Stablecoins were meant to be the boring uncle in the crypto world, safe, sensible, and dull. Although they are not exactly what Satoshi Nakamoto intended, they can be used as a safe haven of utility and calm away from the chaos of pure-play cryptocurrency.
Stablecoins have fiat currency values and are not intended to provide quick riches. Stablecoins play an important part in the cryptocurrency ecosystem because they provide a safe place to store capital and allow assets to be denominated using fiat currencies, rather than volatile tokens.
Events in May proved that crypto stability remains elusive. Due to slow government response, Terra’s LUNA token (now Luna Classic (LUNC),) dropped to almost zero, wiping out $60 Billion. It is obvious that the stablecoin experiment failed. However, I believe Terra’s descent to Earth is the beginning of a new era in which stablecoins are accepted and will be a part of the global economic system. The regulation that is now in place looks well beyond its sell-by date.
Stablecoins are not all created equal
Even though it seems unlikely, the failures of some stablecoins do not mean that the whole concept is dead. Other stablecoins were built on solid foundations and perform as expected.
The algorithmic stablecoins are being emptied. These coins were not fit for purpose as they were made on unstable foundations. There were always critics. Some called Terra a Ponzi scheme. Others argued that Terra and other algorithmics would only be worth their weight if more people bought them.
Algorithmic stablecoins can be created and destroyed without the need for equivalent fiat currencies. Instead, they use smart contracts to create and destroy tokens in order to adjust the price. This system worked and was supported by Anchor, an artificially high-interest-paying mechanism. It worked while many believed in it. The flood gates opened in an old-world bank panic when that trust began to evaporate in May.
Related: What can other algorithmic stabilitycoins learn about Terra’s crash?
There are also other stablecoins that can be backed by assets. These include fiat currencies. Tether (USDT), which is the largest stablecoin in terms of market capitalization, published its asset register to show that its token was fully backed by assets kept in reserve. Tether’s price against the dollar has remained constant, even through current turmoil. It saw a minor drop in value on May 12, when it fell to $0.97.
Circle CEO Jeremy Allaire stated in his Twitter account, USD Coin (USDC), second-largest stablecoin according to value, is completely backed by different assets.
2/ The USDC Reserve is entirely held in cash and U.S. government short-dated obligations. These include U.S. Treasuries maturing in 3 months or less
— Jeremy Allaire (@jerallaire) May 13, 2022
Tether has done a better job than USDC at its primary task of tracking the U.S. Dollar.
The regulators were slow to respond…
Although regulators were increasing their focus on stablecoins prior to the Terra meltdown (though perhaps a little late given what has occurred), they did so. The President of the United States, Joe Biden, signed the Executive Order on Ensuring Responsible Digital Asset Development on March 9, to an unexpected approbation from the wider crypto industry.
Related: Powers on… Biden accepts Blockchain technology, recognizes its advantages and pushes adoption
In early April, the United Kingdom announced its intentions to regulate as-of-yet-unspecified stablecoins. Senator Patrick Toomey of the U.S. Senate Banking Committee introduced the “Stablecoin Transparency of Reserves and Uniform Safe Transactions Act of 2022” that addressed cryptocurrencies whose prices are tied to the U.S. Dollar or other assets.
Ironically, Senator Toomey, speaking with the Financial Times on May 6, when Terra was heading towards zero value, called for regulators to do more to regulate stablecoins. However, even Toomey didn’t seem to be able to predict how fast things would unfold.
“He resisted some of the stricter measures being promoted in Democrats, who believe that stablecoins now have a value so high that their operators should also be regulated as banks.
Things have moved more quickly since then. From May 5, when the Terra route was launched, regulators increased their vigilance. The U.S. Federal Reserve reported on May 9 that stablecoins were “vulnerable” to rans and had no transparency regarding their assets. Janet Yellen, Treasury Secretary, recently spoke out about the urgent need to have guardrails and said that it would be appropriate for legislators to enact legislation by this year.
Related: The United States turns their attention to stabilization
Japan was also the first country and largest economy to regulate non-fiat digital currency in June when its parliament approved regulation of yen linked stablecoins. This was not Terra-collapse-related, but was based on a system first proposed by Japan’s Financial Services Agency (March 2021). The new law provides face-value redemption and restricts stablecoin creation to regulated entities. It also requires stricter Anti-Money Laundering controls.
You are missing the point
These warnings and policy steps are important, but what is missing is a distinction between asset-backed and algorithmic stablecoins. I believe asset-backed fiat stablecoins must be regulated by governments. They should also have capital adequacy regulations and restrictions on what can happen with reserves.
If Algo stablecoins survive as a category, they should be accompanied by extensive warnings about the potential risks to consumers. Algos are just one of many innovations in the past. The next will be coming soon and regulators won’t be prepared for it. People need to look after their wealth and assets. In a decentralized environment, people must protect their assets with care and vigilance.
To add to the feeling that reality is surpassing regulators’ abilities to keep up, existence of fully backed coins like USDC seems to eliminate any need for the U.S government to create its own central bank digital currency or what some refer to as the “digital dollars.”
Related: US central banks digital currency commentators divided on benefits, but unified in confusion
The darkest hours before dawn
We are still only weeks away from the Terra collapse at the time of this writing. Stablecoins are now in a cloud. The long-term effects on the wider ecosystem of blockchain tokens (which remain under pressure since September 2021’s peak) is not yet known.
Many commentators revel in the crypto gloom. This is igniting the latent doubt many people have about Satoshi Nakamoto’s entire crypto project.
Stablecoins, in my view, are “darkest before dawn” because not all stablecoins are created equal. Algorithmic stablecoins were, as it is now evident, a disaster in waiting. Stablecoins that are fully backed — especially within the regulatory framework being adopted in the U.S.A, U.K., and Japan — are an excellent option with important roles in the hybrid crypto/fiat economies. They are now ready for prime time.
This article is not intended to provide investment advice. Every trade and investment involves risk. Readers should do their research before making any decision.
These views, thoughts, and opinions are solely the author’s and do not necessarily reflect the views or opinions of Cointelegraph.
Uldis Teraudkalns, the CEO of NexPay is a Lithuanian fintech startup that provides banking infrastructure for digital assets. Uldis has over a decade of finance and venture investment experience and has been a member of various boards. Uldis is a Stockholm School of Economics graduate in finance and co-host of The Pursuit of Scrappiness. This podcast covers the Baltics’ most prominent business and startup podcasts.