The collapse of the Terra ecosystem, which subsequently depegged its algorithmic stablecoin TerraUSD (UST) value and crashed it to an all-time low of $0.30, has cast doubt over the future of not just algorithmic stablecoins but all stablecoins in general.
UST’s success and stability were intertwined with its sibling, LUNA, which creates arbitrage opportunities that, in theory, should keep UST’s price steady. If UST’s price drops below $1, it can be burned in exchange for LUNA, which lowers the supply of UST and raises its price.
Conversely, if UST’s price goes above a dollar, LUNA can be burned in exchange for UST, which increases the supply of UST and decreases its price. As long as conditions are normal and everything functions correctly, this creates both a mechanism and incentive for keeping the price of UST at $1.
Though algorithmic stablecoins are not usually backed by assets such as other stablecoins, the organization responsible for developing UST and the broader Terra ecosystem, the Luna Foundation Guard (LFG), has nevertheless built a war chest of Bitcoin (BTC) to be used in the event that the UST becomes depegged from the United States dollar.
The idea is that if UST’s price ever drops significantly, the BTC can be loaned out to traders who’ll use it to buy UST and push the price back up, repegging it to the dollar. So, when UST went into a deep dive, LFG deployed more than $1.3 billion dollars worth of BTC (42,000 coins at a price of $31,000 each) to traders who were going to use it to purchase UST, creating demand pressure and bolstering its price. However, that couldn’t save the collapsing ecosystem either, and the spiral effect eventually collapsed the price of the LUNA token as well as its stablecoin.
In the aftermath of the collapse, even centralized stablecoins, such as Tether’s USDT, lost their dollar peg, falling to a low of $0.95. Since stablecoins act as a bridge for various decentralized finance ecosystems, the Terra crash led to high volatility in the decentralized finance market.
Justin Rice, vice president of ecosystem at the Stellar Development Foundation, was pretty skeptical of the future of algorithmic stablecoins in light of the UST collapse. He told Cointelegraph:
“What we’re seeing now, and not for the first time, is an optimistic balancing mechanism unraveling due to natural human responses to market conditions. It is challenging to have algorithmic stablecoins keep their peg when things go sideways, and you have to rely on outside intervention to set things right.”
He also advocated for full transparency from stablecoin issuers with third-party audits. Denelle Dixon, CEO and executive director at the Stellar Development Foundation, hoped the recent debacle would push the conversation about stablecoin regulations among lawmakers. She told Cointelegraph:
“We’ve seen significant progress moving the conversation of stablecoin legislation in the United States. We’ve seen bills from both sides of the aisle that understand the issues and can move this industry forward by providing clarity and guardrails. We also know that this is a global issue and think the same rules should apply with respect to stablecoins and are working to help create that consistency.”
Stablecoin regulations around the globe
For a long time, stablecoins have been on the radar of regulators in many major economies, but the UST collapse acted as a catalyst, forcing U.S., South Korean and many European regulators to take note of the vulnerabilities in these not-so-stable digital dollar pegs.
U.S. regulators are using the incident as grounds to push for more stringent rules around stablecoins and their issuers, with Treasury Secretary Janet Yellen announcing plans for legislation by the end of the year.
Yellen said it would be “highly appropriate” to aim for a “consistent federal framework” on stablecoins by the end of 2022, given the growth of the market. She called for bipartisanship among members of Congress to enact legislation for such a framework.
These could easily be imposed on collateralized stablecoins, such as USD Coin (USDC) and USDT, which are backed by a traditional-style treasury and held by a centralized entity.
Max Kordek, co-founder of blockchain developer platform Lisk, believes the UST collapse will be used by lawmakers to push for central bank digital currencies (CBDC). He told Cointelegraph:
“Trust in algorithmic stablecoins is likely to have greatly diminished because of this incident, and it will be a while before that trust is restored. This will, unfortunately, be used by politicians as an example of why the world requires CBDCs. We don’t need CBDCs; what we do urgently need, though, is reliable, decentralized stablecoins.”
The Congressional Research Service, a legislative agency that supports the U.S. Congress, published a report on algorithmic stablecoins analyzing the UST crash. The research report described the LUNA crash as a “run-like”…
cointelegraph.com