750 million in BTC and $750 million in UST) to stabilize market expectations. By early morning on May 10, LFG addresses transferred in 28,205 Bitcoin, attempting to back UST with Bitcoin reserves.

But all these rescue efforts were too late. Market panic had already set in. According to on-chain data from DeFi Alpha, when Luna’s price dropped to $42, it triggered the first wave of massive liquidations. The chain reaction of liquidations followed: Luna’s price continued to fall, more positions were forcibly closed, further depressing Luna’s price. This is the so-called death spiral—each liquidation reinforcing the next.

By the morning of May 10, Luna’s price had fallen to around $29, and UST, which was previously close to $1, plummeted to a historic low of $0.60. Liquidation amounts reached hundreds of millions of dollars, and the market was plunged into full-blown panic.

Ecosystem Devastation

Luna’s rapid price collapse inflicted catastrophic damage on the entire Terra ecosystem. Within hours, the total value locked (TVL) in the ecosystem plummeted by 40%, from over $200 billion at peak to about $130 billion. Leading protocols within the ecosystem suffered “halving” style blows.

Meanwhile, UST’s market cap evaporated nearly $4 billion in a very short time, dropping from around $17 billion to approximately $14 billion. As the last “firewall” of UST, deposits in Anchor shrank sharply from $18 billion to $7 billion—meaning $7 billion worth of UST was still in circulation and could be further sold, intensifying the de-pegging pressure.

To absorb the remaining circulating UST, Anchor even had to raise the APY to over 20%—a clear admission that UST’s stability was severely compromised, requiring higher yields to attract depositors to hold.

Luna’s Fate: Lost to Time

Looking back at Luna’s failure, the key issue was not flawed strategy per se but insufficient timing.

As early as May 19, 2021, UST experienced a severe de-pegging event, dropping to $0.85. Under emergency intervention by LFG, Luna and UST survived. After this failure, LFG devised a new defense: purchasing Bitcoin and other Layer 1 native tokens as direct collateral for UST, rather than relying solely on Luna for stability.

This new collateral mechanism was theoretically sound. Asset-backed stability is clearly superior to complex algorithms. However, fully implementing this required time to accumulate sufficient Bitcoin reserves. Unfortunately, the market’s rapid decline far outpaced LFG’s reserve accumulation. Before the death spiral fully took hold, LFG lacked the window to complete this strategic shift.

Luna’s ultimate failure was a loss to time—the most ruthless opponent.

Lessons and Aftermath

This crisis shattered confidence in algorithmic stablecoins across the crypto industry. The allure of high yields, the fragility of concentrated liquidity, and underestimating the power of time—these factors intertwined to push an ecosystem once valued in the hundreds of billions into the abyss.

Today, Luna’s price has fallen to $0.07 (as of February 2026), nearly four years after the event, yet its impact persists. This death spiral not only ended Luna’s story but also served as a profound reflection on the fragility of crypto financial systems.