Regulators are concerned about stablecoins as tether after the collapse of the FSO

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

Justin Tallis | AFP via Getty Images

Regulators are increasingly concerned about stablecoins following the collapse of controversial cryptocurrency firm Terra.

TerraUSDan “algorithmic” stablecoin designed to be anchored one by one with American dollarwiped out much of its value this week after an extraordinary bank run that saw billions of dollars suddenly evaporate from its market value.

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

bindOn Thursday, the largest stablecoin in the world slipped below its expected $ 1 for several hours, fueling fears of possible contagion from UST’s de-pegging fallout. Unlike FSO, tether should be backed by sufficient assets held in a reserve.

US Treasury Secretary Janet Yellen addressed both the FSO and tether directly this week. In a congressional hearing, Yellen said such activities do not currently pose a systemic risk to financial stability, but she suggested they could eventually.

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

“They present the same kind of risks that we have known for centuries in connection with bank runs.”

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

The UK government is also taking notice. A government spokesperson told CNBC on Friday that it was ready to take further action on stablecoins after the Earth crash.

“The government has been clear that some stablecoins are not suitable for payment purposes as they share features with unsupported cryptocurrencies,” the spokesperson said.

Britain intends to do so bring stablecoins to the regulation of electronic paymentswhich could see issuers such as Tether and Circle being subject to supervision by the country’s market watchdog.

Separate proposals in the European Union would also bring stablecoins strict regulatory control.

What are stablecoins?

They are a bit like casino chips for the cryptocurrency world. 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 dollar amount for all the stablecoins they want to sell. Issuers of stablecoins aim 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 approximately $ 80 billion.

What happened with UST?

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

  • UST’s price can drop below the dollar when there are too many tokens in circulation but not enough demand
  • smart contracts – lines of code written in the blockchain – would intervene to eliminate the excess MTS and create new units of a token called moonwhich has a variable price
  • There was also an arbitrage system at play, where traders were encouraged to profit from deviations in the price of the two tokens.
  • The idea was that you could always buy $ 1 of the moon for a UST. So, if UST was worth 98 cents, you could essentially buy one, trade it for luna, and pocket 2 cents in profit.

Luna, UST’s twin, is now essentially worthless having previously surpassed $ 100 per coin earlier this year.

The entire system was designed to stabilize UST at $ 1. But it collapsed under the pressure of billions of dollars in liquidations, most notably 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 concerned?

The main concern is that a major stablecoin issuer like Tether may be the next to suffer a “run to the bank”.

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 commercial paper (short-term corporate debt) assets of Lehman Brothers. When Lehman went bankrupt, the investors fled.

Previously, Tether had claimed that its reserves consisted entirely of dollars. But he reversed that position after a 2019 deal with the New York Attorney General. The company’s revelations revealed it had very little cash but a lot of unidentified commercial paper.

Tether now says it is reducing the level of commercial paper it owns and increasing its holdings of US Treasuries.

“We expect recent developments to lead to an increase in regulatory demands for stablecoins,” rating agency Fitch said in a statement Thursday.

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

“Many regulated financial entities have increased their exposure to cryptocurrencies, defi and other forms of digital finance in recent months, and some Fitch-rated issuers could suffer if cryptocurrency 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 cryptocurrency values ​​decline dramatically. However, we believe that the risks to Fitch-rated issuers and real economic activity are generally very low. “