The collapse of the Terra ecosystem, which subsequently disconnected its stablecoin algorithm TerraUSD (UST) value and collapsed it to a historic low of $ 0.30, has raised doubts about the future of not only algorithmic stablecoins but all stablecoins in general.
The success and stability of ICT were intertwined with its sibling, LUNA, which creates arbitrage opportunities that should theoretically keep ICT prices stable. If the price of ICT drops below $ 1, it can be burned in exchange for LUNA, which lowers the supply of ICT and raises its price.
However, if the price of ICT exceeds the dollar, LUNA can be burned in exchange for ICT, which increases the supply of ICT and lowers its price. As long as conditions are normal and everything works right, this creates both a system and an incentive to keep the price of ICT at $ 1.
Although stablecoins’ algorithms are not usually supported by assets like other stablecoins, the organization responsible for the development of ICT and the wider Terra ecosystem, the Luna Foundation Guard (LFG), has nevertheless built a Bitcoin (BTC) war chest to use in the event. where UST will be disconnected from the US dollar.
The idea is that if the price of ICT ever drops significantly, then you can lend BTC to traders who will use it to buy ICT and push the price back up and put it in dollars. So, when UST plunged deep, LFG sent more than $ 1.3 billion worth of BTC (42,000 coins at $ 31,000 each) to traders who wanted to use it to buy ICT, create demand pressure, and strengthen its prices. However, it also could not save the rhythmic ecosystem and the spiral effect eventually collapsed the price of the LUNA symbol as well as its stablecoin.
In the wake of the crash, even centralized stablecoins, such as Tether’s USDT, lost a dollar and fell to a low of $ 0.95. As stablecoins act as a bridge for various diversified financial ecosystems, Terra’s collapse led to large fluctuations in diversified financial markets.
Justin Rice, vice president of ecosystem at Stellar Development Foundation, was skeptical about the future of the stablecoins algorithm in light of the collapse of ICT. He told the Cointelegraph:
“What we are seeing now, and not for the first time, is an optimistic equilibrium system that is dissolving due to natural human responses to market conditions. It’s challenging to let algorithmic stablecoins stick to you when things go awry and you have to rely on outside intervention to fix things.
He also advocated for full transparency from stablecoin issuers through third-party audits. Denelle Dixon, CEO and CEO of the Stellar Development Foundation, hoped that a recent disaster would fuel the debate over stablecoin regulations among lawmakers. She told the Cointelegraph:
“We have seen significant progress in the debate over stablecoin legislation in the United States. We have seen bills from both sides of the aisle that understand issues and can move this industry forward by providing clarity and defense. We also know that this is a global issue and believe that the same rules should apply to stablecoins and we are working to create that consistency.
Stablecoin rules worldwide
For a long time, stablecoins have been on the radar of regulators in many major economies, but the collapse of the UST acted as a stimulus, forcing US, South Korean and many European regulators to address the vulnerability of these unstable digital dollar fixes.
U.S. regulators are using the incident as a reason to push for stricter rules on stablecoins and their issuers, with Treasury Secretary Janet Yellen announcing legislative plans by the end of the year.
Yellen said it was “very appropriate” to aim for a “consistent federal framework” for stablecoins by the end of 2022, given market growth. She called for bilateral partisanship among MPs to legislate for such a framework.
This could easily be applied to mortgaged fixed currencies, such as USD Coin (USDC) and USDT, which are backed by traditional treasuries and owned by a centralized entity.
Max Kordek, co-founder of the blockchain development platform Lisk, believes that the UST collapse will be used by MPs to put pressure on the Central Bank’s digital currency (CBDC). He told the Cointelegraph:
“Trust in algorithmic stablecoins will probably have diminished significantly as a result of this incident and it will be some time before that trust is restored. Unfortunately, this will be used by politicians as an example of why the world demands CBDCs. We do not need CBDCs; What we need, however, is an urgent, reliable, stable currency. “
The Congressional Research Service, a legislative body that supports the US Congress, published a report on the algorithms of stablecoins that analyze the UST collapse. The research report described the LUNA collapse as a “run-like” scenario that led to several investors withdrawing money from the ecosystem at the same time.
The research paper pointed out that these conditions in the traditional financial sector are protected by regulations that protect against such scenarios, but without rules in place, it could lead to market instability in the cryptocurrency ecosystem.
Jonathan Azroual, Vice President of INX Blockchain Asset Management, told Cointelegraph:
Algorithmic stablecoins backed by highly volatile assets are particularly at risk of a “run-in” of the funds that support them if investors lose confidence in the system created to ensure their stable value or simply if the value of the assets behind them goes below the amount of stablecoin issued. “
He believes that the US government will certainly try to speed up its power to control stablecoins, as it shows that they are not a realistic response to a managed digital economy. Regulators may require “stablecoins to be issued by banks subject to federal supervision or by managing them as securities, which will make the SEC oversee them. [Securities and Exchange Commission]. ”
David Puth, CEO of the Center Consortium founded Coinbase, hoped for constructive regulation in the wake of the ICT collapse. He told the Cointelegraph:
“The fact remains that stablecoins are an important part of a growing cryptocurrency ecosystem, and industrial institutions in the United States have been vocal about their desire for clear and constructive regulation.”
Puth hopes for a “reflective and innovative regulation that will keep the United States at the forefront of the blockchain economy.
Apart from the United States, South Korea is another nation that has taken stablecoins seriously after the Terra collapse. Terra’s founder, Do Kwon, has been summoned to the country’s Legislative Assembly for questioning. A Korean regulator has also launched a risk assessment of various cryptocurrencies operating in the country.
The key lesson
Although regulatory discussions about stablecoins have intensified in light of the ICT problem, it has also pointed out that the cryptocurrency market has evolved enough to accommodate $ 40 billion in cuts. This proved that the cryptocurrency market has grown enough to take on a backlash as large as Terra without threatening broader market stability.
It is necessary to note that the collapse of Terra, together with the overall adjustments of the market, has led to the interaction of second-degree effects, such as increased foreign exchange outflows, a significant increase in winding-up proceedings (obviously in derivatives and diversified financing), at at least a temporary decline in DeFi (total value locked and activity has decreased) and liquidity problems.
Thomas Brand, Head of Institution at Coinmotion – a Finnish virtual property service provider – told Cointelegraph:
“I assume that regulators are particularly interested in how cryptocurrency, and especially stablecoin, risks could affect TradFi and CeFi through infection and (indirect) exposure. To date, this risk has not been systematically realized. However, regulators could pay closer attention to these issues soon – mainly if they conclude that at least some of the stablecoins are in the form of shadow banking.
Terra was not a systemic risk at this time, but its melting was limited, although the effects could be seen in various interconnected ecosystems.
Derek Lim, head of cryptocurrency at Bybit Stock Exchange, told the Cointelegraph that while the collapse of ICT had certainly prompted regulators, the cryptocurrency market managed to recover without seeing huge damage in all areas. He explained:
“I would like to point out that one of the main concerns expressed by US regulators in several reports is that a stablecoin bank robbery could cause instability in the broader financial system. This incident has shown that banking on the third largest stablecoin by market value has hardly affected the broader cryptocurrency market, let alone S&P and beyond.
Terra’s spiral disaster not only underlines the need for transparency from stablecoin issuers but also the importance of a regulated market. With clear rules in place, there would have been several gatekeepers to prevent small investors from losing their money. The event has already received observations from around the world.
The Terra collapse could prove to be a turning point for stablecoin regulations around the world, somewhat similar to what Libra’s international stablecoin plans did for CBDCs – that is, encourage regulators to speed up their own plans.
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