Why did algorithmic stablecoins repeat the "death spiral" from Luna to USDe?

October 11, 2025, this day is a nightmare for global encryption investors.

The price of Bitcoin plummeted from a high of $117,000, falling below $110,000 within hours. Ethereum's decline was even more severe, reaching 16%. Panic spread through the market like a virus, with many altcoins crashing instantaneously by 80-90%. Although there was a slight rebound afterward, they still generally fell by 20% to 30%.

In just a few hours, the global encryption market has seen its market value evaporate by hundreds of billions of dollars.

On social media, wails rise and fall, with languages from around the world merging into the same lament. Yet beneath the surface of panic, the real transmission chain is far more complex than it appears.

The starting point of this crash was a statement from Trump.

On October 10, U.S. President Trump announced through his social media that he plans to impose an additional 100% tariff on all imported goods from China starting November 1. The wording of this news is unusually strong; he wrote that U.S.-China relations have deteriorated to the point of “no need for a meeting,” and that the U.S. will retaliate using financial and trade means, justifying this new tariff war on the grounds of China's monopoly on rare earths.

After the news broke, the global market was instantly thrown out of balance. The Nasdaq plummeted 3.56%, marking one of the rare single-day declines in recent years. The dollar index fell 0.57%, crude oil dropped sharply by 4%, and copper prices declined simultaneously. The global capital market fell into a panic sell-off.

In this epic liquidation, the popular stablecoin USDe became one of the biggest casualties. Its decoupling, along with the high-leverage circular loan system built around it, collapsed one after another within a few hours.

This localized liquidity crisis quickly spread, leading to the liquidation of many investors who were using USDe for circular borrowing, and the price of USDe began to decouple across various platforms.

More seriously, many market makers also use USDe as contract margin. When the value of USDe approaches a halving in a short period, the leverage of their positions passively doubles. Even a seemingly safe one-time leverage long position cannot escape the fate of liquidation. The prices of small coin contracts and USDe form a double kill, resulting in heavy losses for market makers.

How did the dominoes of “循环贷” fall?

The Temptation of 50% APY Returns

USDe, launched by Ethena Labs, is a “synthetic dollar” stablecoin. With a market capitalization of approximately $14 billion, it has risen to become the third largest stablecoin in the world. Unlike USDT or USDC, USDe does not have an equivalent dollar reserve but relies on a strategy called “Delta-neutral hedging” to maintain price stability. It holds Ethereum spot while shorting equivalent Ethereum perpetual contracts on derivatives exchanges to offset volatility through hedging.

So, what attracts funds in droves? The answer is simple: high returns.

Staking USDe itself can yield an annualized return of about 12% to 15%, which comes from the funding rates of perpetual contracts. In addition, Ethena collaborates with several lending protocols to provide additional rewards for USDe deposits.

What truly causes the yield to skyrocket is “revolving loans.” Investors repeatedly operate within the lending agreement, collateralizing USDe, lending out other stablecoins, and then exchanging them back into USDe to deposit again. After several rounds of operation, the principal is amplified to nearly four times, with annual yields rising to a range of 40% to 50%.

In the world of traditional finance, an annual return of 10% is already rare. However, the 50% return offered by USDe circular loans is an almost irresistible temptation for profit-seeking capital. As a result, funds continue to flow in, and the USDe deposit pool of the lending protocol often remains in a “full” state; once new quotas are released, they will be snatched up in an instant.

USDe's Decoupling

Trump's remarks on tariffs have triggered panic in global markets, and the encryption market has also entered “risk-averse mode.” Ethereum plummeted 16% in a short period, directly shaking the balance on which USDe relies. However, what truly detonated the decoupling of USDe was the liquidation of a large institution on the Binance platform.

Encryption investor and co-founder of Primitive Ventures Dovey speculated that the real trigger point was a large institution using a cross-margin model on the Binance platform (possibly a traditional trading company that adopts cross-margin) being liquidated. This institution used USDe as cross-margin, and when the market fluctuated wildly, the liquidation system automatically sold USDe to repay debts, causing its price on Binance to plummet to 0.6 dollars.

