The collapse of the stablecoin TerraUSD
has made waves in Washington, attracting the attention of the nation’s top policymakers and adding urgency to an ongoing debate in Congress about cryptocurrency regulation.
At its peak in early May, TerraUSD, also known by its ticker UST, was the third most popular stablecoin, with a market capitalization of nearly $20 billion. Just a few weeks later the blockchain has ceased to function and investors in the coin and related cryptocurrency LUNA
have seen billions in wealth vanish.
“The markets last week definitely caught the eye of D.C.,” Ron Hammond, director of government relations at the Blockchain Association, a crypto industry group, told MarketWatch. “There’s definitely a group of investors who lost a lot of money, and that does elicit concern from folks on Capitol Hill.” He predicts that in the coming weeks there will be a slew of new proposals, some bipartisan, for regulating stablecoins and other aspects of the crypto ecosystem.
Stablecoins are a type of cryptocurrency that aim to maintain a steady value in relation to the U.S. dollar
and are primarily used by crypto traders to park uninvested funds so they are safe from the volatile swings in price that characterize assets like bitcoin
Following Terra’s collapse, other stablecoins experienced volatility and a wave of redemptions. Tether, the largest stablecoin by market capitalization, briefly broke its peg with the dollar last week and has seen $7 billion in redemptions since. Tether said in a Monday blog post that the peg was never broken, because it continued to honor redemptions of $1 for one tether, even if the price on some exchanges fell below $1.
The drama was enough for Treasury Secretary Janet Yellen to urge Congress to quickly pass a new regulatory framework and for Pennsylvania Sen. Pat Toomey, the top Republican on the Senate Banking Committee, to hold a press conference touting his legislation in this area.
Why are policymakers worried about stablecoins?
Stablecoins compete with banks and other regulated financial institutions, so regulators believe they should follow similar rules to promote an equal playing field, protect investors and guard against financial contagion.
Tether issues tokens that it promises to redeem for $1 at any point, and to back up these claims Tether says it maintains reserves equal in value to outstanding tether.
“Economically, it’s a bank, and that means one day, as with Terra, everybody is going to want their money back, and that’s a challenge banks have faced for at least a thousand years,” Neilson said.
Meanwhile, as Tether and other stablecoins grow, they become more integrated into the broader financial system through reserve-fund purchases of commercial and government debt.
“Tether is bigger than most mutual funds who are traditionally the biggest players in commercial paper,” Neilson said, and its role will only grow in that market and the market for government debt as Tether grows. “A complex set of financial connections is being built. I can’t tell you what the straw that breaks the camel’s back is going to be, but one day it’s going to go too far.”
Tether said in emailed comments to MarketWatch that it “publishes information about the maturities and ratings of all our commercial papers” and that its “commercial paper holdings have gone down significantly as a percentage of our reserves” in recent quarters.
Who should get to regulate stablecoins?
The Biden administration believes that the bank-like nature of stablecoins means that stablecoin issuance should be limited to federally regulated banks, as it expressed in a working paper published in November.
Toomey and other congressional Republicans have argued for a framework that gives issuers the option to be regulated by different entities depending on its business model. In particular, Toomey is focused on the possibility that stablecoins will emerge as competitors for payment services and therefore should be regulated by the states as money transmitters. The Pennsylvania Republican is not running for re-election this year.
Paul Kupiec, an economist at the American Enterprise Institute, favors this approach, because he sees the potential for stablecoins to promote innovation in the payments industry.
“Payment stablecoins are essentially like a money order or a traveler’s check, the only difference is they clear and settle on the internet using some kind of blockchain,” he said. “Western Union
operate under this framework.”
What’s in Tether’s box?
Republicans and Democrats disagree on the details of how stablecoins should be regulated, but there is widespread agreement that any regulation should require very detailed disclosure of a stablecoin’s backing assets.
Tether has had a run-in with U.S. regulators in the past for its disclosure policies. In October the Commodity Futures Trading Commission fined Tether for $42.5 million for misleading customers about the quality of the reserves that back its stablecoin, and said that Tether only held sufficient reserves of dollars to back outstanding tether tokens 27.6% of the days during a 26-month sample between 2016 and 2018.
Tether said in a statement at the time that the issues in the CFTC case have been “fully resolved” and that it “has always maintained adequate reserves and has never failed to satisfy a redemption request.”
Today the company issues regular statements on the composition of its reserves, attested to by the independent auditor MHA Cayman, though these disclosures fall well short of what’s required of federally regulated money market funds or banks.
Bennett Tomlin, host of the Crypto Critics’ Corner podcast, said in an interview that questions remain as to what actually backs Tether’s reserves, and this poses a threat to the crypto market broadly.
“Tether manages a portfolio of conservative liquid assets with a focus on preserving our reserves,” the company said in emailed comments to MarketWatch. “Tether’s customers continue to place their trust and confidence in Tether, as exhibited through the stablecoin’s growth and market cap of 80bn. In doing so, they are telling the market that Tether’s disclosures are sufficient to make well-informed decisions.”
Tether also disputed the notion that a loss of confidence in its stablecoin could impact the broader crypto market. “Tether losing its peg will not tank Bitcoin and Ethereum. It would only cost more to purchase Bitcoin and Ethereum using Tether.”
Crypto lobbyist keep up the pressure
Volatility in digital assets comes against a backdrop of rapid growth of the industry’s presence in Washington, D.C. The number of lobbyists representing crypto advocates nearly tripled from 115 in 2018 to 320 last year, according to an analysis by Public Citizen, while spending almost quadrupled from $2.2 million to $9 million over the same period.
Hammond of the Blockchain Association says these trends are matched by growing interest among lawmakers on both sides of the aisle who sometimes struggle to keep up with the rapidly changing world of digital assets.
But Capitol Hill is running up against the hard reality of the calendar, he said, noting that the looming election and concerns over inflation and other matters could make it difficult to pass legislation before there’s a new Congress in 2023.
“There’s a timeline here, and if Congress doesn’t act regulators might step in” and impose a framework that is less than ideal, he said. “It’s a pretty tight window here and it’s a complicated subject to tackle.”