$ 60 billion Earth washout not the Bear Stearns moment of cryptocurrencies: regulators

WASHINGTON – It has been brutal weeks for the cryptocurrency market.

Half a trillion dollars was wiped out of the industry’s market capitalization when terraUSD, one of the most popular US dollar-pegged stablecoins, imploded virtually overnight.

Meanwhile, digital currencies such as ether continue to beat the price charts as sales continue to hammer the industry.

Some investors have called the events of the past month a Bear Stearns moment for cryptocurrencies, comparing the contagion effect of a failed stablecoin project with the fall of a major Wall Street bank that ultimately heralded mortgage debt and the 2008 financial crisis.

“It really revealed some deeper vulnerabilities in the system,” said Michael Hsu, as Currency Controller for the US Department of the Treasury.

“Clearly, you’ve seen contagion, not just from the ground to the larger crypto ecosystem, but also to tether, to other stablecoins, and I think it’s something that wasn’t a foregone conclusion. And I think it’s something people really need to pay attention to. “.

But so far, government officials don’t seem to be worried about a cryptocurrency crash destroying the economy at large.

Several senators and regulators told CNBC on the sidelines of the DC Blockchain Summit this week that spillover effects are contained, cryptocurrency investors shouldn’t go crazy, US regulation is the key to success for cryptocurrencies, and more importantly, the cryptocurrency class. cryptocurrencies aren’t going anywhere.

“There must be rules in this game that make it more predictable, transparent, where there are the necessary protections for consumers,” said Senator Cory Booker, D-NJ.

“What we don’t want to do is stifle a new industry and innovation so that we miss out on opportunities. Or what I’m seeing right now, a lot of these opportunities are moving overseas and we miss the economy, growth and job creation. work is part of it. So this is a really important space, if we put the right legislation in place, it can actually be useful for the industry and protect consumers, ”Booker continued.

A contained event

In early May, a popular stablecoin known as terraUSD, or UST, plummeted in value in what some described as a “bank run” as investors rushed to withdraw their money. at their height, luna and UST had a combined market value of nearly $ 60 billion. Now I am essentially worthless.

Stablecoins are a type of cryptocurrency whose value is linked to the price of a real asset, such as the US dollar. UST is a specific breed known as an “algorithmic” stablecoin. Unlike the USDC (another popular dollar-pegged stablecoin), which has fiat assets in reserve as a way to back up its tokens, UST depends on your computer code to self-stabilize its value.

UST stabilized prices near $ 1 by linking it to a twin token called luna via computer code running on the blockchain – essentially, investors could “destroy” one coin to help stabilize the price of the other. Both coins were issued by an organization called Terraform Labs, and the developers used the underlying system to build other applications such as NFT and decentralized finance apps.

When the moon price became unstable, investors rushed out of both tokens, causing prices to plummet.

UST’s failure, while contagious, didn’t come as a huge surprise to some cryptocurrency experts.

Coin Metrics’ Nic Carter tells CNBC that no algorithmic stablecoin has ever succeeded, noting that the fundamental problem with UST was that it was largely supported by trust in the issuer.

Senator Cynthia Lummis, R-Wyo., Who is among Capitol Hill’s most progressive lawmakers when it comes to cryptocurrencies, agrees with Carter.

“There are a couple of types of stablecoins. What has failed is an algorithmic stablecoin, very different from an asset-backed stablecoin,” Lummis told CNBC. She said he hoped consumers could see that not all stablecoins are created equal and that choosing an asset-backed stablecoin is essential.

This sentiment was echoed by the CEO of the International Monetary Fund at the annual meeting of the World Economic Forum in Davos.

“Please don’t give up on the importance of this world,” said IMF chief Kristalina Georgieva. “It offers us faster service, much lower costs and greater inclusion, but only if we separate the apples from the oranges and bananas.”

Georgieva also pointed out that stablecoins are not backed by supporting assets they are a pyramid scheme and stressed that the responsibility for erecting protective barriers for investors rests with regulators.

“I think regulation is likely to happen faster due to the events of the past few weeks,” said Hester Peirce of the Securities and Exchange Commission, who also noted that stablecoin legislation was already pending before the fall of the FSO.

