The $60 billion Terra flush is not a Bear Stearns moment for crypto: Regulators

WASHINGTON — It has been a brutal few weeks for the cryptocurrency market.

As terraUSD, one of the most popular dollar-pegged stablecoins, collapsed almost overnight, $0.5 trillion was wiped off the industry’s market cap.

At the same time, digital currencies such as ether Continue to take a beating on the price chart as the sell-off continues to hit the industry.

Some investors refer to last month’s events as Bear Stearns moment For cryptocurrencies, the contagion effects of failed stablecoin projects were compared to the collapse of a major Wall Street bank that ultimately heralded the mortgage debt and financial crisis of 2008.

“It does reveal some deeper holes in the system,” said Michael Hsu, acting comptroller of currency at the U.S. Treasury Department.

“Obviously, you’re seeing contagion, not just from terra to the wider crypto ecosystem, but from Tether to other stablecoins, which I don’t think was expected. I think that’s something people have to really focus on.”

But so far, government officials do not appear to be concerned that the collapse of the cryptocurrency will affect the wider economy.

Several senators and regulators told CNBC on the sidelines of this week’s DC Blockchain Summit that spillovers are manageable, crypto investors shouldn’t panic, U.S. regulation is key to crypto’s success, and crucially , the crypto asset class is not going anywhere.

“The game needs to have rules, make it more predictable, make it more transparent, and need consumer protection,” said Sen. Cory Booker, D-N.J.

“What we don’t want to do is stifle a new industry and innovation so we lose opportunities. Or what I’m seeing right now, a lot of those opportunities just move overseas and we miss out on economic growth and job creation is part of that So if we can regulate it properly, it’s going to be a very important space that actually helps the industry and protects consumers,” Booker continued.

Included events

In early May, a popular stablecoin known as terraUSD or UST plummeted in value in what some called a “bank run” as investors rushed to withdraw their funds. at their heights, The combined market cap of luna and UST is nearly $60 billion. Now they basically worthless.

A stablecoin is a cryptocurrency whose value is pegged to the price of a real-world asset such as the U.S. dollar. UST is a specific breed known as an “algorithmic” stablecoin. Unlike USDC (another popular dollar-pegged stablecoin), which has fiat assets as a way to back its tokens, UST relies on computer code to self-stabilize its value.

UST is linked to a sister coin called luna through computer code running on the blockchain, which stabilizes the price near $1 — essentially, an investor can “destroy” a coin to help Stabilize the price of another coin. Both coins are issued by an organization called Terraform Labs, and developers use the underlying system to create other applications, such as NFTs and decentralized finance applications.

When the price of luna became volatile, investors flooded both tokens, causing prices to plummet.

The failure of UST, while contagious, was not a surprise to some cryptocurrency insiders.

Coin Metrics’ Nic Carter told CNBC that no algorithmic stablecoin has ever been successful, noting that the fundamental problem with UST is that it is largely backed by trust in issuers.

Wyoming Senator Cynthia Lummis, one of the most progressive lawmakers on Capitol Hill on encryption, agreed with Carter.

“There are several types of stablecoins. The ones that fail are algorithmic stablecoins, which are very different from asset-backed stablecoins,” Lummis told CNBC. She said she wants consumers to see that not all stablecoins are created equal and that choosing an asset-backed stablecoin is critical.

This view was echoed by the managing director of the International Monetary Fund At the World Economic Forum Annual Meeting in Davos.

“I implore you not to give up the importance of this world,” said IMF Managing Director Kristalina Georgieva. “It provides us all with faster service, lower cost. and more inclusiveness, but only if we separate apples from oranges and bananas.”

Georgieva also stressed that there are no asset-backed stablecoins is a pyramid scheme And stressed that regulators have the responsibility to set up protective guardrails for investors.

“I think because of the events of the last few weeks, we may be able to regulate more quickly,” said the SEC’s Hester Peirce, noting that stablecoin legislation was on the agenda before the fall of the UST.

“We have to make sure … that the ability for people to try different models is preserved, and in a manner that complies with regulatory guardrails,” the SEC commissioner continued.

