The cryptocurrency market is looking quite brutal right now. Bitcoin has been in the red for the longest run in its history, and ether is at its lowest point since 2020. While it looks a little bleak, it is not unprecedented; cryptocurrencies are well-known for their volatility and the current economic climate isn’t just affecting crypto right now.
But what is unprecedented is the story of the algorithmic stablecoin TerraUSD (Terra) and the cryptocurrency tied to it, Luna. Billions of dollars in crypto wealth have been wiped out, shocking the whole crypto market.
In April Luna’s price was at $116 and it fell to a fraction of a penny a mere few weeks later. While this sort of collapse has been seen in smaller less established currencies, this is the first time it has happened for something this size (Luina had a market cap of just over $40 billion before its collapse).
Could this situation have benefitted from more comprehensive regulation? Let’s look a little deeper into stablecoins as an entity and what regulation could look like.
What is a stablecoin?
A stablecoin is any cryptocurrency designed to have a stable price, usually by being pegged to some sort of asset, such as a commodity like gold or a fiat currency like the US Dollar. Some are linked to Decentralised Autonomous Organisations (DAOs) which control issuance and pricing.
Why do we need stablecoins?
Cryptocurrencies have been very volatile throughout their existence. At the beginning of 2018, the entire market lost around 70% of its value, entering a bear market (a prolonged decline), before rallying in late 2020. It reached a peak in mid-November 2021 and has been tumbling again. Since the peak, all major cryptocurrencies are down 50% on average, with swings of more than 10% day-to-day not being unusual.
This level of volatility has made it extremely difficult fr cryptocurrencies to be used as a reliable medium of exchange. People cannot afford to be paid for their goods with a coin that may lose its value the next day.
Stablecoins attempted to remove the volatility by stabilising the value of a coin. By pegging it to the price of another asset, the value of the coin remains relatively steady.
Can they benefit from regulation?
One of the initial key issues during the rise and fall of the first coin offerings was the legal and regulatory categorisation of such activities. As with most new phenomena, regulators were slow to respond, but eventually, they did.
From the initial perception of the crypto sector is a “wild wild west” or a “no man’s land”, cryptocurrencies finally found their categorisation under existing, albeit amended laws. Obviously, dependent on the respective token model and the difference between utility, security and payment tokens.
The question is what this means with respect to stablecoin regulation. The underlying asset a stablecoin is pegged to could be anything like fiat currencies like the Dollar, commodities like precious metals, or even other cryptocurrencies. The idea behind it is that the holder can redeem the coin at the current exchange rate of the pegged asset, which creates this element of stability. Though that may not always be the case if you take in the current volatility of traditional markets like fiat currencies and commodities.
In this sense, stablecoins can be equated to Security Token Offerings (STOs), which need to be supported by something tangible like equities, bonds or promissory notes. Since STOs are more like traditional securities, regulations could be applied in a similar way and in accordance with their securities regulations.
But, despite their label, many so-called stablecoins are neither “stable” nor “coins” in the true sense of either word. So, whilst stablecoin is a marketing term that has been widely adopted by the industry, more neutral terms, may be more accurate starting points for regulatory analysis in many instances.
Critics have doubled down on their calls for regulation, yet it is important not to rush into panic-driven regulation, that will stymie the growth of coins. It is important to remember Terra is an outlier and nearly all leading stablecoins continue to hold their value – although they are not immune to collapse.
But action is needed. While the UK and the US have led the way in talking about stablecoin regulation, there has been little in the way of meaningful action.
A failure to act will make it difficult to advocate for the use of stablecoins if they continue to expose consumers to the volatility they were designed to avoid.
The time for allowing the sector the freedom to grow and innovate seems to have passed and some order needs to be put in place. Regulation offers consumer protection and helps eliminate excessively risky practices, to allow stablecoins to reach their full potential. If this potential is realised, many believe it will transform the global economy and change the way we deal with finance forever.
We now find ourselves in a similar situation that has been reached with the more mainstream cryptocurrencies regarding a stable framework for regulation, which means the approach should be the same. It is a fine line that has to be walked; on the one hand, users must be protected, and their assets kept secure. But, on the other, we cannot have a heavy-handed approach that will hinder the growth and innovation of this sector.
But what we do know is a regulatory framework must be established to prevent the case of Terra and Luna from ever repeating itself again.
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