In 2022, the Crypto Assets market was shocked by the dramatic collapse of the Terra ecosystem. This event was not a traditional Hacker attack, but rather revealed the inherent vulnerabilities of Algorithmic Stablecoins.

The core mechanism of Terra revolves around its stablecoin UST being pegged to the US dollar at a 1:1 ratio, a process maintained by the dynamic supply of the LUNA token. When the price of UST deviates from 1 dollar, arbitrageurs can profit by minting or burning UST, theoretically able to maintain the stability of UST. However, this seemingly clever design hides crises.

In May 2022, a large-scale sell-off of UST suddenly occurred in the market, possibly due to institutional liquidations or investor panic. This caused the price of UST to fall below its peg, triggering a series of chain reactions. A large number of users began to destroy UST in exchange for LUNA, causing the supply of LUNA to expand from about 300 million coins to trillions in a short period, directly leading to a price crash.

The sharp drop in LUNA's price has caused it to lose the ability to support UST, further exacerbating the decoupling of UST. Market panic quickly spread, and investors frantically sold off LUNA and UST, creating a vicious cycle: the sell-off led to a more severe decoupling, and the decoupling triggered more sell-offs. Ultimately, the liquidity of the Terra ecosystem was completely drained, LUNA nearly reached zero, and UST lost all its value.

The fundamental reason for this incident lies in the lack of sufficient risk resistance capability in Terra's Algorithmic Stablecoin mechanism. When faced with external pressure and market panic, its internal arbitrage mechanism completely failed, triggering a disastrous chain reaction. This not only caused significant economic losses but also sounded the alarm for the entire Crypto Assets industry, prompting a re-examination of the risks and challenges associated with Algorithmic Stablecoins.

The collapse of Terra provides valuable lessons for the Crypto Assets ecosystem, emphasizing the importance of robust risk management and system design. It reminds us that while pursuing innovation, we must also fully consider the system's stability under extreme market conditions. In the future, designers of Crypto Assets projects need to be more cautious, ensuring that their mechanisms can withstand various market tests to avoid similar disasters from happening again.