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Turns on … When will we learn from a recent story to protect our cryptocurrency and ourselves? – Cointelegraph magazine – Mail Bonus

Stablecoins provide a false sense of security. They indicate to the uninitiated and / or carelessly that a particular currency is pegged to the US dollar, or the dollar equivalent in terms of value and stability, and that if you want to convert your stablecoin into dollars, you can do so. so easily and instantly. Yet they do nothing like that, like showed the recent collapse of Terra and its TerraUSD stablecoin and LUNA symbol and was also clearly demonstrated in September 2008 with the collapse of the main fund of the money market reserve fund at the height of the global financial crisis.


Turns on… is a monthly column by Marc Powers, who spent much of his 40-year legal career dealing with complex securities cases in the United States after joining the SEC. He is currently an adjunct at Florida International University College of Law, where he teaches a course on “Blockchain & the Law.”


So let me now say unequivocally what is obvious: If you are an owner or investor in any of the cryptocurrencies, you need to understand this lack of protection and protect the part of your wealth that is in digital assets. You can protect these assets by storing them in cool digital wallets, on exchanges listed with the US Securities and Exchange Commission or with any other entity under the control of the SEC, CFTC or the Treasury. Even BitLicenses and exchanges, such as Coinbase and Gemini, could not provide adequate protection.

As I write this column, the UST value is about $ 0.07. A month ago, it was one of the top 10 cryptocurrencies in terms of market value and remained stable at $ 1. It was considered a reliable, “secure” cryptocurrency for trading, eliminating business risk and providing liquidity to traders, both for trading on central exchanges and on distributed systems. Not anymore.

While some disagree, cryptocurrencies are speculative in both value and utility. Their prices are volatile and it is best understood when considering a new choice of economic, capital market and financial systems – supported by new technologies that are still being developed and tested in countless ways. Crypto is being tested by criminals who want to hack vulnerable blockchains for illegal gain, investigated by governments seeking to regulate or ban its use, and constantly being worked on by developers trying to improve public source code. Therefore, it falls under the category of “optional assets”.

Those involved in investment management and analysis have been led to believe that stablecoins are a viable solution to avoid the risks associated with cryptocurrencies – not unlike the SEC-listed reserve fund, which has over 60 billion dollars in its assets. maximum, as a safe haven to invest money and earn interest. The reserve fund, and most other money market funds in the early 1920s, introduced themselves as an alternative to keeping cash in deposit accounts with banks and as a way to earn better interest rates than banks were providing. Its stock price was always supposed to hold $ 1 net worth (the measurement that mutual funds are trading in general) because it was considered to be short-lived in US-backed bonds. full faith and faith US Treasury Department. Yet in the financial crisis of September 16, 2008 – the day after the reputable investment company Lehman Brothers filed for bankruptcy – “the reserve fund” broke down. NAV dropped to $ 0.97 from $ 1 connection.

Why? Well, for reasons parallel to the ICT crash. As it turns out, part of the reserve fund was not invested in US bonds and government bonds, but in commercial paper issued by companies, not the government. This was done to increase the return on the money market – to offer investors who are willing to invest their money in the fund higher competitive interest rates rather than traditional banks. However, this approach had two fundamental problems, as mutual fund investors would learn. At that time, money market funds were neither insured nor protected by Federal Deposit Insurance Corporation like bank accounts nor were they insured against losses by Securities Investor Protection Corporation like shares in brokerage accounts.

Second, as noted above, more than half of the fund’s portfolio was invested in commercial securities rather than US-backed securities. When Lehman Brothers filed for bankruptcy, investors became concerned that money market mutual funds owned Lehman Brothers trading securities. So the next day a raid on those funds began. And although the reserve fund reportedly had less than 1.5% in Lehman Brothers, NAV fell below $ 1. In the end, the fund was closed and wound up, but not before the US government participated in two types of legislation: a temporary liquidity insurance plan and a debt insurance plan. Both merged mutual funds of investors in mutual funds and secured short-term liabilities issued by participating banks. (These plans and protections ended in 2012.)

