After the fall of Terra to Earth, prepare for the era of stablecoins

Stablecoins were supposed to be the boring uncle of the crypto world – safe, sensitive, and boring. Probably not what Satoshi Nakamoto had in mind, but they are meant to be a haven of calm and reassuring usefulness, away from the turmoil of pure cryptocurrencies.

With values ​​pegged to fiat currencies, stablecoins were intended to be useful rather than provide get-rich-quick schemes. They play an important role in the cryptocurrency ecosystem by providing a safer place to store capital without having to cash out entirely, and by allowing assets to be denominated in fiat currencies rather than volatile tokens.

However, the events of May demonstrated that crypto stability is still elusive. With governments slow to respond, Terra’s LUNA token – which has since been renamed Luna Classic (LUC) – plummeted to near zero in value, wiping out $60 billion along the way. The obvious conclusion would be that the stablecoin experiment failed. But I believe the fall of Terra to Earth is the precursor to a new era where stablecoins will become established, accepted, and beneficial components of the global economic system. And the regulations that have only just been put in place already seem well past their expiry date.

Not all stablecoins are created equal

While that seems unlikely right now, the failure of a few stablecoins doesn’t negate the whole concept. Other stablecoins have been built on solid ground and are working as intended.

What is happening is an algorithmic stablecoin cleanup. These are rooms that were never fit for purpose because they were built on insecure foundations. There have always been criticisms: some have called Terra a Ponzi scheme and argued that it, and other algorithms, would only be valuable if more and more people bought them.

Algorithmic stablecoins are unregulated and not backed by equivalent amounts of the underlying fiat currency – or anything, for that matter. Instead, they deploy smart contracts to create or destroy the available supply of tokens to adjust the price. It’s a system that worked, backed by an artificially high interest payment mechanism called Anchor, when enough people believed it. Once that confidence began to evaporate in early May, the floodgates opened in a classic old-world banking run.

Related: What can other algorithmic stablecoins learn from Terra’s crash?

But there are other classes of stablecoins that are backed by assets, including fiat currencies. Tether (USDT), the world’s largest stablecoin by market cap, has published its asset ledger to demonstrate that its token is fully backed by assets held in reserve. Tether’s value against the dollar has remained constant, including during the current turmoil, with only a relatively minor hit on May 12, when its value fell to $0.97.

Circle CEO Jeremy Allaire wrote on his Twitter account that USD Coin (USDC), the second largest stablecoin by value, is fully backed by different assets.

2/ The USDC reserve is held entirely in cash and short-term US government bonds, consisting of US Treasury bills with maturities of 3 months or less

— Jeremy Allaire (@jerallaire) May 13, 2022

The USDC has done even better than Tether in its main task: tracking the US dollar.

Regulators are slow to react…

Regulators were stepping up their focus on stablecoins before Terra’s collapse, although perhaps a bit late, given what happened. In the United States, President Joe Biden signed his executive order on ensuring responsible development of digital assets on March 9 – with an unexpected chorus of approval from the broader crypto industry.

Related: Powers On… Biden Accepts Blockchain Technology, Recognizes Its Benefits, And Pushes For Its Adoption

At the beginning of April, the UK announced its intention to regulate unspecified stablecoins. In the same month, a prominent member of the US Senate Banking Committee, Senator Patrick Toomey, introduced the “Stablecoin Transparency of Reserves and Uniform Safe Transactions Act of 2022,” dubbed the Stablecoin TRUST Act for short, dealing with cryptocurrencies whose prices are pegged to the US dollar or other assets.

Ironically, in an interview with the Financial Times published on May 6, as Terra began its descent to zero, Senator Toomey called regulators to do more to regulate stablecoins “before a bad thing happens.” However, even he doesn’t seem to have predicted how quickly things would unfold:

“He pushed back on some of the tougher measures promoted by Democrats, who believe stablecoins are now worth so much money that their operators should be regulated like banks.”

Since then, things have started to go faster. Once the Terra route began, beginning around May 5, regulators quickly increased their level of vigilance. In a May 9 report, the US Federal Reserve said stablecoins were “vulnerable to runs” and lacked transparency about their assets. And Treasury Secretary Janet Yellen recently commented on the urgent need for guardrails, saying it would be “very appropriate” for lawmakers to pass legislation as early as this year.

Related: US turns its attention to stablecoin regulation

Elsewhere, in June, Japan became one of the first countries – and by far the largest economy – to regulate a form of non-fiat digital currency when its parliament approved the regulation of yen-linked stablecoins. This was not related to the collapse of Terra, but based on a scheme first proposed by the Japan Financial Services Agency in March 2021. The new law guarantees repayment of face value, limits the creation of stablecoins to regulated institutions and demands stricter anti-money laundering measures.

…and miss the point

Despite these warnings and emerging policy measures, what seems to be missing is a clear distinction between algorithmic and asset-backed stablecoins. In my opinion, fiat asset-backed stablecoins should be regulated by governments and have capital adequacy rules and restrictions on what can be done with reserves.

Algo stablecoins, if they survive as a class, should come with plenty of health warnings about the risks that rest on the shoulders of consumers. Algos are the latest in a long line of innovations – the next one won’t be long in coming, and regulators won’t be ready either. The reality is that people have to take care of their own assets and wealth. Any fully decentralized environment still requires people to closely and vigilantly guard their own assets.

And compounding the sense that reality is beyond regulators’ ability to keep up, the existence of fully collateralized coins, such as USDC, seems to remove any need for the US government to develop its own central bank digital currency, or whatever some call it the “digital dollar.

Related: Commentators on US central bank digital currency divided on benefits, unified in confusion

The darkest before dawn

As of this writing, we are only weeks away from Terra’s collapse. As a result, stablecoins are under a cloud, and the long-term impact on the broader blockchain token ecosystem, which remains under pressure since prices peaked in September 2021, is still unclear.

Many commentators are reveling in the crypto gloom, fueling the latent skepticism that many people feel about the entire crypto project launched by Satoshi Nakamoto.

In my opinion, when it comes to stablecoins, it’s all about being “darkest before dawn”. Most people didn’t understand – and still don’t understand – that not all stablecoins are created equal. Algorithmic stablecoins, as is now evident, were an impending disaster. Fully backed stablecoins – ideally in the planned or enacted regulatory environment in the US, UK, and Japan, among others – are a perfectly sensible option with important roles to play in the hybrid crypto-fiat economies of the world. future. Their time has come.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.

The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.