How Does the Design of Algorithmic Stablecoins, like Terra/Luna, Create Vulnerabilities to Psychological Contagion?

Algorithmic stablecoins often maintain their peg through complex mechanisms that rely on trader confidence and arbitrage opportunities. The Terra/Luna model, for example, depended on a dual-token system where faith in the value of LUNA was essential to the stability of the UST stablecoin.

Once that confidence was shaken, psychological contagion took hold. A mass loss of faith created a "bank run" scenario where the stabilizing mechanism itself became the engine of the death spiral, as redeeming the stablecoin minted worthless governance tokens.