The stability of USDe originally relied on two key conditions. The first is a positive funding rate, meaning that in a bull market, short sellers need to pay fees to long traders, allowing the protocol to profit. The second is sufficient market liquidity, ensuring that users can exchange USDe at a price close to 1 dollar at any time.

But on October 11, these two conditions collapsed simultaneously. Market panic led to a sharp rise in short-selling sentiment, and the funding rate for perpetual contracts quickly turned negative. The large short positions held by the protocol shifted from being “the payer” to “the payee”, needing to continuously pay fees, which directly eroded the value of the collateral.

Once USDe starts to decouple, market confidence quickly collapses. More people join the selling spree, prices continue to plunge, and a vicious cycle is fully formed.

Clearing Spiral of Circulation Loan

In the lending agreement, when the value of the user's collateral falls to a certain level, the smart contract will automatically trigger liquidation, forcibly selling the user's collateral to repay their debt. When the price of USDe drops, those positions that have added multiple leverage through circular lending quickly fall below the liquidation line.

The liquidation spiral has now begun.

Smart contracts automatically sell the USDe of liquidated users on the market to repay their borrowed debts. This further increases the selling pressure on USDe, leading to a further drop in its price. The price drop then triggers more liquidation of cyclical loan positions. This is a typical “death spiral.”

Many investors may only realize at the moment of liquidation that their so-called “stablecoin wealth management” is actually a high-leverage gamble. They believe they are just earning interest, but are unaware that the operation of revolving loans has magnified their risk exposure several times. When the price of USDe fluctuates sharply, even those investors who consider themselves conservative cannot escape the fate of being liquidated.

Market Maker Liquidation and Market Crash

Market makers are the “lubricants” of the market, responsible for placing orders and matching trades, providing liquidity for various encryption assets. Many market makers also use USDe as collateral on exchanges. When the value of USDe plummets in a short period, the value of these market makers' collateral also significantly decreases, leading to their positions on the exchange being forcibly liquidated.

According to statistics, this massive crash in the encryption market has resulted in a liquidation scale of hundreds of billions of dollars. It is noteworthy that most of this hundreds of billions does not come solely from retail investors' one-way speculative positions, but also includes a large amount of hedge positions from institutional market makers and arbitrageurs. In the case of USDe, these professional institutions originally used sophisticated hedging strategies to avoid risks, but when USDe, which was regarded as a “stable” margin asset, suddenly plummeted, all risk control models failed.

On derivative trading platforms like Hyperliquid, a large number of users faced liquidation, and holders of the platform's HLP (Liquidity Provider Vault) made a windfall profit of 40% overnight, with profits soaring from 80 million dollars to 120 million dollars. This figure indirectly demonstrates the enormous scale of the liquidations.

When market makers collectively face liquidation, the consequences are disastrous. The market's liquidity is instantly drained, and the bid-ask spread is sharply widened. For those altcoins with smaller market caps and already insufficient liquidity, this means that prices, which are already falling, will collapse even faster due to the lack of liquidity. The entire market falls into a panic sell-off, and a crisis triggered by a single stablecoin ultimately evolves into a systemic collapse of the entire market ecosystem.

Echoes of History: The Shadow of Luna

This scene feels familiar to investors who experienced the bear market of 2022. In May of that year, a cryptocurrency empire named Luna collapsed dramatically in just seven days.

The core of the Luna incident is an algorithmic stablecoin called UST. It promised annual returns of up to 20%, attracting billions of dollars in funds. However, its stability mechanism relied entirely on market confidence in another token, LUNA. When UST lost its peg due to massive sell-offs, confidence collapsed, and the arbitrage mechanism failed, ultimately leading to the unlimited issuance of LUNA tokens, with the price plummeting from $119 to less than $0.0001, resulting in about $60 billion in market value evaporating.

By juxtaposing the USDe event with the Luna event, we can discover astonishing similarities. Both used yields far beyond the norm as bait to attract a large amount of funds seeking stable returns. Both exposed the fragility of their mechanisms under extreme market conditions and ultimately fell into a death spiral of “price decline, confidence collapse, liquidation sell-off, further price decline.”

They have all evolved from a crisis of a single asset into a systemic risk affecting the entire market.