With TerraUSD, Terraform Labs created so-called algorithmic stablecoin – one that is not backed by assets such as cash or US government bonds but relies on trading and treasury management to maintain NAV’s value of $ 1. This is reportedly included in the UST mortgage, in part, with Bitcoin. However, actual assets that supported ICT were apparently many times lower than their market value. So, when it was run on UST, everything crashed.

Now other stablecoin issuers, such as Circle with USD Coin and Tether with USDT, will say that this can not happen with their currencies. The problem was because ICTs were underfunded, algorithmically stablecoin, while supported one-on-one by the dollar and US government securities. But that is not entirely true. A study of Tether The New York State Attorney’s Office found that a good amount of the insurance was not dollars but a loan or commercial paper.

This is the same type of mortgage that took down the Reserve Fund in 2008 in a rush. It is also true that neither Circle’s nor Tether’s stablecoins are protected against investor losses by state-funded institutions such as SIPC or FDIC.

So, what are some executions from the UST / LUNA “break the buck” price collapse?

  1. What happened to UST / LUNA is neither new nor unique. It happened before with the Reserve Fund in 2008 in a magnificent way and with a lot of work in its time. And just as investors in the Terraform Labs stablecoin product were not insured with any government assistance, so was the reserve market’s money market.
  2. There will likely be some US government investigations and / or interrogations surrounding this recent crisis. For those who oppose encryption, there will likely be calls to control the entire blockchain industry initially to protect investors. However, it is important to remember that the reserve fund was managed by the SEC as a mutual fund. That fact did not stop the raid on the fund. So overuse of knees is not a cure.
  3. Yes, there should be some regulation and regulator for stablecoins and their issuers – if not the SEC or the CFTC, then maybe the Treasury. The role that this currency now plays in the capital market and financial transactions in the cryptocurrency ecosystem is enormous and important. Investors should consider that when they use stablecoin it is correct and fully secured and that they have a clear, unequivocal redemption right on the mortgage if requested.
  4. Terraform Labs and its founder, Do Kwon, will face both criminal and civil investigations and litigation following the UST / LUNA collapse. Kwon is likely to face prosecution in both South Korea, where he is located, and the United States. There will be class action lawsuits. It will not be beautiful and things will drag on for a long time. Last fall, the SEC began research into another Terraform Labs project, the Mirror Protocol. In February 2022, a judge in southern New York held that Terraform Labs and Kwon had to comply with the SEC’s investigation requirements in that case. Now, with UST / LUNA, things will get much, much worse for both.
  5. It was reported a few days after the UST / LUNA run that Coinbase added risk information to its listings. The centralized stock exchange pointed out that its clients could be considered “unsecured creditors” in the event of its bankruptcy. This puts back and forth what I wrote about last year: Coinbase and Gemini are not listed on the SEC as a stock exchange – they are only licensed under the BitLicense Government of New York State. The meaning is varied. Most importantly, it means that clients ‘accounts are not protected by SIPC for up to $ 500,000 in cash and securities and that neither exchange is subject to the SEC’s separation rules on clients’ assets and funds.

What this all means is that you, and only you, are responsible for protecting your cryptocurrencies and assets. So, be careful and considerate where you choose to store your digital assets and when deciding whether it makes sense to have significant value in your stablecoins.


Marc Powers is currently an adjunct at Florida International University College of Law, where he teaches “Blockchain & the Law” and “Fintech Law.” He recently retired from the Am Law 100 law firm, where he built both his domestic securities department and supervised work experience, as well as the hedge fund industry. Marc began his legal career in the SEC’s enforcement department. During his 40 years in law, he participated in litigation, including the Bernie Madoff Ponzi scheme, the recent pardon of the president and the trial of Martha Stewart’s insider trading.


The views expressed are those of the authors only and do not necessarily reflect the views of the Cointelegraph or the Florida International University College of Law or its affiliates. This article is for general information purposes only and should not be construed as legal or investment advice.


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