Stablecoins are supposed to be the boring uncle of the crypto world – safe, logical and boring. They’re probably not what Satoshi Nakamoto had in mind, but they’re supposed to provide a reassuring haven of calm and benefit away from the turbulence of pure cryptocurrencies.
With values pegged to fiat currencies, stablecoins were intended to be useful rather than offer get-rich-quick schemes. They play an important role in the cryptocurrency ecosystem by providing a safer place to store capital without having to fully cash out, and allowing assets to be displayed in fiat currencies rather than temporary tokens.
However, events in May showed that crypto stability is still elusive. With a slow response from governments, Terra’s LUNA token, which has since been renamed Luna Classic (LUNC), has approached zero in value and wiped out $60 billion along the way. The obvious conclusion would be that the stablecoin experiment failed. But I believe Terra’s fall to Earth heralds a new era in which stablecoins will become established, accepted and useful components of the global economic system. And only now, the regulation seems to have passed its sale date.
Not all stablecoins are born equal
While that seems unlikely at the moment, the failure of a few stablecoins doesn’t make the whole concept go away. Other stablecoins have been built on solid ground and are performing as expected.
What is happening is the liquidation of algorithmic stablecoins. These are coins that are never fit for purpose as they are built on insecure foundations. There have always been critics: Some have called Terra a Ponzi scheme, arguing that it and other algorithms will only gain value if more people buy them.
Algorithmic stablecoins are not regulated and are not backed by equivalent amounts of the base fiat currency or anything for that matter. Instead, they implement smart contracts to create or destroy the existing token supply to adjust the price. While enough people believe it, it’s a functioning system powered by an artificially high interest payment mechanism called Anchor. As that trust began to evaporate in early May, the floodgates opened on classic, old-world banks.
Related: What can other algorithmic stablecoins learn from Terra’s collapse?
However, there are other classes of stable currencies backed by assets, including fiat currencies. Tether (USDT), the world’s largest stablecoin by market capitalization, has released its asset record to show that its token is fully backed by assets held in a reserve. Including the current turmoil, Tether’s value against the dollar remained consistent with only a relatively minor drop when it dropped to $0.97 on May 12.
Circle CEO Jeremy Allaire wrote on his Twitter account that USD Coin (USDC), the second largest stablecoin by value, is backed by completely different assets.
2/ The USDC reserve is held entirely in short-term US government obligations consisting of cash and US Treasuries of 3 months or less.
– Jeremy Allaire (@jerallaire) May 13, 2022
USDC even outperformed Tether in its primary task: tracking the US dollar.
Regulators were quick to react…
Regulators were focusing on stablecoins before the Terra meltdown, although perhaps a little late given what happened. In the United States, President Joe Biden signed the Executive Order on Ensuring the Responsible Development of Digital Assets on March 9 – to an unexpected chorus of approval from the wider crypto industry.
Related: The Powers Are Open… Biden accepts blockchain technology, acknowledges its benefits and pushes adoption
Earlier in April, the UK announced its intention to regulate stablecoins, which has yet to be specified. That same month, Senator Patrick Toomey, a prominent member of the U.S. Senate Banking Committee, introduced the “2022 Stablecoin Transparency and Uniform Secure Transactions Act”, simply referred to as the Stablecoin TRUST Act, which deals with fixed cryptocurrencies. US dollars or other assets.
Ironically, on May 6, as Terra began to descend towards zero, Senator Toomey in an interview with the Financial Times urged regulators to do more to regulate stablecoins “before something bad happens.” However, even he didn’t seem to have anticipated how quickly things would unfold:
“It has pushed back against stricter measures promoted by Democrats who believe that stablecoins are now very valuable and that their operators should be regulated like banks.”
Since then, things started to move faster. From about May 5th, when the Terra route began, regulators quickly increased their vigilance. In a report released May 9, the US Federal Reserve said stablecoins are “open to work” and lack transparency about their holdings. And Treasury Secretary Janet Yellen recently commented on the urgent need for railings, saying it would be “extremely appropriate” for lawmakers to enact the law later this year.
Related: United States turns its attention to stablecoin regulation
Elsewhere, in June, Japan became one of the first countries and by far the largest economy to issue a non-fiat digital currency when its parliament approved the regulation of yen-linked stablecoins. This was not related to the Terra collapse, but was based on a regime first proposed by Japan’s Financial Services Agency in March 2021. The new law guarantees par value redemption, restricts stablecoin creation to regulated institutions, and requires stricter Anti-Money Laundering measures.
… and they miss the point
Despite these warnings and emerging policy steps, what seems missing is a clear distinction between algorithmic and asset-backed stablecoins. In my view, asset-backed fiat stablecoins should be regulated by governments and have capital adequacy rules and restrictions on what can be done with reserves.
Algo stablecoins should come with comprehensive health warnings about the risks that remain on consumers’ shoulders if they survive as a class. Algos are the latest in a long series of innovations – the next one won’t be long before and regulators won’t be ready for it either. The truth is that people should take care of their own wealth and wealth. Any fully decentralized environment always requires people to closely and carefully protect their own assets.
And compounding the sense that the reality has outstripped the regulators’ ability to keep up, the existence of fully backed coins like USDC seems to obviate the need for the US government to develop its own central bank digital currency, or what some call “”. digital dollar.”
Related: U.S. central bank digital currency commentators split over benefits, united in disarray
darkest before dawn
At the time of writing this article, we’re only a few weeks behind Terra’s collapse. As a result, stablecoins are under a cloud and the long-term impact on the broader ecosystem of blockchain tokens, which has come under pressure since prices peaked in September 2021, is still unclear.
Many commentators are enjoying the crypto gloom, fueling the implicit skepticism many people feel about the entire crypto project uncovered by Satoshi Nakamoto.
In my opinion, when it comes to stablecoins, it’s the “darkest before dawn” situation. Most people did not and still do not understand that all stablecoins are not born equal. Algorithmic stablecoins, as it is now clear, were a disaster waiting to happen. Fully-backed stablecoins – ideally within the regulatory environment planned or adopted in the US, UK and Japan, among others – are a perfectly logical option with important roles to play in the hybrid crypto-fiat economies of the future. It’s their time.
This article does not contain investment advice or advice. Every investment and trading move involves risk and readers should do their own research when making a decision.
The views, opinions and views expressed here are those of the author alone and do not reflect or represent those of Cointelegraph.
Uldis Tēraudkalns CEO of NexPay, a Lithuanian fintech startup that provides banking infrastructure for the digital asset industry. Uldis has more than ten years of experience in finance and venture investment management and has served on the boards of different companies. Uldis holds a master’s degree in finance from the Stockholm School of Economics and is a co-host. In Search of the JunkyardA leading business and startup podcast in the Baltic.