UST (TerraUSD Classic)

• The Bottom Line: UST was a failed “algorithmic stablecoin” whose spectacular 2022 collapse serves as one of the most powerful cautionary tales in modern finance, perfectly illustrating the dangers of speculation, complexity, and assets that lack any genuine intrinsic_value.
• Key Takeaways:
• What it is: A cryptocurrency that attempted to maintain a $1 peg not by holding actual dollar reserves, but through a complex, automated relationship with a sister token, LUNA.
• Why it matters: Its catastrophic failure wiped out over $40 billion in investor capital, demonstrating the immense risks of systems built on algorithms and faith instead of tangible, underlying value. It is a textbook case study in the difference between speculation and investing.
• How to use it: Not as an investment, but as a mental model. The story of UST is a powerful tool to stress-test new “innovative” assets against the timeless principles of value investing: understand what you own, demand a margin_of_safety, and be deeply skeptical of promises of high, easy returns.

Imagine you're at a casino. You go to the cashier, hand over a real $100 bill, and receive 100 casino chips. Each chip is worth $1. You can play with them, and when you're done, you can go back to the cashier and exchange your chips for real dollars. This works because the casino keeps your $100 bill (and everyone else's) in a vault. For every $1 chip in circulation, there's a real $1 backing it. This is how a traditional, collateralized stablecoin (like USDC or USDT) works. It's simple, and it's backed by real assets. Now, imagine a different, “magical” casino. This casino has no vault full of dollars. Instead, when you ask for a $1 chip, it just creates one for you. To keep this magical chip worth $1, the casino runs a clever, automated system. Next to the chip cashier is another counter that trades the casino's own “loyalty points” (let's call them LUNA points). The system is programmed with a simple rule: anyone can, at any time, exchange one magical chip for exactly $1 worth of LUNA points, or vice versa.

• If the chip's price on the open market drops to $0.99, smart traders see an opportunity. They can buy up the cheap chips for 99 cents, take them to the casino's special counter, and instantly exchange them for $1 worth of LUNA points, pocketing a risk-free penny on each one. This buying pressure is supposed to push the chip's price back up to $1.
• If the chip's price rises to $1.01, traders do the opposite. They take $1 worth of their LUNA points, swap them for a chip now worth $1.01, and sell it for a quick profit. This selling pressure is supposed to bring the price back down to $1.

This was the basic idea behind UST (the magical chip) and LUNA (the loyalty points). It was an “algorithmic stablecoin.” It wasn't backed by a vault of dollars, but by an algorithm and the belief that LUNA would always have value and that traders would always be there to “arbitrage” the price back to $1. For a while, the magic worked. But what happens if people suddenly lose faith in the whole casino? What if they start to think the LUNA loyalty points are worthless? In May 2022, that's exactly what happened. A few large players started selling huge amounts of UST. The price dropped slightly below $1. The algorithm kicked in, as designed, and started creating billions upon billions of new LUNA tokens to swap for the UST being sold. But because so many people were rushing for the exit at once, the supply of LUNA exploded, causing its price to crash. This triggered a “death spiral.” The more UST people sold, the more new LUNA was created. The more LUNA was created, the more its price fell. The more LUNA's price fell, the less confidence people had that the system could save UST. This feedback loop spun out of control until both UST and LUNA became virtually worthless. The magical chip wasn't backed by anything real, and when the magic spell of collective belief was broken, its value vanished.

“The most dangerous words in investing are: 'this time it's different'.” - Sir John Templeton

For a value investor, the story of UST is not just a fascinating disaster; it is a profound validation of core principles. It's a case study in what not to do and what to watch out for. A disciplined value investor would have identified the fatal flaws in UST from the outset by applying fundamental tenets of their philosophy.

• A Complete Absence of Intrinsic Value: A value investor's first question is always, “What is the underlying business or asset, and what is its worth?” A share of a company like Microsoft represents a claim on real assets, brilliant engineers, valuable intellectual property, and decades of future profits. A bond represents a legal claim on contractually obligated cash flows. UST represented… a claim on an algorithm's ability to maintain confidence. It owned no productive assets. It generated no cash flow. Its existence was purely self-referential, a classic speculative_asset with no anchor to economic reality. Without an intrinsic_value to calculate, a value investor sees nothing to invest in.
• The Illusion of a Margin of Safety: The most sacred principle in value investing is the margin_of_safety. You calculate what something is worth, and then you insist on buying it for a significant discount. This discount is your protection against bad luck, errors in judgment, or unforeseen events. UST was the antithesis of this concept. Its design was praised for being “capital efficient,” which is a dangerous euphemism for “lacking reserves.” There was no safety net. The system's only defense mechanism was to print more of its own volatile token, LUNA. This is like trying to put out a fire with gasoline. When the crisis hit, there was no discount, no underlying asset value to cushion the fall. The price didn't just fall below its intrinsic value; it fell to its intrinsic value: zero.
• A Flagrant Violation of the Circle of Competence: Warren Buffett famously advises investors to stay within their “circle_of_competence“—to only invest in things they truly understand. The UST/LUNA mechanism was a labyrinth of crypto-economic theory, smart contracts, and reflexive feedback loops. To promote it, its creators offered a seemingly simple product: a savings account on the “Anchor Protocol” that paid a staggering, near-20% annual yield on UST deposits. How many of the millions who deposited their money could genuinely explain the death spiral risk? Or how that yield was being sustained? ¹⁾. Complexity often serves to hide risk, and UST was a masterclass in this dangerous form of obfuscation.
• The Seductive Lure of Speculation: Benjamin Graham drew a sharp line between investing and speculating. “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” The ~20% yield from Anchor was a siren song for speculators. In a world where government bonds paid next to nothing, this impossibly high, “stable” return was a red flag the size of a billboard. It attracted a flood of capital from people chasing yield, not from investors who had thoroughly analyzed the underlying risks. It promised an inadequate—in fact, non-existent—guarantee for the safety of principal, and its collapse proved Graham's definition to be timeless.