Legislation to crack down on shadow banking

For Commodity Futures Trading Commission Commissioner Caroline Pham, the UST debacle highlights how much regulators need to do to prevent a possible comeback of shadow banking — a banking system where financial activity is facilitated by unregulated intermediaries or in an unregulated situation.

Pham said many of the existing safeguards could do the trick.

“It’s always faster to build a regulatory framework when it already exists,” Pham said. “You’re just talking about expanding the regulatory spectrum around newer, novel products.”

Months before the failure of the UST algorithmic stablecoin project, the President’s Working Group on Financial Markets published a report Outline the regulatory framework for stablecoins. In it, the organization divides the stablecoin space into two main camps: transactional stablecoins and payment stablecoins.

Today, stablecoins are often used to facilitate the trading of other digital assets. The report aims to develop best practices for regulating stablecoins for wider use as a means of payment.

“For banking regulators like me, we are historians of similar monetary instruments,” said Hsu, whose Office of the Comptroller of the Currency co-authored the report.

“It’s a very familiar story and the way to deal with it is prudential regulation. That’s why I think some options, the suggestion of a more banking-like regulation type approach is a good place to start.”

A key question for regulators and lawmakers to address, Pham said, is whether stablecoins, including a subset of algorithmic stablecoins, are actually derivatives.

If people start to frankly view some of these really novel crypto tokens as lottery tickets. You might make a fortune and get rich quick when you go to the lottery, but you might not.

Caroline Fan

Commissioner of the U.S. Commodity Futures Trading Commission

Generally speaking, a derivative is a financial instrument that allows people to trade based on the price fluctuations of the underlying asset.The underlying asset can be just about anything, including commodities like gold, or – depending on how The SEC is currently considering — A cryptocurrency such as Bitcoin.

The SEC regulates securities, but for everything that is not a security, the CFTC may have some regulatory touchpoints, Pham said.

“We regulate commodity-based derivatives, but we also have certain areas … we regulate the spot market directly,” Pham said.

“The last time we…had something like this in a financial crisis — risky, opaque, complex financial products — and Congress came up with a solution for that, and that was Dodd-Frank,” Fan continued, referring to The Wall Street Reform and Consumer Protection Act of 2010 was passed in response to the Great Depression. The bill includes stricter derivatives regulation, as well as new restrictions related to the trading practices of FDIC insurers.

“If some of these traded stablecoins are actually derivatives, then basically, you’re talking about custom basket swaps, then traders have to manage the risk associated with that,” Pham explained.

Congress calls the shots

Ultimately, SEC Commissioner Peirce said, Congress will dictate how to move forward with cryptocurrency regulation. While Wall Street’s top regulator is already using the powers it has to act, Congress needs to assign enforcement responsibilities.

Lummis worked with Sen. Kirsten Gillibrand of D.N.Y. to articulate this regulatory division in a proposed bill.

“We’re setting it on top of the current asset regulatory framework, including the CFTC and the SEC,” Lummis told CNBC. “We’re making sure the tax is a capital gain and not ordinary income. We’ve dealt with some of the accounting procedures, some of the definitions, and we’re looking at consumer protection and privacy.”

The bill also explores stablecoin regulation. Lummis said the bill takes into account the existence of this particular subset of digital assets and requires them to be either FDIC insured or more than 100% backed by hard assets.

Booker said there is a panel in the Senate where “good people on both sides of the aisle” get together and work together to solve problems.

“I want to have the right regulations,” Booker continued. “I don’t think the SEC is a lot of the place to regulate the industry. Obviously ethereum and bitcoin, being most cryptocurrencies, are more of a commodity.”

But before a bill is pushed into law on Capitol Hill, Pham said cryptocurrency investors need to be more cautious.

“Frankly, if people start thinking of some of these really novel crypto tokens as lottery tickets, then when you go to the lottery, you might make a fortune and get rich quick, but you might not,” Pham said .

“I think my concern is that without proper customer protections and proper disclosure, people will buy some of these crypto tokens thinking they’re guaranteed to make a fortune,” she said.