Of course, there are also some differences between the two. Luna is a purely algorithmic stablecoin with no external asset backing. In contrast, USDe has excess collateral in the form of encryption assets like Ethereum. This gives USDe a stronger resilience in times of crisis compared to Luna, which is why it hasn't dropped to zero like Luna.

In addition, after the Luna incident, global regulators have raised red flags on algorithmic stablecoins, which has placed USDe in a much stricter regulatory environment since its inception.

However, the lessons of history seem not to have been remembered by everyone. After the collapse of Luna, many vowed to “never touch algorithmic stablecoins again.” But just three years later, faced with an annualized yield of up to 50% on USDe circular loans, people once again forgot the risks.

What is even more concerning is that this incident has revealed not only the vulnerability of algorithmic stablecoins but also the systemic risks of institutional investors and exchanges. From the collapse of Luna to the FTX crash, and from the chain liquidations of small and medium-sized exchanges to the crisis of the SOL ecosystem, this path has already been traversed in 2022. However, three years later, large institutions using cross-margin are still utilizing high-risk assets like USDe as collateral, ultimately triggering a chain reaction amid market volatility.

The philosopher George Santayana once said: “Those who cannot remember the past are condemned to repeat it.”

Awe the market

There is an unbreakable iron law in the financial markets: risk and return are always proportional.

The reason why USDT or USDC can only offer lower annualized returns is that they are backed by real dollar reserves, which carry very low risk. USDe can provide a 12% return because it takes on the potential risks of a delta-neutral hedging strategy in extreme situations. The reason why USDe circular lending can offer a 50% return is that it has layered four times the leverage risk on top of the base return.

When someone promises you “low risk, high return,” he is either a fraud or you have not yet understood where the risks lie. The danger of cyclical lending lies in the concealment of its leverage. Many investors do not realize that their repeated mortgage lending operations are, in fact, a form of high-leverage speculation. Leverage is a double-edged sword; it can amplify your gains in a bull market, but it will also double your losses in a bear market.

The history of financial markets has repeatedly proven that extreme situations will occur. Whether it is the global financial crisis of 2008, the market crash in March 2020, or the Luna collapse in 2022, these so-called “black swan” events always arrive when people least expect them. The fatal flaw of algorithmic stablecoins and high-leverage strategies lies in the fact that their original design is based on the bet that extreme situations will not happen. This is a gamble that is destined to lose.

Why do so many people rush in despite knowing the risks? Perhaps human greed, luck, and the herd mentality can explain part of it. In a bull market, continuous success can numb people's awareness of risk. When those around are making money, very few can resist the temptation. But the market will always remind you at some point, in the most brutal way: there is no such thing as a free lunch.

How can ordinary investors survive in this tumultuous ocean?

First, you need to learn to identify risks. When a project promises more than 10% “stable” returns, when its mechanism is so complex that you cannot explain it to an outsider in one sentence, when its main purpose is to earn profits rather than practical applications, when it lacks transparent and verifiable fiat reserves, and when it is being wildly promoted on social media, you should raise the alarm.

The principles of risk management are simple and timeless. Don't put all your eggs in one basket. Don't use leverage, especially with hidden high-leverage strategies like circular loans. Don't fantasize that you can escape before a crash; during the Luna crash, 99% of people did not escape.

The market is much smarter than any individual. Extreme situations will definitely occur. When everyone is chasing high returns, it is often the time when the risks are the greatest. Remember the lesson of Luna, where a market value of 60 billion dollars vanished in seven days, leaving hundreds of thousands of people's savings in vain. Remember the panic on October 11, when 280 billion dollars evaporated in just a few hours, leading to countless liquidations. Next time, such a story might happen to you.

Buffett said, “Only when the tide goes out do you discover who's been swimming naked.”

In a bull market, everyone seems like an investment genius, and a 50% return appears to be within easy reach. But when extreme situations occur, one realizes that they have long been standing on the edge of a cliff. Algorithmic stablecoins and high-leverage strategies have never been “stablecoin wealth management” but rather high-risk speculative tools. A 50% return is not a “free lunch” but rather bait at the edge of the cliff.

In the financial markets, surviving is always more important than making money.