A new stablecoins bill in the United States House of Representatives proposed imposing a two-year ban on new algorithmically-linked stablecoins like TerraUSD (UST).
The proposed legislation would require the Treasury Department to conduct a study of UST-like stablecoins in cooperation with the United States Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Securities and Exchange Commission.
An algorithmic stablecoin is a digital asset whose value is kept constant by an algorithm. While an algorithmic stablecoin is tied to the value of a real asset, it is not backed by one.
The stablecoin bill has been in the works for several months and has been delayed on numerous occasions. Treasury Secretary Janet Yellen has repeatedly spearheaded the collapse of Terra when she called for more regulation of the crypto space.
The failure of the Terra ecosystem, which began with the depegging of its algorithmic stablecoin UST, eventually wiped out the $40 billion ecosystem. This led to a crypto contagion that saw the crypto market lose nearly $1 trillion in market value in a matter of weeks.
Markets have yet to recover from the contagion, and Terra’s collapse definitely cast a shadow over the future of algorithmic stablecoins and has become a hot topic for critics, including certain policymakers, who have used it to advocate for tougher policies on cryptocurrency use cryptocurrencies. The recent draft proposal to temporarily ban such stablecoins is one such example. Under the current draft law, it would be illegal to issue or create new “endogenously collateralized stablecoins.”
The draft proposal raised mixed feelings on Crypto Twitter. While some market observers thought it was a good idea that would help avoid more such meltdowns, others believed the Terra fiasco set the industry back years. Regarding the two-year temporary ban, some suggested that while algorithmic stablecoins may not be the culprit, the execution by the Terra team cast a shadow over the entire algorithmic stablecoin industry.
In many ways, Do Kwon set the crypto space back years. Most Terra fans don’t even know that the “decentralization maxi” game was pure LARP – Terra was one of the most centralized L1s and the primary support of UST ($3 billion in BTC) sat in the wallet with no oversight a guy. https://t.co/MJ2c7U1kgJ
— FatMan (@FatManTerra) September 21, 2022
Mriganka Pattnaik, CEO of risk monitoring service provider Merkle Science, told Cointelegraph about the impact of the Terra contagion on stablecoin regulation that regulators need to take a broader approach than a temporary ban. She believes that merging all algorithmic stablecoins and banning them across the board will hamper innovation, stating:
“In light of the collapse of Terra and the ripple effect it caused, algorithmic stablecoins need to regain trust from regulators and consumers alike. Regulators can push for partially collateralized models, set transparency standards, and require issuers to provide white papers detailing how their particular stablecoin offering works, its operating structure, the minting and burning mechanism, and the type of algorithm they use to preserve value use, highlighting unique risks posed by the offer and analyzing whether it can have a potential contagion effect on overall financial stability.”
It is important to understand that even within algorithmic stablecoins, there are finer categorizations, for example rebase, seignorage, and fractional algorithmic stablecoins. Another vertical to consider is the fact that algorithmic stablecoins are inherently decentralized – so getting a ban on them will be harder to enforce.
Patnaik added that clinging to the notion that decentralization and regulatory controls can never be aligned is counterproductive. The most proactive thing stablecoin issuers can do is “come together and propose technical solutions to regulatory issues related to algorithmic stablecoins.”
Jay Fraser, director of strategic partnerships at the Boston Security Token Exchange, explained to Cointelegraph how Do Kwon’s action and marketing tactics should be blamed for the bad press algorithmic stablecoins received in the aftermath:
“There’s the question of how Do Kwon both marketed Terra and how he used user funds during and after the collapse. If there had been good regulation before and during the collapse, part of it would have included a clearer message about the risks of investing money in untested technology. I think many investors may not have been aware of the risks.”
He added that the Terra debacle set a precedent for other decentralized finance and crypto investors to be more transparent and “regulations are being put in place to ensure consumers and investors are not affected by bad practices.”
A “balance moment” for algorithmic stablecoins
The Terra stablecoin project is somewhat reminiscent of the fate of Facebook’s, now Meta, stablecoin project Libra, later named Diem. The social media giant got involved in the crypto space in 2019 when it announced its plans to launch a universal stablecoin whose adoption would have been boosted by Facebook’s suite of social messaging apps and services like Instagram and Whatsapp.
The stablecoin would be pegged to the value of a basket of fiat currencies, including the US dollar, British pound, euro, Japanese yen, Singapore dollar, and some short-term assets that are commonly considered cash equivalents.
Facebook registered the project in Switzerland, hoping to bypass regulatory oversight from several nations, but to no avail. Facebook was immediately rebuffed by regulators around the world, and founder Mark Zukerberg even faced multiple congressional hearings on the matter. Changing the name to Diem didn’t help his cause much and the project was eventually shelved in late January 2022.
Like the ill-fated Diem/Libra, the disintegration of Terra’s $40 billion ecosystems forced regulators to take an interest in the burgeoning industry and even forced several regulatory changes.
Just as Libra forced regulators to realize the reality of private companies issuing money in the digital age, Terra has led lawmakers to take a closer look at who can issue a stablecoin, opening the gates for banks and other financial institutions to participate in the creation of the crypto market.
Dion Guillaume, global communications head at crypto exchange platform Gate.io, told Cointelegraph that Terra is a stress test that could benefit the industry:
“It was definitely a huge stress test. However, I think this will eventually change for the better. For one thing, crypto users need to know that when someone is offering you crazy high returns, something fishy is going on in the background. Also, projects need to know how to prioritize long-term goals over short-term pleasure. For example, many analysts have pointed out the shortcomings in Terra’s UST stablecoin that it is impossible to create a capital-efficient, decentralized stablecoin, but users have continued to use Terra and projects have continued to build on it. Let’s hope the industry learns a lesson from this setback.”
Jason P. Allegrante, chief legal and compliance officer at Fireblocks, explained that Terra’s failure has accelerated Congress’s preparation of a promising bipartisan bill, much like Diem did for regulators. He told Cointelegraph:
“We can see with hindsight that it has accelerated the drafting of a very promising bipartisan bill by Congress that will introduce stablecoin legislation while significantly normalizing the industry. Not only is this a direct response to the collapse of Terra, but the impact will be transformative, bringing clarity to the regulatory classifications of stablecoins, in what quantity and quality they must be reserved, how they are backed by other assets, and so on. ”
He added that the experience from the Terra implosion will spark innovation in true stablecoin products and ultimately “drive more organizations and individuals to invest in cryptocurrencies and related technologies for years to come.”
Terra’s collapse might have sparked crypto contagion, but it created a watershed moment for the stablecoin industry. It has forced policymakers to look at the bigger picture and find better ways to protect consumers. It has also piqued policymakers’ interest in the particular and complex nature of the industry and made them realize that one policy will not work for the entire industry.
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