The new draft stablecoin legislation in the US 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 stablecoin study similar to the UST in collaboration with the U.S. Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Securities and Exchange Commission. Exchange Commission.
An algorithmic stablecoin is a digital asset whose value is kept stable by an algorithm. Although an algorithmic stablecoin is pegged to the value of a real-world 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 cited Terra’s collapse when calling for more regulation of the crypto space.
The failure of the Terra ecosystem that started with the deactivation of its algorithmic stablecoin UST ended the $40 billion ecosystem. This led to a crypto contagion that saw the crypto market lose almost a trillion dollars in market value in a couple 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 became a hot topic for critics, including some policymakers who have been using to advocate for stricter policies for cryptocurrencies. The latest draft proposal to temporarily ban these stablecoins is a case in point. Under the current draft of the bill, it would be illegal to issue or create new “endogenously collateralized stablecoins.”
The draft proposal sparked mixed emotions from Crypto Twitter. While some market observers he called It’s a good idea, which would help prevent more such collapses, others believed that the Terra fiasco has set the industry back for years. Pointing to the two-year temporary ban, some suggested that while algorithmic stablecoins might not be to blame, Team Terra’s execution has cast a shadow over the entire stablecoin industry algorithmic
In many ways, Do Kwon took the crypto space back years ago. Most Terra fans don’t even realize that the “maxi decentralization” game was pure LARP: Terra was one of the most centralized L1s, and the main support of UST ($3 million in BTC) was sitting on a man’s wallet without any supervision. https://t.co/MJ2c7U1kgJ
— FatMan (@FatManTerra) September 21, 2022
Speaking about the impact of Terra contagion on the regulation of stablecoins, Mriganka Pattnaik, CEO of risk monitoring service provider Merkle Science, told Cointelegraph that regulators need to take a broader approach than a temporary ban. She believes that lumping all algorithmic stablecoins together and putting a blanket ban on them will hinder innovation, stating:
“In light of Terra’s collapse and the ripple effect it created, algorithmic stablecoins will need to regain the trust of regulators and consumers. Regulators can push partially collateralized models, set transparency standards and demand issuers to submit white papers highlighting how their particular stablecoin offering works, their operating structure, the minting and recording mechanism and the type of algorithm they use to maintain value, the unique risks presented by the offer and analyze whether it may have a potential spillover effect on broader financial stability.”
It is important to understand that even within algorithmic stablecoins, there are smaller categorizations, for example, rebase, lordship, and fractional algorithmic stablecoins. Another vertical to consider here is the fact that algorithmic stablecoins are decentralized in nature; therefore, a ban will be more difficult to enforce.
Patnaik added that it is counterproductive to maintain the idea that decentralization and regulatory controls can never be aligned. The most proactive thing stablecoin issuers can do is to “come together and propose technical solutions to the regulatory issues surrounding algorithmic stablecoins.”
Jay Fraser, director of strategic partnerships at Boston Security Token Exchange, explained how Do Kwon’s marketing and action tactics were to blame for the bad press algorithmic stablecoins received afterward, telling Cointelegraph:
“There is the issue of how Do Kwon marketed Terra and how he used user funds during and after the collapse. If there had been good regulation before and during the collapse, some of it would have involved more messaging clear about the risks involved in investing money in unproven technology. I think many investors may not have been aware of the risks.”
He added that the Terra debacle set a precedent for decentralized financial peers and crypto investors to be more transparent, and that “regulations will be put in place to ensure that consumers and investors are not affected by poor practices.”
A “Balance Moment” for Algorithmic Stablecoins
The Terra stablecoin project is somewhat reminiscent of the fate of Facebook’s Libra stablecoin project, now Meta, which was later renamed Diem. The social media giant got involved in the crypto space in 2019 when it announced plans to launch a universal stablecoin, the adoption of which would have boosted Facebook’s line of social messaging apps and services, like Instagram and Whatsapp.
The stablecoin was to be pegged to the value of a basket of fiat currencies including the US dollar, the British pound, the euro, the Japanese yen, the Singapore dollar and some generally considered short-term assets cash equivalents.
Facebook registered the project in Switzerland and hoped to avoid regulatory oversight from several nations, but to no avail. Facebook faced immediate pushback from regulators around the world and founder Mark Zukerberg even faced several congressional hearings on the same. The name change to Diem didn’t help his cause much, and the project was eventually shut down at the end of January 2022.
Like the ill-fated Diem/Libra venture, the disintegration of Terra’s $40 billion ecosystems forced regulators to take an interest in the nascent industry and even forced several regulatory changes.
Just as Libra forced regulators to wake up to the reality of private entities issuing money in the digital age, Terra has made lawmakers take a closer look at who can issue a stablecoin, opening the door to for banks and other financial institutions to get involved in the nascent. crypto market
Dion Guillaume, global head of communications at crypto exchange platform Gate.io, told Cointelegraph that Terra was a stress test that could benefit the industry:
“It was a big stress test, no doubt. However, I think this will eventually get better. On the one hand, crypto users should know that when someone offers you crazy high returns, there is something fishy about background. In addition, projects must know how to prioritize long-term goals over short-term pleasure. For example, many analysts have pointed out the flaws of Terra’s UST stablecoin, which is that it is impossible to create a decentralized stablecoin and capital-efficient, but users continued to use Terra and projects continued to build on it. We hope the industry will learn a lesson from this setback.”
Jason P. Allegrante, chief legal and compliance officer at Fireblocks, explained that, much like what Diem did for regulators, Terra’s failure has accelerated Congress’s drafting of a promising bipartisan bill. He told Cointelegraph:
“We can see in hindsight that he accelerated the writing of a very promising bipartisan bill in Congress, which will introduce stablecoin legislation, significantly normalizing the industry in the process. It is not only a direct response to the collapse of Terra , but the impact will be transformative, providing clarity on the regulatory classifications of stablecoins, in what quantity and quality they must be reserved, how they will be backed by other assets, etc.
He added that Terra’s implosion experience will trigger innovation in true stablecoin products and ultimately “drive more organizations and individuals to invest in cryptocurrencies and related technologies in the coming years.”
The collapse of Terra may have caused crypto contagion, but it created a starting point for the stablecoin industry. It has forced policymakers to look at the bigger picture and find better ways to protect consumers. It has also raised the interest of policy makers in the diverse and complex nature of the industry and made them realize that a common policy will not work for the whole industry.