Terra could leave a similar regulatory legacy to that of Facebook’s Libra

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New draft leg­is­la­tion on sta­ble­coins in the Unit­ed States House of Rep­re­sen­ta­tives pro­posed to impose a two-year ban on new algo­rith­mi­cal­ly pegged sta­ble­coins like Ter­raUSD (UST).

The pro­posed leg­is­la­tion would require the Depart­ment of the Trea­sury to con­duct a study of sta­ble­coins sim­i­lar to UST 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. 

An algo­rith­mic sta­ble­coin is a dig­i­tal asset the val­ue of which is kept steady by an algo­rithm. While 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 now and has been delayed on numer­ous occa­sions. Trea­sury Sec­re­tary Janet Yellen has repeat­ed­ly cit­ed the Ter­ra col­lapse when call­ing for more reg­u­la­tion of the cryp­to space.

The Ter­ra ecosys­tem fail­ure that 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 a tril­lion dol­lars worth of mar­ket val­ue with­in a cou­ple of weeks.

Mar­kets have yet to recov­er from the con­ta­gion, and the Ter­ra col­lapse def­i­nite­ly cast a shad­ow on 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 put a tem­po­rary ban on such sta­ble­coins is one such exam­ple. Under the cur­rent draft of the bill, it would be ille­gal to issue or cre­ate new “endoge­nous­ly col­lat­er­al­ized stablecoins.”

The draft pro­pos­al evoked mixed emo­tions from Cryp­to Twit­ter. While some mar­ket observers called it a good idea, which would help avoid fur­ther such col­laps­es, oth­ers believed the Ter­ra fias­co has put the indus­try back by years. Point­ing toward the two-year tem­po­rary ban, some implied that even though algo­rith­mic sta­ble­coins might not be the cul­prit, the exe­cu­tion by the Ter­ra team has cast a shad­ow on the whole algo­rith­mic sta­ble­coin industry. 

Talk­ing about the impact of Ter­ra con­ta­gion on the 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. She believes lump­ing all algo­rith­mic sta­ble­coins togeth­er and putting a blan­ket ban on them will ham­per 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 alike. The reg­u­la­tors can push for par­tial­ly col­lat­er­al­ized mod­els, set trans­paren­cy stan­dards, and require the issuers to sub­mit white papers high­light­ing how their par­tic­u­lar sta­ble­coin offer­ing works, its oper­a­tional struc­ture, mint and burn mech­a­nism and the kind of algo­rithm they use to main­tain the val­ue, the unique risks the offer­ing presents and ana­lyze 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 minute cat­e­go­riza­tions, 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 hard­er to enforce a ban on them. 

Pat­naik added that it is coun­ter­pro­duc­tive to hold onto the notion that decen­tral­iza­tion and reg­u­la­to­ry con­trols can nev­er be in align­ment. The most proac­tive thing sta­ble­coin issuers can do is “come togeth­er and pro­pose tech­ni­cal solu­tions to reg­u­la­to­ry prob­lems sur­round­ing algo­rith­mic stablecoins.”

Jay Fras­er, direc­tor of strate­gic part­ner­ships at Boston Secu­ri­ty Token Exchange, explained how Do Kwon’s action and mar­ket­ing tac­tics were to be blamed for the bad press algo­rith­mic sta­ble­coins received in the after­math, telling Cointelegraph:

“There’s the issue of how Do Kwon both mar­ket­ed Ter­ra as well as how he used user funds dur­ing and after the col­lapse. If there were to have been good reg­u­la­tion in place ahead of and dur­ing the col­lapse, part of it would have involved clear­er mes­sag­ing around the risks involved in invest­ing mon­ey in untest­ed tech­nol­o­gy. I think a lot of investors were per­haps not aware of the risks.”

He added that the Ter­ra deba­cle set a prece­dent for fel­low decen­tral­ized finance and cryp­to investors to be more trans­par­ent and “reg­u­la­tions will be put in place to ensure con­sumers and investors aren’t affect­ed by poor practices.”

A “Libra moment” for algorithmic stablecoins

The Ter­ra sta­ble­coin project some­what recalls the fate of Facebook’s, now Meta, sta­ble­coin project Libra, which was lat­er dubbed 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 ele­vat­ed 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 includ­ing the U.S. dol­lar, the Great British pound, euro, Japan­ese yen, 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 from mul­ti­ple nations, but unsuc­cess­ful­ly. Face­book faced imme­di­ate push­back from reg­u­la­tors across the globe and founder Mark Zuker­berg even faced mul­ti­ple Con­gres­sion­al hear­ings regard­ing the same. The name change to Diem didn’t help its cause much and the project was even­tu­al­ly shut down by the end of Jan­u­ary 2022.

Like the ill-fat­ed Diem/Libra ven­ture, the dis­in­te­gra­tion of Terra’s $40 bil­lion ecosys­tems forced reg­u­la­tors to show inter­est in the nascent indus­try and even forced sev­er­al reg­u­la­to­ry changes. 

Just as Libra forced reg­u­la­tors to wake to the real­i­ty of pri­vate enti­ties issu­ing mon­ey in the dig­i­tal era, Ter­ra has made law­mak­ers take a clos­er look at who can issue a sta­ble­coin, open­ing the gates for banks and oth­er finan­cial insti­tu­tions to get involved in the nascent cryp­to market.

Dion Guil­laume, glob­al head of com­mu­ni­ca­tion at cryp­to exchange plat­form Gate.io, told Coin­tele­graph that Ter­ra was a stress test that could ben­e­fit the industry:

“It was a huge stress test, for sure. How­ev­er, I think this will even­tu­al­ly work out for the bet­ter. For one, cryp­to users need to know that when some­one offers you crazy high yields, some­thing fishy is going on in the back­ground. Plus, projects need to know how to pri­or­i­tize long-term goals over short-term plea­sure. For exam­ple, many ana­lysts have point­ed out the flaws in Terra’s UST sta­ble­coin cre­at­ing a cap­i­tal-effi­cient, decen­tral­ized sta­ble­coin is impos­si­ble, yet users con­tin­ued to use Ter­ra, and projects 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 quite sim­i­lar to 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 it accel­er­at­ed Con­gress’ draft­ing 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 Terra’s col­lapse, but the impact will be trans­for­ma­tive, pro­vid­ing clar­i­ty on the reg­u­la­to­ry clas­si­fi­ca­tions of sta­ble­coins, what quan­ti­ty and qual­i­ty they must be reserved in, how they will be backed by oth­er assets and so on.” 

He added that the expe­ri­ence from the Ter­ra implo­sion will unleash inno­va­tion in true sta­ble­coin prod­ucts and ulti­mate­ly “dri­ve more orga­ni­za­tions and indi­vid­u­als to invest in cryp­tocur­ren­cies and relat­ed tech­nolo­gies in the com­ing years.”

The Ter­ra col­lapse might have led to a cryp­to con­ta­gion, but it cre­at­ed a water­shed for the sta­ble­coin indus­try. It has forced pol­i­cy­mak­ers to look at the broad­er pic­ture and find bet­ter ways to pro­tect con­sumers. It has also ignit­ed inter­est from pol­i­cy­mak­ers in the dis­tinct and com­plex nature of the indus­try and made them real­ize that a com­mon pol­i­cy won’t work for the whole industry.



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