The new stablecoin bill in the US House of Representatives has proposed imposing a two-year ban on new algorithmically pegged stablecoins like TerraUSD (UST).

The proposed legislation would require the Treasury Department to conduct a study of UST-like stablecoins in collaboration with the United States Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Securities and Exchange Commission. Values.

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

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

The failure of the Terra ecosystem that began with the decoupling of its UST algorithmic stablecoin ultimately wiped out the $40 billion ecosystem. This led to a crypto contagion that saw the crypto market lose almost a trillion dollars in market value in a couple of weeks.

Markets have yet to recover from the contagion, and the Terra collapse definitely cast a shadow over the future of algorithmic stablecoins and became a hot topic for critics, including certain lawmakers who have been using it to advocate for tougher policies for stablecoins. cryptocurrencies. The latest draft proposal to temporarily ban such stablecoins is a case in point. Under the current draft of the bill, it would be illegal to issue or create new “endogenously collateralized stablecoins.”

The draft proposal evoked mixed emotions from Crypto Twitter. While some market watchers I call It’s a good idea, which would help prevent more collapses of this type, others believed that the Terra fiasco had set the industry back for years. Pointing towards the two-year temporary ban, some hinted that while algorithmic stablecoins might not be to blame, the execution by the Terra team has cast a shadow over the entire algorithmic stablecoin industry.

Speaking about the impact of the Terra contagion on stablecoin regulation, Mriganka Pattnaik, CEO of risk monitoring service provider Merkle Science, told Cointelegraph that regulators need to take a broader approach than a temporary ban. She believes that lumping all algorithmic stablecoins together and banning them in general will hamper innovation, stating:

“In light of the Terra collapse and the ripple effect it created, algorithmic stablecoins will need to regain the trust of regulators and consumers alike. Regulators can push for partially collateralized models, set transparency standards, and require issuers to submit white papers highlighting how their particular stablecoin offering works, its operating structure, mint-and-burn mechanism, and type of algorithm they use. to maintain value, the unique risks presented by the offering and whether it may have a potential contagion effect on broader 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 more difficult to impose a ban on them.

Patnaik added that it is self-defeating to cling to the notion that decentralization and regulatory controls can never be aligned. The most proactive thing stablecoin issuers can do is “get together and come up with technical solutions to the regulatory issues surrounding algorithmic stablecoins.”

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

“There is the question of how Do Kwon marketed Terra and how he used user funds during and after the crash. If good regulation had been in place before and during the crash, some of it would have involved clearer messaging about the risks involved in pouring money into unproven technology. I think a lot of investors were maybe not aware of the risks.”

He added that the Terra debacle set a precedent for other investors in decentralized finance and crypto to be more transparent and “regulations will be put in place to ensure that consumers and investors are not affected by malpractice.”

A “Libra moment” for algorithmic stablecoins

The Terra Stablecoin project is somewhat reminiscent of the fate of Facebook’s Libra project, now Meta, Stablecoin, which was later named Diem. The social media giant got involved in the crypto space in 2019 when he announced his plans to launch a universal stablecoin whose adoption would have been elevated by Facebook’s line of social messaging apps and services, including Instagram and Whatsapp.

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

Facebook registered the project in Switzerland and hoped to circumvent regulatory oversight from various nations, but to no avail. Facebook faced immediate pushback from regulators around the world and founder Mark Zukerberg even faced multiple hearings in Congress regarding the same thing. The name change to Diem didn’t help his cause much, and the project was eventually shut down at the end of January 2022.

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

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

Dion Guillaume, global head of communications for cryptocurrency exchange, told Cointelegraph that Terra was a stress test that could benefit the industry:

“It was a big stress test, for sure. However, I think this will eventually work out for the better. For one thing, cryptocurrency users need to know that when someone offers them crazy high returns, something fishy is going on in the background. Additionally, projects must know how to prioritize long-term goals over short-term pleasure. For example, many analysts have pointed out that the flaws in Terra’s UST stablecoin make it impossible to create a decentralized, capital-efficient stablecoin, yet users continued to use Terra and projects continued to build on it. Let’s hope the industry learns a lesson from this setback.”

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

“We can see in hindsight that he sped up Congressional drafting of a very promising bipartisan bill, which 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 transformational, providing clarity on stablecoin regulatory classifications, what quantity and quality they should be reserved in, how they will be backed by other assets, etc.

He added that the experience of the Terra implosion will trigger innovation in true stablecoin products and ultimately “drive more organizations and individuals to invest in cryptocurrencies and related technologies in the years to come.”

The collapse of Terra might have led to crypto contagion, but it created a turning point for the stablecoin industry. It has forced policymakers to look at the bigger picture and find better ways to protect consumers. It also piqued the interest of policymakers in the different and complex nature of the industry and made them realize that a common policy will not work for the entire industry.

This post Terra could leave a regulatory legacy similar to Facebook’s Libra

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