WASHINGTON — The past few weeks have been brutal for the crypto market.
Half a trillion dollars was wiped from the sector’s market capitalization as terraUSD, one of the most popular US dollar-pegged stablecoins, imploded virtually overnight.
Meanwhile, digital coins such as ether continue to take a beating on the price charts, as selling continues to hammer the industry.
Some investors have called the events of the past month a Bear Stearns moment for crypto, comparing the contagion effect of a failed stablecoin project to the fall of a major Wall Street bank that ultimately predicted mortgage debt and 2008 financial crisis.
“It really exposed deeper vulnerabilities in the system,” said Michael Hsu, acting Comptroller of Currency for the US Treasury Department.
“Obviously you’ve seen the contagion, not just from terra to the wider crypto ecosystem, but also to other stablecoins, and I think that’s something that wasn’t assumed. And I think that’s something people really need to pay attention to.”
But so far, government officials don’t seem to be worried about a crypto crash destroying the wider economy.
Several senators and regulators told CNBC on the sidelines of the DC Blockchain Summit this week that the ripple effects are contained, that crypto investors should not panic, that US regulation is key to the success of cryptocurrencies and, importantly, that the crypto asset class isn’t going anywhere.
“There have to be rules to this game that make it more predictable, transparent, where there are the necessary consumer protections,” said Sen. Cory Booker, D-NJ.
“What we don’t want to do is stifle new industry and innovation in order to lose opportunities. Or what I’m seeing right now, a lot of those opportunities are just moving overseas, and we’re missing out on the economic growth and job creation that is part of it. So this is a really important space if we have the right regulations, it can actually help the industry and protect consumers,” Booker continued.
A contained event
In early May, a popular stablecoin known as terraUSD, or UST, plummeted in value, in what some described as a “bank run,” as investors rushed to withdraw their money. At their peak, Luna and UST had a combined market value of nearly $60 billion. Now they are essentially worthless.
Stablecoins are a type of cryptocurrency whose value is tied to the price of a real-world asset, such as the US dollar. UST is a specific breed, known as an “algorithmic” stablecoin. Unlike USDC (another popular dollar-pegged stablecoin), which has fiat assets in reserve as a way to back up its tokens, UST relied on computer code to self-stabilize its value.
UST stabilized prices near $1 by linking it to a sister token called luna via computer code running on the blockchain – essentially investors could “destroy” one coin to help stabilize the price of the other . Both coins were issued by an organization called Terraform Labs, and the developers used the underlying system to create other applications such as NFTs and decentralized finance applications.
When the price of luna became volatile, investors rushed into both tokens, causing prices to plummet.
The failure of UST, while contagious, did not come as much of a surprise to some crypto insiders.
Nic Carter of Coin Metrics told CNBC that no algorithmic stablecoin has ever been successful, noting that the fundamental problem with UST was that it was largely backed by trust in the issuer.
Sen. Cynthia Lummis, R-Wyo., who is among Capitol Hill’s most progressive crypto lawmakers, agrees with Carter.
“There are several types of stablecoins. The one that failed is an algorithmic stablecoin, very different from an asset-backed stablecoin,” Lummis told CNBC. She said she hoped consumers could see that not all stablecoins are created equal and that choosing an asset-backed stablecoin is key.
This sentiment was echoed by the managing director of the International Monetary Fund at the annual meeting of the World Economic Forum in Davos.
“I beg you not to withdraw from the importance of this world,” said IMF director Kristalina Georgieva. “It gives all of us faster service, much lower costs and greater inclusion, but only if we separate the apples from the oranges and bananas.”
Georgieva also pointed out that stablecoins not backed by assets to support them are a pyramid scheme and stressed that the responsibility lies with regulators to put in place protective safeguards for investors.
“I think it’s likely that we’re going to speed up regulation because of the events of the past few weeks,” said Hester Peirce of the Securities and Exchange Commission, who also noted that stablecoin legislation is already on the agenda. before the fall of the UST.
“We need to make sure that we … preserve people’s ability to experiment with different models, and do so in a way that fits within regulatory guardrails,” the SEC commissioner continued.
