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$60 billion Terra washout not crypto’s Bear Stearns moment: regulators


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

Half a trillion dollars was wiped off the sector’s market cap as terraUSD, one of the crucial popular U.S. dollar-pegged stablecoins, imploded virtually overnight.

Meanwhile, digital coins corresponding to ether proceed to take a beating on the value charts, because the sell-off keeps hammering the industry.

Some investors have called the events of the last month a Bear Stearns moment for crypto, comparing the contagion effect of a failed stablecoin project to the autumn of a serious Wall Street bank that ultimately foretold the 2008 mortgage debt and financial crisis.

“It really revealed some deeper vulnerabilities within the system,” said Michael Hsu, acting Comptroller of the Currency for the U.S. Treasury Department.

“Clearly, you saw contagion, not only from terra to the broader crypto ecosystem, but to tether, to other stablecoins, and I believe that is something that wasn’t assumed. And I believe that is something people have to essentially concentrate to.”

But up to now, government officials aren’t anxious a few crypto crash taking down the broader economy.

Several senators and regulators told CNBC on the sidelines of the DC Blockchain Summit this week that the spillover effects are contained, crypto investors shouldn’t freak out, U.S. regulation is the important thing to success for cryptocurrencies, and crucially, the crypto asset class is not going anywhere.

“There must be rules to this game that make it more predictable, transparent, where there are the needed consumer protections,” said Sen. Cory Booker, D-NJ.

“What we don’t need to do is choke a latest industry and innovation out in order that we lose out on opportunities. Or what I’m seeing at once, lots of these opportunities just move offshore, and we’re missing the economic growth and job creation that is a component of it. So it is a really necessary space if we get the regulation right, that may actually be helpful to the industry and protecting consumers,” continued Booker.

A contained event

In early May, a preferred stablecoin referred to as terraUSD, or UST, plummeted in value, in what some have described as a “bank run,” as investors rushed to tug out their money. At their height, luna and UST had a combined market value of virtually $60 billion. Now, they’re essentially worthless.

Stablecoins are a form of cryptocurrency whose value is tethered to the value of a real-world asset, corresponding to the U.S. dollar. UST is a selected breed, referred to as an “algorithmic” stablecoin. Unlike USDC (one other popular dollar-pegged stablecoin), which has fiat assets in reserve as a technique to back their tokens, UST relied on computer code to self-stabilize its value.

UST stabilized prices at near $1 by linking it to a sister token called luna through computer code running on the blockchain — essentially, investors could “destroy” one coin to assist stabilize the value of the opposite. Each coins were issued by a corporation called Terraform Labs, and developers used the underlying system to create other applications corresponding to NFTs and decentralized finance apps.

When the value of luna became unstable, investors rushed out of each tokens, sending prices crashing.

UST’s failure, though infectious, wasn’t much of a surprise to some crypto insiders.

Coin Metrics’ Nic Carter tells CNBC that no algorithmic stablecoin has ever succeeded, noting that the elemental problem with UST was that it was largely backed by faith within the issuer.

Sen. Cynthia Lummis, R-Wyo., who’s amongst probably the most progressive lawmakers on Capitol Hill in terms of crypto, agrees with Carter.

“There are a pair kinds of stablecoins. The one which 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 made equal and that selecting an asset-backed stablecoin is crucial.

That sentiment was echoed by the managing director of the International Monetary Fund on the World Economic Forum’s annual meeting in Davos.

“I’d beg you not to tug out of the importance of this world,” said IMF chief Kristalina Georgieva. “It offers us all faster service, much lower costs, and more inclusion, but provided that we separate apples from oranges and bananas.”

Georgieva also stressed that stablecoins not backed by assets to support them are a pyramid scheme and emphasized that the responsibility falls to regulators to place up protective guardrails for investors.  

“I believe it is probably going that we will have regulation occur faster due to events of recent weeks,” said Securities and Exchange Commission’s Hester Peirce, who also noted that stablecoin laws was already on the docket before the autumn of UST.

“We now have to make certain to…preserve the flexibility of individuals to experiment with different models, and accomplish that in a way that matches inside regulatory guardrails,” continued the SEC Commissioner.

