LUNA

LUNA was one of the two native cryptocurrencies of the Terra blockchain, a project that aimed to create a new kind of decentralized financial ecosystem. LUNA’s primary job was to act as a stabilizing mechanism for its sister coin, TerraUSD (UST), an algorithmic stablecoin. The idea was that UST would always be worth exactly one U.S. dollar. The LUNA token was designed to absorb any price wobbles in UST through a clever, but ultimately flawed, mint-and-burn mechanism. If UST's price fell below $1, traders could buy the cheap UST and swap it for $1 worth of newly created LUNA, pocketing a small profit and helping push UST's price back up. This system created a symbiotic relationship where the stability of one depended entirely on the perceived value of the other. In May 2022, this relationship catastrophically failed, leading to one of the most infamous collapses in financial history, wiping out over $40 billion in market value in a matter of days.

The story of LUNA is a masterclass in systemic risk and the difference between a clever idea and a resilient one. Its collapse wasn't just bad luck; it was a feature of its design.

Imagine a financial seesaw. On one end sits UST, which needs to stay perfectly balanced at $1. On the other end is LUNA. The protocol's algorithm acted as the fulcrum.

• If UST fell below $1: The algorithm incentivized traders to buy the discounted UST from the open market and trade it with the protocol for $1 worth of LUNA. This process “burned” the UST (removing it from circulation) and “minted” new LUNA. The buying pressure was supposed to lift UST back to its $1 peg.
• If UST rose above $1: The reverse would happen. Traders could trade $1 worth of LUNA to the protocol for one UST (now worth slightly more than $1), which they could sell for a profit. This minted new UST and burned LUNA, increasing UST supply and pushing its price back down to $1.

To supercharge this system, the developers created the Anchor Protocol, a lending platform that offered an eye-watering, near-20% annual yield on UST deposits. This created enormous, artificial demand for UST, which in turn propped up the price of LUNA, making the whole ecosystem seem incredibly successful.

In early May 2022, a few large withdrawals from the Anchor Protocol, combined with major sales of UST on the open market, caused UST to lose its peg and fall below $1. This triggered a panic, and the theoretical balancing act became a terrifying “death spiral.”

1. Step 1: The De-Peg. As UST's price fell, investors rushed to exit.
2. Step 2: The Arbitrage Flood. Panicked holders used the protocol's main escape hatch: they swapped their broken UST for $1 worth of LUNA.
3. Step 3: LUNA's Price Crash. The market was suddenly flooded with newly minted LUNA from these redemptions, all of which was being sold immediately. This crashed LUNA's price.
4. Step 4: Hyperinflation. Here's the fatal flaw: as LUNA's price plummeted, the protocol had to mint exponentially more LUNA to redeem each UST for its “$1 worth.” The supply of LUNA ballooned from around 350 million to over 6.5 trillion in less than a week—a textbook case of hyperinflation.
5. Step 5: Total Collapse. The crashing LUNA price destroyed any confidence that it could ever back UST, rendering the stablecoin worthless. The seesaw didn't just tip over; it shattered into a million pieces.

The LUNA saga provides timeless lessons that echo the core principles of value investing. While the technology was new, the human behaviors of fear, greed, and folly were as old as markets themselves.

A value investor, following the teachings of Benjamin Graham, seeks to buy assets for less than their intrinsic value—the underlying worth of a business based on its assets, earnings, and cash flow. LUNA had no such foundation. Its value was derived entirely from faith in a complex algorithm and the continued growth of its ecosystem. There were no factories, no patents, no real-world cash flows to analyze. When that faith evaporated, its value went to zero. There was no margin of safety, the bedrock principle of value investing that provides a cushion against miscalculation or bad luck.

The 20% yield from the Anchor Protocol was a giant red flag. A prudent investor always asks, “Where is the return coming from?” In this case, the yield wasn't generated by a productive economic enterprise. It was an unsustainable marketing expense, paid for by the project's own treasury to lure in capital. When an investment offers returns that are wildly out of line with the broader market, it is often masking immense, hidden risks.

An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative. LUNA was, by this definition, a pure speculation. Its design was inherently fragile, and it offered no true safety of principal. Its buyers were not investing in a durable asset; they were betting that a complex, reflexive system would continue to attract new money indefinitely—a modern version of the “greater fool theory.” For the value investor, the lesson is clear: distinguish between investing in durable value and speculating on price momentum. LUNA was a powerful, and painful, reminder of the difference.