River's Educational Channel

← back to home page

How arbitrageurs made 25x in the Terra/Luna collapse

Since apparently people are not discerning about Internet advice, nothing here should be taken as investment or financial advice.

As you might already know, TerraUSD (UST), a stablecoin which was pegged to the dollar, unpegged and dropped dramatically. In doing so, it took down its algorithmic counterpart, LUNA, which dropped from an all-time high around $100 to less than 1 cent.

In the midst of that collapse, an unusually large arbitrage opportunity popped up on May 12th, 2022. The trade went something like this:

  1. Buy UST at a discount, since prices had dropped to $0.20-$0.50. (2x-5x gain)
  2. Exchange the UST for LUNA at the official $1 exchange rate.
  3. Convert LUNA to Wrapped LUNA (WLUNA)
  4. Sell the WLUNA on Coinbase, where prices were significantly higher than the official exchange rate (another 2x-5x gain).

This was a bloodbath as arbitrageurs got in on the crash at the expense of LUNA bagholders, since converting UST to LUNA created new LUNA. That seignorage happend at lower and lower LUNA valuations, meaning that each UST could become hundreds of LUNA.

The inflation was breathtaking, jumping suddenly from 300-400MM to 6-7 TRILLION. Chart of LUNA supply
                jumping from 340 million to 6+ Trillion, taken from Messari.io

As always, retail traders got shafted, with many of them not even knowing about the insane inflation, much less the arbitrage that was happening. Effectively, buying LUNA was betting on the fundamentals of how TerraUSD worked as an "algorithmic stablecoin". It didn't work, and Luna 2 will notably not have the algorithmic stablecoin mechanism, but people treated it instead like an ordinary hyped token. If you bought in after analyzing the algorithmic stablecoin mechanism, then that's just a mistake in your analysis. However, if you bought in because Do Kwon was trash talking on Twitter, that's a much sadder situation.

Copyright 2021 River's Educational Channel

Some links on this website are affiliate links - River's Educational Channel may receive a commission if you purchase an item through the link.