Terra Cryptocurrency: Rise, Collapse, and the Aftermath of UST and LUNA

What is Terra?

Terra cryptocurrency is a blockchain protocol and payment platform designed for algorithmic stablecoins, launched in 2018 by Terraform Labs, a startup co-founded by Do Kwon and Daniel Shin. Its primary claim to fame was the Terra stablecoin and the associated cryptocurrency, LUNA. However, in May 2022, TerraUSD (UST) and LUNA collapsed, leading to a temporary halt of the Terra cryptocurrency. This event wiped out around $45 billion in market capitalization within a week. By January 21, 2024, Terraform Labs had filed for bankruptcy.

Design and Functionality

The Terra cryptocurrency uses a proof-of-stake consensus model and is designed to support fiat-pegged stablecoins to power its payment system. Several stable coins were developed using the Terra protocol, including TerraUSD, which ranked as the third-largest stable coin by market capitalization prior to its collapse in 2022.The Terra cryptocurrency also housed a thriving ecosystem of decentralized applications (DApps) like Anchor, Mirror, and Pylon, which utilized its stablecoin infrastructure.

Terra’s algorithmic stablecoins were pegged to various currencies, like TerraUSD (UST) being tied to the U.S. dollar. The cryptocurrency LUNA served as a reserve asset, supporting the stability of the Terra ecosystem while also functioning as a governance token for voting on proposals. UST’s peg was maintained through a complex “burn and mint” equilibrium, where one token (UST) was supposed to remain stable while the other (LUNA) absorbed volatility.

The Anchor Protocol, one of Terra’s key projects, was a lending platform offering a 19.45% yield to those who deposited UST. This unusually high return drew criticism, with some calling Terra’s model a potential Ponzi scheme. Another prominent project, the Mirror Protocol, offered financial derivatives that mimicked traditional stocks.

History and Rise

Terraform Labs was co-founded in Seoul, South Korea, in 2018 by Do Kwon and Daniel Shin. By 2019, the company had launched its first cryptocurrency token and raised over $200 million from firms like Arrington Capital, Coinbase Ventures, and Galaxy Digital. In January 2022, the Luna Foundation Guard (LFG) was established to help stabilize UST’s price. LFG built a reserve, primarily consisting of Bitcoin, valued at $2.4 billion just before UST broke its peg. Terra also signed a $38.15 million sponsorship deal with the Washington Nationals Major League Baseball team, providing branding and naming rights.

While Kwon held the majority of shares in Terraform Labs, Shin announced his disassociation from the company in May 2022, though records showed that he still retained a small share of ownership in both Terraform Labs and Chai Holdings.

Collapse of Terra

In early May 2022, Terra’s UST began losing its peg to the U.S. dollar. Within a week, UST’s value dropped to just 10 cents, while LUNA’s value plummeted from an all-time high of $119.51 to almost zero. The collapse wiped out $45 billion in market capitalization, triggered by flaws in Terra’s protocol and an attack on its liquidity pool. Terraform Labs temporarily halted the Terra blockchain on May 13, 2022, after failing to restore the 1:1 peg of UST to the dollar despite using reserves held by the Luna Foundation Guard.

Several factors contributed to the collapse, including mass withdrawals from the Anchor Protocol, declining confidence in cryptocurrencies, and a drop in Bitcoin’s value. The “mint and burn” system further destabilized the relationship between UST and LUNA. By May 25, a new LUNA cryptocurrency was issued, and the original blockchain was renamed Terra Classic, with its original token rebranded as LUNA Classic (LUNC). However, the new LUNA, referred to as “Terra 2.0,” lost value soon after its release on exchanges.

In a post-collapse interview, Do Kwon admitted that his faith in Terra seemed “irrational,” though he denied allegations that it was a Ponzi scheme. In March 2023, Kwon was arrested in Montenegro while attempting to travel using false documents. In addition, U.S. authorities charged him with fraud.

Regulatory and Legal Troubles

Terraform Labs, incorporated in Singapore, did not obtain a license under the Payment Services Act, and the company dissolved its Korean entity shortly before UST’s collapse. The U.S. Securities and Exchange Commission (SEC) subpoenaed Kwon in 2021 regarding Terraform’s Mirror Protocol, but Kwon refused and sued the SEC. However, in February 2022, a U.S. court ruled that the SEC could continue its investigation. By February 2023, the SEC officially charged Kwon and Terraform Labs with fraud.

South Korean authorities, including the Financial and Securities Crimes Joint Investigation Team, have also targeted the Terra-Luna crisis. Travel bans were placed on former Terraform developers, and lawsuits have been filed against Terraform Labs and its founders, including class actions in the U.S. and Singapore. An arrest warrant was issued for Daniel Shin in November 2022, further intensifying legal scrutiny of the company and its executives.