When the third largest stablecoin collapsed this week, investors lost more than $25 billion.
They’re going to be getting a great deal of attention over the next few days and weeks as the fall of the TerraUSD stablecoin lights a fire under the push to regulate the dollar-pegged cryptocurrencies and reignites a fight on Capitol Hill over who will have control.
TerraUSD, or UST, started losing its dollar peg over the weekend, and was worth 31 cents as of Wednesday morning May 11), two days after it broke its dollar peg and one day after it began to spiral in earnest.
See also: TerraUSD’s Price Collapse Shows Vulnerability of Dollar-Pegged Cryptos
Stablecoins are a potential competitor to fiat currencies in the payments market because they bypass many financial intermediaries making payments cheaper and available in or close to real time. And speaking to the Senate Banking Committee on May 10, Treasury Secretary Janet Yellen pointed out that the ongoing collapse “simply illustrates that [stablecoins are] a rapidly growing product.”
She added, “there are risks to financial stability and we need a framework that’s appropriate.”
Something Different
If there’s a silver lining in the collapse of the TerraUSD stablecoin over the past two days, it is that unlike other top stablecoins like Tether, USD Coin, and BinanceUSD, its dollar peg was not backed by hard assets — generally fiat or other financial instruments of varying quality.
Instead, TerraUSD, or UST, it is an “algorithmic” stablecoin, with the peg supported by an automated arbitrage mechanism with a second cryptocurrency, Terra, which goes by LUNA on exchanges. UST’s partner coin Terra — LUNA on exchanges — started the month at $80. Its currently at $1.18, down more than 96%. Investors have lost about $27.5 billion in that time.
An “algorithmic” stablecoin, UST’s peg supported by an automated arbitrage mechanism with a second free-floating cryptocurrency, Terra, which goes by LUNA on exchanges. It started the month at $80. It dropped as low as $0.85 this morning, down 99% with a market cap approaching $500,000. It has since bounced back to $4.50 as the stablecoin’s backers scramble to save it.
These unbacked stablecoins have gotten less attention, in part because they only recently started becoming significant players in the stablecoin space.
That will, obviously, change.
Get a Move On
As will the sense of urgency.
In February, the Financial Stability Board (FSB) issued a stablecoin report that basically told governments to move faster on regulating stablecoins, and especially the assets that back them.
Read more: FSB Tells National Regulators to Move Faster on Stablecoin Regulation
“Reported outstanding stablecoin assets are equivalent to almost 20% of the total size of U.S. assets held in institutional and retail prime money market funds,” it said. If the market lost confidence in the value of those asset-backed stablecoins, run could ensue, which “could lead to fire sales of those assets, creating disruptions in the markets in which the reserve is invested, such as the short-term funding markets.”
How Much Regulation?
If you look back over what regulators and central bankers have been saying about stablecoins over the past three years, their biggest fear, at least in the short term, is that they could suffer bank run-style panics that could spread over into the broader financial system.
The biggest concern has been ensuring that the reserves backing those one-to-on reserves is sufficient and given proper oversight.
The President’s Working Group on Financial Stability’s recent Stablecoin Report, which Yellen chaired, said among other things there should be strict anti-money-laundering (AML) rules and that only federally insured banks should be permitted to issue stablecoins.
Also read: Powell, Yellen Clash Over Stablecoin Regulation at Senate Hearing
That has drawn some pushback, primarily from Republican congressmen and senators who believe that state-run banks and other institutions should be allowed to issue stablecoins.
That recommendation by the Stablecoin Report “is misguided and wrong,” said Wyoming Senator Cynthia Lummis, a Republican and avid crypto supporter. “There are other, safer ways of achieving the same objectives. For example, we could require 100% of stablecoin reserves to be maintained off-balance sheet, or require stablecoin reserves to be maintained at a Federal Reserve Bank, which is, by definition, risk-free.”
Federal Reserve Chairman Jerome Powell, an appointee of President Trump, called the report “perplexing” and added “the mechanism by which the value of [stablecoins are kept stable] vary significantly. Why suggest they all must be regulated the same way and treated as depository institutions?”
EU Cracks Down
The European Union intends to have an important role in addressing potential risks that could arise from stablecoin issuance.
In the EU, Mairead McGuiness, the European commissioner recently pushed for global coordination of crypto regulation. That would include those made in the forthcoming Markets in Crypto-Assets (MiCA) framework. Among other things, it would require stablecoin issuers to have at least 2% of their backing assets in cash “at all times.”
That would jump to 3% for those with a market cap of more than 1 billion euros. There would also be strict AML rules, requiring the identification of all parties in a stablecoin transaction — possibly of any amount.
See also: EU Crypto Industry Coordinates Efforts to Amend EU Rules
These requirements wouldn’t fit algorithmic stablecoins, which have no reserve, making their legality questionable.
Are Payments in Danger?
That’s bad enough.
But the FSB noted that while stablecoins are currently used mainly to ease the trading of cryptocurrencies, they are starting to be used for payments.
Read more: Treasury Under Secretary Adds FedNow to Stablecoin vs Digital Dollar Debate
“In the event that stablecoins were used more extensively for payment, they would face many of the same risks as current payment systems, including credit risk, liquidity risk, operational risk, risks arising from improper or ineffective governance, and settlement risk,” the FSB said.
A run, it added, could “impair the availability of critical financial services on which the real economy depends, threaten confidence, and operate as a channel through which financial shocks spread.”
That’s something Yellin said about stablecoins back in December, warning that there are “significant risks associated with these currencies, risks to the payment system, risks of runs and risks related to the concentration of economic power.”
You’ll notice which one she put first.
We’re always on the lookout for opportunities to partner with innovators and disruptors.
Learn More