Terra could leave a similar regulatory legacy to that of Facebook’s Libra

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A new draft of stablecoin legislation in the US House of Representatives proposed imposing a two-year ban on new algorithmically linked stablecoins like TerraUSD (UST).

The proposed legislation would require the Department of the Treasury to conduct a study on UST-like fiat currencies in cooperation with the US Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Securities and Exchange Commission.

An algorithmic stablecoin is a digital asset whose value is kept stable by an algorithm. While an algorithmic stablecoin is tied to the value of a real world asset, it is not backed by one.

The stablecoin bill has been in the works for a few months and has been delayed on numerous occasions. Treasury Secretary Janet Yellen has repeatedly cited the Terra collapse in calling for more regulation of the crypto space.

Terra’s ecosystem failure, which started with the depegging of its algorithmic stablecoin UST, ultimately wiped out the $40 billion ecosystem. This led to a crypto contagion that saw the crypto market lose nearly trillions of dollars in market value within a few weeks.

Markets have not yet recovered from the contagion, and Terra’s collapse has certainly cast a shadow over the future of algorithmic stablecoins and has become a hot topic for critics including certain policymakers, who have used it to advocate for stricter policies for cryptocurrencies. The latest draft proposal to put a temporary ban on such stablecoins is one such example. Under the current draft of the bill, it would be illegal to issue or create new “endogenously guaranteed stablecoins”.

The draft proposal evoked mixed emotions from Crypto Twitter. While some market observers called it is a good idea that would help avoid further such collapses, others believed that the Terra failure set the industry back for years. Pointing to the two-year temporary ban, some implied that although algorithmic stablecoins may not be the culprit, the execution of the Terra team cast a shadow over the entire algorithmic stablecoin industry.

Speaking about the impact of Terra contagion on stablecoin regulation, Mriganka Pattnaik, CEO of risk monitoring service provider Merkle Science, told Cointelegraph that regulators should take a broader approach than going for a temporary ban. She believes that lumping all algorithmic stablecoins together and putting a blanket ban on them will stifle innovation, stating:

“In light of the collapse of Terra and the ripple effect it created, algorithmic stablecoins will have to regain the trust of regulators and consumers alike. The regulators can push for partially guaranteed models, set transparent standards, and require the issuers to send white papers highlighting how their special stalcoin offering works, its operational structure, mint and burn mechanism and the type of algorithm they use to store the value, the unique risks the proposal presents and analyze whether it can have a potential contagion effect on wider financial stability. “

It is important to understand that even within algorithmic stablecoins, there are smaller categorizations, for example, rebase, seigniorage and fractional algorithmic stablecoins. Another vertical to consider here is the fact that algorithmic stablecoins are decentralized in nature – therefore it will be harder to enforce a ban on them.

Patnaik added that it is counterproductive to hold onto the notion that decentralization and regulatory controls can never be in alignment. The most proactive thing that stablecoin issuers can do is “get together and propose technical solutions to regulatory issues around stablecoin algorithms.”

Jay Fraser, director of strategic partnerships at Boston Security Token Exchange, explained how Do Kwon’s performance and marketing tactics were to blame for the bad press algorithmic stablecoins received in the aftermath, telling Cointelegraph:

“There is the issue of how Do Kwon both marketed Terra and also how he used user funds during and after the collapse. If there had been good regulation before and during the collapse, part of it would have involved clearer messaging about the risks involved in investing money in unproven technology. I think many investors may not have been aware of the risks.”

He added that the Terra fiasco set a precedent for fellow decentralized funds and crypto investors to be more transparent and “regulations will be put in place to ensure that consumers and investors are not affected by bad practices.”

“Book moment” for algorithmic stablecoins

The Terra stablecoin project somewhat recalls the fate of Facebook’s Libra stablecoin project, now Meta, which was later called Diem. The social media giant got involved in the crypto space in 2019 when it announced its plans to launch a universal stablecoin, the adoption of which would be boosted by Facebook’s line of social messaging apps and services including Instagram and Whatsapp.

The stablecoin was pegged to the value of a basket of trusted currencies including the US dollar, the Great British pound, euro, Japanese yen, Singapore dollar and some short-term assets generally considered to be cash equivalents.

Facebook registered the project in Switzerland and hoped to bypass regulatory oversight from several nations, but failed. Facebook faced immediate pushback from regulators around the world and founder Mark Zukerberg even faced several Congressional hearings on the same. The name change to Diem did not help its cause much and the project was eventually shut down by the end of January 2022.

Like the ill-fated Diem/Libra venture, the disintegration of Terra’s $40 billion ecosystems forced regulators to show interest in the nascent industry and even forced several regulatory changes.

Just as Libra forced regulators to wake up to the reality of private entities issuing money in the digital age, Terra made lawmakers take a closer look at who can issue a stablecoin, opening the gates for banks and other financial institutions to get involved in the nascent. crypto market.

Dion Guillaume, global head of communications at crypto exchange platform Gate.io, told Cointelegraph that Terra was a stress test that could benefit the industry:

“It was a huge stress test, for sure. However, I think this will work better in the end. First, crypto users should know that when someone offers you crazy high returns, something fishy is going on in the background. Furthermore, projects must know how to prioritize long-term goals over short-term pleasure. For example, many analysts pointed out the flaws in Terra’s UST stablecoin while creating a capital-efficient, decentralized stablecoin is impossible, yet users continued to use Terra, and projects continued to build on it. Let’s hope that the industry learns a lesson from this failure.”

Jason P. Allegrante, chief legal and compliance officer at Fireblocks, explained that much like what Diem did for regulators, Terra’s failure accelerated Congress’ drafting of a promising bipartisan bill. He told Cointelegraph:

“We can see in hindsight that it accelerated Congress’ drafting of a very promising bipartisan bill that will introduce stablecoin legislation, significantly normalizing the industry in the process. Not only is this a direct response to the Terra collapse, but the impact will be transformative, providing clarity on the regulatory classifications of stablecoins, in what quantity and quality they must be reserved, how they will be backed by other assets, etc.

He added that the experience of the Terra implosion will unleash innovation in true stablecoins and ultimately “drive more organizations and individuals to invest in cryptocurrencies and related technologies in the coming years.”

Terra’s collapse may have caused crypto contagion, but it created a watershed for the stalcoin industry. It forced policymakers to look at the bigger picture and find better ways to protect consumers. It also ignited the interest of policy makers in the distinct and complex nature of the industry and made them realize that a common policy will not work for the whole industry.