“We need to make sure we … preserve people’s ability to experiment with different models and do it in a way that is within regulatory boundaries,” the SEC Commissioner continued.

Legislation against shadow banking

For Commissioner Caroline Pham of the Commodity Futures Trading Commission, the collapse of the FSO highlights how much action regulators need to take to protect themselves from a possible return of shadow banking, which is a type of banking system where financial assets are facilitated by unregulated intermediaries or in unregulated circumstances.

Pham says many existing protections could do the trick.

“It is always faster to support a regulatory framework when it already exists,” said Pham. “You’re just talking about extending the regulatory perimeter around new and new products.”

Months before the UST algorithmic stablecoin project collapsed, the President’s Working Group on Financial Markets published a report outlining a regulatory framework for stablecoins. In it, the group divides the stablecoin landscape into two main fields: stablecoin trading and payment stablecoin.

Today, stablecoins are generally used to facilitate the trading of other digital assets. The report seeks to define best practices for regulating stablecoins to be used more widely as a means of payment.

“For those like me, the bank regulators, we’re kind of a historian of money-like instruments,” said Hsu, whose Office of the Comptroller of the Currency co-authored the report.

“This is a very familiar story and the way to deal with it is prudential regulation. This is why I think some of the options, the proposals for a more regulatory banking approach, are a good place to start.”

The key question that regulators and lawmakers face is whether stablecoins, including the subset of algorithmic stablecoins, are actually derivatives, Pham says.

If people started thinking of some of these really innovative crypto tokens like frankly, lottery tickets. When you go and buy a lottery ticket, you might make a big hit and get rich quick, but you might not.

Caroline Pham

CFTC Commissioner

Generally speaking, a derivative is a financial instrument that allows people to trade on the price fluctuations of an underlying asset. The underlying asset can be almost anything, including commodities like gold or, depending on the way the SEC is currently thinking – a cryptocurrency like bitcoin.

The SEC regulates stocks, but for anything that isn’t a stock, the CFTC likely has a regulatory contact point on it, Pham says.

“We have derivatives regulation on a commodity basis, but we also have some areas … where we directly regulate spot markets,” said Pham.

“The last time we had … something that exploded like this during the financial crisis – risky, opaque and complex financial products – Congress found a solution for that, and that was with Dodd-Frank,” he said. Pham continued, referring to the Wall Street Reform and Consumer Protection Act, passed in 2010 in response to the Great Recession. The act included stricter regulation of derivatives, as well as new restrictions on the business practices of FDIC-insured institutions.

“If some of these trading stablecoins are, in fact, derivatives, then in practice, you are talking about a custom basket swap, and therefore it is the dealer who has to manage the risk associated with it,” explained Pham.

Congress calls the shots

Ultimately, SEC Commissioner Peirce says, Congress calls the shots on how to move forward with cryptocurrency regulation. While the main Wall Street regulator is already acting using the authority it has, Congress must share enforcement responsibilities.

Lummis partnered with Senator Kirsten Gillibrand, DNY, to spell out this regulatory division of labor in a bill.

“We are putting it on top of the current regulatory framework for assets, including the CFTC and SEC,” Lummis told CNBC. “We are making sure that taxation is capital gains and not ordinary income. We have gone through some accounting procedures, some definitions, we are looking at consumer protection and privacy.”

The bill also delves into the regulation of stablecoins. Lummis says the bill contemplates the existence of this specific subset of digital assets and requires them to be secured by the FDIC or backed for more than 100% by physical assets.

Booker says there is a group in the Senate with “good people on both sides of the aisle” coming together and working together to get it right.

“I want the rules to be right,” Booker continued. “I don’t think the SEC is the place to regulate much of this industry. Clearly, ethereum and bitcoin, which are most cryptocurrencies, are more like commodities.”

But until Capitol Hill passes a bill, Pham says cryptocurrency investors need to exercise much more caution.

“If people started thinking about some of these really innovative crypto tokens like frankly, lottery tickets, when you go and buy a lottery ticket, you could take a big leap and get rich quick, but you might not,” Pham said.

“I think what I am concerned about is that without adequate customer protections in place and the right disclosures, people are buying some of these crypto tokens with the intention of getting rich,” he said.