Legislating against shadow banking

For Commissioner Caroline Pham of the Commodity Futures Trading Commission, the UST meltdown highlights just how much motion regulators have to take to guard against a possible return of shadow banking — that’s, a form of banking system during which financial activities are facilitated by unregulated intermediaries or under unregulated circumstances.

Pham says lots of existing safeguards could do the trick.

“It is often faster to get up a regulatory framework when it’s already existing,” said Pham. “You are just talking about extending the regulatory perimeter around newer, novel products.”

Months before the UST algorithmic stablecoin project failed, the President’s Working Group on Financial Markets published a report outlining a regulatory framework for stablecoins. In it, the group divides the stablecoin landscape into two fundamental camps: trading stablecoins and payment stablecoins.

Today, stablecoins are typically used to facilitate trading of other digital assets. The report looks to set down best practices to manage stablecoins to be more widely used as a method of payment.

“For many who are like me, bank regulators, we’re kind-of historians of money-like instruments,” said Hsu, whose Office of the Comptroller of the Currency co-authored the report.

“It is a really familiar story, and the technique to take care of it’s prudential regulation. For this reason I believe a few of the options, the proposals for more of a bank type of regulatory-type approach is a great place to begin.”

The important thing query that regulators and lawmakers need to handle is whether or not stablecoins, including the subset of algorithmic stablecoins, are in truth derivatives, says Pham.

If people began to take into consideration a few of these really novel crypto tokens as frankly, lottery tickets. Once you go and you purchase a lottery ticket, you would possibly strike it big, and get wealthy quick, but you would possibly not.

Caroline Pham

CFTC commissioner

Generally speaking, a derivative is a financial instrument that permits people to trade on the value fluctuations of an underlying asset. The underlying asset might be almost anything, including commodities corresponding to gold or — in accordance with the way in which the SEC is currently considering — a cryptocurrency corresponding to bitcoin.

The SEC regulates securities, but for every thing that is just not a security, the CFTC probably has some regulatory touchpoint over it, says Pham.

“We now have the regulation over derivatives based on commodities, but we even have certain areas … where we directly regulate spot markets,” said Pham.

“The last time we had … something blow up like this within the financial crisis — dangerous, opaque, complex financial products — Congress got here up with an answer for that, and that was with Dodd-Frank,” continued Pham, referring to the Wall Street Reform and Consumer Protection Act, passed in 2010 in response to the Great Recession. The act included stricter regulation of derivatives, plus latest restrictions related to the trading practices of FDIC-insured institutions.  

“If a few of these trading stablecoins are, in truth, derivatives, mainly, you are talking a few custom basket swap, after which it is the dealer who has to administer the danger related to that,” explained Pham.

Congress calls the shots

Ultimately, SEC Commissioner Peirce says, Congress calls the shots on the best way to move forward on crypto regulation. While Wall Street’s top regulator is already acting using the authority that it has, Congress must divvy up enforcement responsibilities.

Lummis has paired up with Sen. Kirsten Gillibrand, D-N.Y., to spell out this division of regulatory labor in a proposed bill.

“We’re setting it on top of the present regulatory framework for assets, including the CFTC and the SEC,” Lummis told CNBC. “We’re ensuring that the taxation is capital gains and never unusual income. We have handled some accounting procedures, some definitions, we’re consumer protection and privacy.”

The bill also delves into stablecoin regulation. Lummis says that the bill contemplates the existence of this specific subset of digital assets and requires that they either be FDIC-insured or greater than 100% backed by hard assets.

Booker says there may be a bunch within the Senate with “good folks on either side of the aisle” coming together and partnering to get it right.

“I would like there to be the proper regulation,” continued Booker. “I do not think the SEC is the place to manage lots of this industry. Clearly, ethereum and bitcoin, that are the vast majority of the cryptocurrencies, are more commodity-like.”

But until Capitol Hill pushes a bill into law, Pham says that crypto investors have to exercise a complete lot more caution.

“If people began to take into consideration a few of these really novel crypto tokens as frankly, lottery tickets, if you go and you purchase a lottery ticket, you would possibly strike it big, and get wealthy quick, but you would possibly not,” said Pham.

“I believe what I’m anxious about is that without appropriate customer protections in place, and the proper disclosures, that individuals are buying a few of these crypto tokens considering that they are guaranteed to strike it wealthy,” she said.

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