Regulators are itching for stablecoins like Tether after UST crash

The entire stablecoin market is now worth more than $160 billion.

Justin Tallis | AFP via Getty Images

Regulators are increasingly concerned about stablecoins after the collapse of controversial cryptocurrency startup Terra.

TerraUSD, an “algorithmic” stablecoin that must be pegged one-for-one to the US dollar, has wiped much of its value this week after a surprising run on the bank saw billions of dollars suddenly evaporate from its value. market.

Also known as UST, the cryptocurrency operated using a complex code mechanism combined with a floating token called luna to balance supply and demand and stabilize prices, as well as a multi-million dollar stack of bitcoin.

Tether, the world’s largest stablecoin, also fell below its expected value of $1 for several hours on Thursday, fueling fears of possible contagion from the fallout from the UST decoupling. Unlike UST, Tether is supposed to be backed by sufficient assets held in a reserve.

US Treasury Secretary Janet Yellen directly addressed the issue of UST and Tether “breaking money” this week. In a congressional hearing, Yellen said such assets do not currently pose a systemic risk to financial stability, but she suggested they eventually might.

“I wouldn’t characterize it on this scale as a real threat to financial stability, but they are growing very rapidly,” he told lawmakers on Thursday.

“They present the same kind of risks that we have known about for centuries in relation to bank runs.”

Yellen urged Congress to pass federal regulation of stablecoins by the end of this year.

The UK government is also taking note. A government spokesperson told CNBC on Friday that he is ready to take further action on stablecoins after the collapse of Terra.

“The government has made it clear that certain stablecoins are not suitable for payment purposes as they share characteristics with unbacked crypto assets,” the spokesperson said.

Britain plans to bring stablecoins within the scope of electronic payments regulation, which could make issuers such as Tether and Circle subject to oversight by the country’s markets watchdog.

Separate proposals in the European Union would also subject stablecoins to strict regulatory oversight.

What are stable coins?

They are like casino chips for the world of cryptocurrencies. Traders buy tokens like tether or USDC with real dollars. The tokens can then be used to trade bitcoin and other cryptocurrencies.

The idea is that whenever someone wants to cash out, they can get the equivalent number of dollars for the number of stablecoins they want to sell. Stablecoin issuers are meant to hold a sufficient level of money corresponding to the number of tokens in circulation.

Today, the entire stablecoin market is worth more than $160 billion, according to data from CoinGecko. Tether is the largest in the world, with a market value of around $80 billion.

What happened to the UST?

UST is a unique case in the world of stablecoins. Unlike Tether, it had no real cash to back its purported dollar peg, though it was at one point partially backed by Bitcoin.

Instead, UST relied on a system of algorithms. It was something like this:

  • The price of UST can drop below a dollar when there are too many tokens in circulation but not enough demand.
  • smart contracts (lines of code written on the blockchain) would be activated to remove excess UST and create new units of a token called luna, which has a floating price
  • There was also an arbitrage system in play, in which traders were encouraged to profit from deviations in the price of the two tokens.
  • The idea was that you could always buy $1 a moon for a UST. So if UST was worth 98 cents, you could basically buy one, trade it to luna, and make a 2 cent profit.

Luna, the sister token to UST, is now basically worthless after having topped $100 per coin earlier this year.

The entire system was designed to stabilize the UST at $1. But it collapsed under the pressure of billions of dollars in liquidations, particularly on Anchor, a lending platform that promised users interest rates of up to 20% on their savings. Many experts say this was unsustainable.

Why are regulators worried?

The main fear is that a major stablecoin issuer like Tether could be the next to experience a “bank run”.

Yellen and other US officials have often compared them to money market funds. In 2008, the Reserve Primary Fund, the original money market fund, lost its net asset value of $1 per share. The fund held some of its assets in commercial paper (short-term corporate debt) from Lehman Brothers. When Lehman went bankrupt, investors fled.

Previously, Tether said that its reserves consisted entirely of dollars. But he reversed this position after a 2019 settlement with the New York attorney general. Disclosures from the firm revealed that he had very little cash but a lot of unidentified business paper.

Tether now says it is reducing the level of commercial paper it holds and increasing its US Treasury bill holdings.

“We expect recent developments to lead to an increase in stablecoin regulatory calls,” ratings agency Fitch said in a note on Thursday.

While the risks of stablecoins like tether “may be more manageable” than algorithmic ones like UST, it ultimately comes down to the creditworthiness of the companies that issue them, according to Fitch.

“Many regulated financial entities have increased their exposure to crypto, defi and other forms of digital finance in recent months, and some Fitch-rated issuers could be affected if crypto market volatility becomes severe,” the company said.

“There is also the risk of an impact on the real economy, for example through negative wealth effects if crypto asset values ​​fall sharply. However, we believe the risks to Fitch-rated issuers and economic activity real are generally very low.

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