The goal is not to “apply” UST, but to apply the harsh lessons from its failure. You can use its story to create a mental checklist—a “Litmus Test”—to protect yourself from similar traps in the future, whether they appear in cryptocurrency, tech stocks, or any other corner of the market.

Before considering any investment, especially one that seems new, innovative, or unusually profitable, run it through these four questions.

1. 1. What is the ultimate source of its value?
   • Ask yourself: “What do I actually own here?” Is it a fractional ownership of a profitable business that sells real products or services (a stock)? Is it a loan to a solvent entity that is legally required to pay me back (a bond)? Or is its value dependent on a complex mechanism, market sentiment, or the hope that someone else will buy it from me for a higher price later (greater_fool_theory)?
   • If the value is not anchored to a tangible, cash-flow-producing asset, it is likely a speculation, not an investment.
2. 2. Where does the “yield” or “return” truly come from?
   • High returns must come from somewhere. Is the return generated by a company's profits? Is it interest paid from a borrower's successful business operations? Or is it being manufactured? Be highly suspicious of yields that are subsidized by venture capital funds to attract users, or that are paid out by printing more of a related, volatile token.
   • Unsustainable yields are a classic marketing gimmick to attract capital into fragile systems. Real returns come from real, sustainable economic activity.
3. 3. Where is the true margin of safety?
   • Ask the question: “What happens if my primary thesis is wrong?” What protects my principal from permanent loss? In a stock, the margin of safety might be a strong balance sheet and a purchase price far below the company's liquidation value. In a bond, it's the assets backing the loan.
   • Be wary if the proposed “safety net” is part of the same complex system you are investing in. A true margin of safety should be independent of the mechanism that is supposed to generate your return.
4. 4. Can I simply and confidently explain this to a teenager?
   • This is the ultimate test of your own understanding. If you cannot explain how the investment works, how it makes money, and what its primary risks are in simple, clear language, you have ventured outside your circle_of_competence.
   • Complexity is where risk hides. If you don't understand it, don't invest in it. Period.

Let's use our Litmus Test to compare two hypothetical assets vying for a spot in your portfolio.

While UST ultimately proved to be a failure, it's important for investors to understand the promised advantages that made it so attractive, as these same siren songs will undoubtedly be used to promote future speculative assets.

• Capital Efficiency: In theory, by not needing to hold one real dollar for every UST in circulation, the Terra ecosystem could use its capital for other purposes, like funding development. This was pitched as a revolutionary advantage over “inefficient” asset-backed stablecoins, but it was precisely this lack of collateral that made it fatally fragile.
• Decentralization: Proponents argued that since UST wasn't reliant on a single company or bank to hold its dollar reserves, it was a more “decentralized” and censorship-resistant form of stable money. In practice, the system's fate rested in the hands of a small group of developers and its founder.
• High, “Stable” Yield: The ~20% yield offered on the Anchor Protocol was UST's single greatest marketing tool. It attracted billions of dollars in capital and created enormous demand for UST, which was essential for the stability of the entire system. This manufactured yield was the fuel for the speculative fire.

• No Intrinsic Anchor: This was the mortal wound. The system's value was not anchored to anything in the real world. It was a monetary perpetual motion machine that was always destined to fail, as its value was based entirely on confidence and a belief in its own mechanics.
• The Death Spiral Mechanism: The reflexive relationship with LUNA was not a bug; it was a feature. The system was designed to create a feedback loop. While it worked for small price deviations in a bull market, it was guaranteed to create a catastrophic, self-reinforcing “death spiral” during a bank run. It was an accident waiting to happen.
• Dependence on Perpetual Growth: The entire UST/LUNA model was predicated on a constantly growing ecosystem and a continuously rising price for LUNA. It had no blueprint for surviving a prolonged market downturn or a crisis of confidence. Value investing, in contrast, is about building a portfolio that can survive—and even thrive—during the inevitable storms.

• speculation_vs_investing
• intrinsic_value
• margin_of_safety
• circle_of_competence
• risk_management
• greater_fool_theory
• asset_allocation