A new bill on stablecoins in the United States House of Representatives proposed imposing a two-year ban on new algorithmically pegged stablecoins like TerraUSD (UST).
The proposed legislation would require the Treasury Department to conduct a study on UST-like stablecoins. in collaboration 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.
A Algorithmic stablecoin is a digital asset whose value is kept stable by an algorithm. Although an algorithmic stablecoin is tied to the value of a real-world asset, not backed by one.
The stablecoin bill has been in the works for several months and has been delayed numerous times. Treasury Secretary Janet Yellen has repeatedly cited the collapse of Terra in calling for more regulation of the cryptocurrency space.
The failure of the Terra ecosystem, which began with the withdrawal of its algorithmic stablecoin UST, ended the $40 billion ecosystem. This led to a cryptocurrency contagion that saw the crypto market lose almost a trillion dollars of market value in a couple of weeks.
Markets have not yet recovered 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 certain policymakers who have been using it to advocate for stricter policies for cryptocurrencies.. The latest draft proposal to temporarily ban this type of stablecoin is a case in point. Under the current bill, it would be illegal to issue or create new “endogenously collateralized stablecoins”.
The draft proposal sparked mixed emotions on Crypto Twitter. While Some market observers qualified like a good ideawhich would help prevent further collapses of this type, others believed the Terra fiasco has set the industry back for years. Pointing to the two-year temporary ban, some hinted that while algorithmic stablecoins might not be to blame, the execution of the Terra team has cast a shadow over the entire algorithmic stablecoin industry.
In many ways, Do Kwon set the crypto space back by years. Most Terra fans don’t even realize that the “decentralization maxi” spiel was pure LARP – Terra was one of the most centralized L1s, and UST’s primary backing ($3b in BTC) was sitting in one guy’s wallet with no oversight. https://t.co/MJ2c7U1kgJ
— FatMan (@FatManTerra) September 21, 2022
In many ways, Do Kwon set the cryptocurrency space back for years. Most Terra fans don’t even realize that the “maximum decentralization” talk was pure LARP: Terra was one of the most centralized L1s, and the main backer of UST ($3B BTC) I was sitting on some guy’s purse without any supervision.
Speaking about the impact of the Terra contagion on stablecoin regulation, Mriganka Pattnaik, CEO of risk monitoring service provider Merkle Science, told Cointelegraph that regulators need to take a broader approach than going for a temporary ban. Consider that lumping all algorithmic stablecoins together and banning them across the board will hamper innovationand states that:
“In light of the Terra collapse and the ripple effect it created, algorithmic stablecoins will need to regain the trust of regulators and consumers alike. Regulators can push partially collateralized models, set transparency standards, and require issuers to submit white papers highlighting how their particular stablecoin offering works, its operating structure, the mint-and-burn mechanism and the type of algorithm they use to hold value, the unique risks the offering presents, and whether it can have a potential contagion effect on broader financial stability.
It is important to understand that even within algorithmic stablecoins, there are more granular categorizations.s, for example, rebase, seigniorage, and fractional algorithmic stablecoins. Another vertical to consider here is the fact that algorithmic stablecoins are decentralized in nature, therefore it will be more difficult to enforce a ban on them.
Patnaik added that it is counterproductive to cling to 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 the Boston Security Token Exchange, explained how Do Kwon’s action and marketing tactics were to blame for the bad press algorithmic stablecoins received aftertelling Cointelegraph:
“There is the question of how Do Kwon marketed Terra and how he used user funds during and after the crash. If there had been good regulation before and during the crash, some of it would have involved a clearer message about the risks involved. pouring money into unproven technology. I think a lot of investors weren’t aware of the risks.”
He added that Terra debacle set precedent for decentralized finance peers and crypto investors to be more transparent and “regulations will be put in place to ensure that consumers and investors are not affected by bad practices.”
A “Libra moment” for algorithmic stablecoins
The Terra stablecoin project is somewhat reminiscent of the fate of Facebook’s (now Meta) stablecoin project Libra., which was later baptized as Diem. The social media giant got involved in the cryptocurrency space in 2019 when it announced plans to launch a universal stablecoin whose adoption would have been boosted by Facebook’s line of social messaging apps and services, including Instagram and WhatsApp.
The stablecoin was to be pegged to the value of a basket of fiat currencies which included the US dollar, the British pound, the euro, the Japanese yen, the Singapore dollar, and some short-term assets generally considered to be cash equivalents.
Facebook registered the project in Switzerland and hoped to bypass regulatory oversight in several countries, but failed.. Facebook immediately faced opposition from regulators around the world and its founder, Mark Zukerberg, even faced multiple hearings in Congress regarding the same. The name change to Diem did not help his cause much and the project ended up being closed at the end of January 2022.
Like the ill-fated Diem/Libra company, the disintegration of Terra’s $40 billion ecosystems forced regulators to take an interest in the nascent industry and even forced several regulatory changes.
In the same way that 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 for banks and other financial institutions to get involved in the nascent cryptocurrency market..
Dion Guillaume, global head of communication for cryptocurrency exchange Gate.io, told Cointelegraph that Terra was a stress test that could benefit the industry:
“It was a great stress test, for sure. However, I think this will end up being positive. On the one hand, cryptocurrency users need to know that when someone offers you extremely high returns, something fishy is going on in the background. In addition, projects have to 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: creating a decentralized and capital efficient stablecoin is impossibleand yet users continued to use Terra, and projects continued to build on top of it. Let’s hope the industry learns a lesson from this setback.“.
Jason P. Allegrante, chief legal and compliance officer at Fireblocks, explained that similar to what Diem did for regulators, the failure of Terra has accelerated the writing by Congress of a promising bipartisan bill. He told Cointelegraph:
“We can see in hindsight that this accelerated the drafting by Congress of a very promising bipartisan bill, which will introduce stablecoin legislation, significantly normalizing the industry in the process. Not only is this a direct response to the Terra collapse, but that the impact will be transformational, providing clarity on the regulatory classifications of stablecoins, in what quantity and quality they should be reserved, how they will be backed by other assets, etc.”
He added that Terra implosion experience will trigger innovation in true stablecoin products and ultimately “will drive more organizations and individuals to invest in cryptocurrencies and related technologies in the years to come”.
The collapse of Terra may have caused a contagion of cryptocurrencies, but has created a turning point for the stablecoin sector. He has forced policymakers to look at the bigger picture and find better ways to protect consumers. Too a aroused the interest of policy makers in the different and complex nature of the sector and made them realize that a common policy will not work for the whole sector.
Clarification: The information and/or opinions expressed in this article do not necessarily represent the views or editorial line of Cointelegraph. The information set forth herein should not be taken as financial advice or investment recommendation. All investment and commercial movement involve risks and it is the responsibility of each person to do their due research before making an investment decision.