Legislating against shadow banking
For Commissioner Caroline Pham of the Commodity Futures Trading Commission, the collapse of the UST highlights how regulators must take steps to protect themselves against a possible return of shadow banking, i.e. a type banking system in which financial activities are facilitated by unregulated intermediaries. or in unregulated circumstances.
Pham says a lot of existing warranties could do the trick.
“It’s always faster to put a regulatory framework in place when it already exists,” Pham said. “You’re just talking about expanding the regulatory perimeter around new innovative products.”
Months before the failure of the UST algorithmic stablecoin project, the President’s Financial Markets Task Force released a report outlining a regulatory framework for stablecoins. In it, the group divides the stablecoin landscape into two main camps: trading stablecoins and payment stablecoins.
Today, stablecoins are typically used to facilitate trading in other digital assets. The report seeks to define best practices for regulating stablecoins so that they are more widely used as a means of payment.
“For those like me, banking regulators, we are sort of historians of monetary instruments,” said Hsu, whose Office of the Comptroller of the Currency co-authored the report.
“It’s a really familiar story, and the way to deal with it is prudential regulation. That’s why I think some of the options, the proposals for a more banking-like regulatory approach are a good place to start.”
The key question that regulators and lawmakers need to address is whether stablecoins, including the subset of algorithmic stablecoins, are in fact derivatives, Pham says.
Generally speaking, a derivative is a financial instrument that allows people to trade on the price fluctuations of an underlying asset. The underlying asset can be almost anything, including commodities such as gold or – depending on how the SEC currently thinks – a cryptocurrency such as bitcoin.
The SEC regulates securities, but for anything that isn’t a security, the CFTC likely has a regulatory touchpoint on it, Pham says.
“We have commodity-based derivatives regulation, but we also have certain areas … where we regulate spot markets directly,” Pham said.
“The last time we had … something like this in the financial crisis — risky, opaque, complex financial products — Congress found a solution to that, and that was with Dodd-Frank,” Pham continued, referring to the Wall Street Reform and Consumer Protection Act, passed in 2010 in response to the Great Recession. The law included stricter regulation of derivatives, as well as new restrictions related to the business practices of FDIC-insured institutions.
“If some of these trading stablecoins are, in fact, derivatives, basically you’re talking about a custom basket exchange, and then it’s the dealer who has to manage the risk associated with that,” Pham explained.
Congress takes the lead
Ultimately, says SEC Commissioner Peirce, Congress decides how to move crypto regulation forward. While Wall Street’s top regulator is already acting using the authority it has, Congress needs to divide enforcement responsibilities.
Lummis has partnered with Sen. Kirsten Gillibrand, DN.Y., to spell out this regulatory division of labor in a bill.
“We place it above the current regulatory framework for assets, including the CFTC and the SEC,” Lummis told CNBC. “We ensure that taxation is on capital gains and not on ordinary income. We’ve covered some accounting procedures, some definitions, we’re looking at consumer protection and privacy.”
The bill also delves into the regulation of stablecoins. Lummis says the bill contemplates the existence of this specific subset of digital assets and requires that they be FDIC-insured or backed more than 100% by durable assets.
Booker says there’s a group in the Senate with “good people from both sides of the aisle” coming together and teaming up to get it right.
“I want there to be the right regulations,” Booker continued. “I don’t think the SEC is the place to regulate much of this industry. Obviously, ethereum and bitcoin, which make up the majority of cryptocurrencies, are more like commodities.”
But until Capitol Hill enacts a bill, Pham says crypto investors need to exercise a lot more caution.
“If people started thinking of some of these really new crypto tokens as, frankly, lottery tickets, when you go and buy a lottery ticket, you could hit it big and get rich quick, but you couldn’t,” said Pham.
“I think what worries me is that without the proper customer protections in place and the right disclosures, people are buying some of these crypto tokens thinking they’re guaranteed to get rich,” he said. she stated.
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$60 Billion Terra Wash Not Bear Stearns Crypto Moment: Regulators
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