The TerraUSD collapse: how an "algorithmic stablecoin" lost $40 billion, and what it teaches

Stablecoins are supposed to be the boring part of crypto: tokens worth one dollar, used to move money between trades. In May 2022, TerraUSD (UST) stopped being boring. Within days it lost its peg, its sister token LUNA collapsed with it, and tens of billions of dollars of value disappeared.

This guide explains how UST was supposed to work, what happened, what US regulators proved in court, how the case ended and how the rules for stablecoins have changed since.

How UST was meant to keep its peg

Most large stablecoins hold reserves, such as cash and short-term government debt, so each coin can be redeemed for a dollar. See stablecoins explained.

UST took a different approach. According to the SEC, it was a so-called “algorithmic stablecoin” that supposedly maintained its peg to the US dollar by being interchangeable for another of the company’s tokens, LUNA. The idea was that traders could always swap UST and LUNA at a rate that pushed UST back towards $1, so no full dollar reserves were needed.

That only works while people believe both tokens have value. If confidence in UST falls, people swap it for LUNA and sell; more LUNA floods the market; LUNA’s price falls; and the mechanism meant to defend the peg makes things worse.

The SEC’s enforcement director put it bluntly when the charges were filed: in the SEC’s view, the Terraform ecosystem was “neither decentralized, nor finance”, and the price of UST was controlled by the defendants, not any code.

More than one token: the Terra ecosystem

UST was the centre of a wider set of products. According to the SEC’s complaint, from April 2018 until the collapse in May 2022, Terraform and its founder, Do Kwon, raised billions of dollars by selling an interconnected suite of crypto assets, many in unregistered transactions:

Because everything was linked, a loss of confidence in one part spread quickly to the rest.

The 20% yield

UST wasn’t only promoted as stable. The SEC said Terraform and Kwon marketed it as a “yield-bearing” stablecoin, advertised as paying as much as 20% interest through the Anchor Protocol. That kind of return on something designed to stay at $1 attracted large deposits, and it should have raised an obvious question: where does a steady 20% come from? See crypto lending and earn accounts.

May 2022: the collapse

The SEC describes what happened next: in May 2022, UST depegged from the US dollar, and the price of UST and Terraform’s other tokens plummeted to close to zero. In its 2024 announcement, the SEC said this wiped out $40 billion in market value nearly overnight, causing devastating losses to countless investors, including numerous retail investors who poured their life savings into the ecosystem.

What the SEC proved

On 16 February 2023, the SEC charged Terraform Labs and Do Kwon with securities fraud and with offering and selling securities in unregistered transactions. Among its allegations:

• They marketed their tokens to investors seeking profit, claiming the tokens would increase in value.
• They misled investors about the stability of UST.
• They repeatedly claimed that a popular Korean mobile payment app used the Terra blockchain to settle transactions, which would accrue value to LUNA. The SEC later described this as a false claim to have found a legitimate real-world use for crypto.

The legal timeline

According to the SEC:

The $4.5 billion settlement

The SEC set out the amounts:

• Terraform: $3,586,875,883 in disgorgement, $466,952,423 in prejudgment interest and a $420,000,000 civil penalty.
• Do Kwon: $110,000,000 in disgorgement and $14,320,196 in prejudgment interest (jointly with Terraform), plus an $80,000,000 civil penalty.

Terraform also agreed to stop selling its crypto assets, wind down its operations, replace two directors and distribute its remaining assets to investor victims and creditors through a liquidation plan in its bankruptcy case. A settlement figure doesn’t mean victims got back what they lost: how much each person recovered depended on the bankruptcy process.

Algorithmic vs reserve-backed: what’s different now

The collapse shaped how regulators approach stablecoins. In the US, the GENIUS Act, signed on 18 July 2025, created the first federal regulatory system for payment stablecoins. Comparing it with how UST worked shows why:

These points come from the White House’s summary of the law and the Congressional Research Service. Payment stablecoins under the law aren’t federally insured.

Elsewhere:

• Canada: crypto trading platforms can only offer fiat-backed stablecoins that meet the Canadian Securities Administrators’ conditions.
• United Kingdom: stablecoin issuers come under the FCA’s new cryptoasset regime from October 2027. See the UK’s new crypto rules.

Lessons for anyone holding stablecoins

1. Ask what backs it. Reserves you can verify are very different from a promise that an algorithm will hold the price.
2. Check the disclosures. Under the GENIUS Act, regulated US issuers publish their reserves monthly; an issuer that won’t show its backing is a warning sign.
3. Be suspicious of high yields. If a “stable” dollar token pays far more than banks or government bonds, someone is taking on risk, and it may be you.
4. Don’t confuse marketing with safety. UST was promoted as stable and high-yielding; a jury later found that investors had been misled.
5. Watch for de-pegs. Even well-known stablecoins can trade below $1 when people doubt their reserves.
6. Remember there’s no deposit insurance. See is your crypto insured?
7. Watch for recovery scams. Big collapses attract fake “recovery” services aimed at victims. See crypto recovery scams.

For other cautionary tales from the same period, see what happens if an exchange goes bust and crypto Ponzi schemes.