May 2022 — The Week Crypto Nearly Broke
In the second week of May 2022, something happened that was supposed to be impossible.
A stablecoin — a cryptocurrency specifically designed to maintain a stable value of $1 — lost its peg and collapsed to near zero. Within 72 hours, over $40 billion in value had been wiped out. Millions of people lost savings. Some lost everything.
The coin was called TerraUSD. Its sister token, Luna, collapsed alongside it. The event sent shockwaves through the entire crypto market and triggered regulatory responses worldwide.
To understand what happened — and why it matters — you need to understand what stablecoins actually are.
What is a Stablecoin?
Bitcoin and Ethereum are volatile. Their prices can move 10–20% in a single day. That makes them poor tools for everyday transactions or storing savings if you need predictable value.
Stablecoins solve this by pegging their value to a stable asset — usually the US dollar. One USDC is always worth approximately one dollar. One Tether (USDT) is always worth approximately one dollar.
This makes stablecoins genuinely useful:
- Trading. Moving in and out of positions without converting to fiat
- International payments. Sending dollars anywhere in the world instantly and cheaply
- Savings. Holding dollar value in a crypto wallet, particularly valuable in countries with unstable local currencies
- DeFi. The primary currency for lending, borrowing, and liquidity protocols
The Four Types of Stablecoin
Not all stablecoins work the same way. The mechanism used to maintain the peg matters enormously — and carries very different risk profiles.
1. Fiat-Backed
For every token issued, the company holds an equivalent amount of real dollars in reserve.
Examples: USDC, Tether (USDT). Risk: You're trusting the issuing company to actually hold the reserves they claim.
2. Commodity-Backed
Backed by physical commodities — most commonly gold. One token represents a fixed amount held in a vault.
Risk: Counterparty risk on the custodian. Redemption may be complex or slow.
3. Crypto-Backed
Backed by other cryptocurrencies, typically over-collateralised. You lock up $150 of Ethereum to mint $100 of stablecoin.
Examples: DAI. Risk: If the backing asset drops sharply, positions can be liquidated.
4. Algorithmic
No real collateral. The peg is maintained by an algorithm that adjusts supply and demand between two linked tokens.
Example: TerraUSD — the one that collapsed. Risk: Catastrophic under stress conditions.
The Terra/Luna Death Spiral
TerraUSD (UST) was an algorithmic stablecoin. Its peg to $1 was maintained through a relationship with a sister token called Luna.
The mechanism: if UST traded above $1, you could burn Luna to create UST. If UST traded below $1, you could burn UST to create Luna, restoring the peg. The system relied on arbitrageurs constantly correcting any deviation.
It worked — until it didn't.
In May 2022, large sell orders began pushing UST below its peg. The algorithm responded by minting more Luna to absorb the selling pressure. But this flooded the market with Luna, crashing its price. With Luna worth less, the algorithm had to mint even more of it to maintain the peg. Which crashed Luna further. Which required more minting.
This is the death spiral. Once it begins, there is no mechanism to stop it.
Within 72 hours:
- UST fell from $1 to under $0.10
- Luna fell from $80 to effectively zero
- $40 billion in combined market value was erased
- The broader crypto market lost hundreds of billions in collateral damage
Are Stablecoins a Trojan Horse?
Stablecoins are, by design, dollar-denominated digital assets. They extend the reach of the US dollar into the crypto ecosystem.
From one angle, this is financial inclusion — giving people in Argentina, Turkey, or Nigeria access to dollar stability without a US bank account.
From another angle, it represents a new form of dollar dominance — and potentially a mechanism for financial surveillance and control that bypasses local financial systems entirely.
The regulatory debate around stablecoins — including the GENIUS Act discussed in the previous article — is partly about bringing these assets under government oversight before they become too systemic to control.
The False Sense of Security
The most important risk with stablecoins is psychological.
The word "stable" implies safety. It implies that whatever happens in the crypto market, your stablecoin holdings are protected. This is not true, and believing it is dangerous.
Every stablecoin carries risks: the issuer could fail or be shut down, smart contract bugs could drain funds, the peg mechanism could fail under extreme conditions, regulatory action could freeze assets.
Understanding these risks is not a reason to avoid stablecoins. They are genuinely useful tools. But using them without understanding what's underneath is how people get hurt.
Conclusion
Stablecoins are the most widely used application in crypto — the bridge between volatile digital assets and the stability of fiat currency. They make DeFi function, enable global payments, and provide dollar access to millions without bank accounts.
They also carry real risks that their name obscures. Terra/Luna is a reminder of what happens when the mechanism fails under pressure.
Use them. But understand them first.