Original compilation: 0x11, Foresight News
Original compilation: 0x11, Foresight News
stable currencystable currencyAnd ammunition for the entire crypto industry.
However, getting lost in the conversation is a source of disagreement and confusion. A better understanding of the nature of the problem and the reasons behind it can help protect consumers while protecting innovation.
First, it is important to clarify terminology. A stablecoin is a cryptocurrency whose price is nominally "pegged" to a stable asset such as the U.S. dollar. The recent debacle is often blamed on so-called "algorithmic stablecoins," which are created and destroyed with programmatic incentives to maintain price stability.
But the attack on stablecoins is ill-timed here. Putting aside the fact that UST should never be considered a "stablecoin," the real problem has nothing to do with computer code, but with a concept as old as finance itself: collateralization, or the use of assets to back value.
This is a key point that policymakers around the world will need to consider when drafting legislation to prevent future Terra-like collapses. If lawmakers believe that algorithms are to blame, they risk creating regulations that backfire and stifle innovation. Poorly designed laws can disrupt markets, encourage regulatory arbitrage, and reduce the influence of Western democracies in the emerging, distributed internet economy known as Web3.
The promise of decentralized finance (DeFi) depends in large part on blockchain's breakthrough ability to execute transparent algorithmic contracts with instant finality.
The vast majority of “decentralized” stablecoins backed by blockchain assets like bitcoin and ethereum have done well amid recent market volatility, able to handle extreme price swings and massive redemptions. In general, algorithms are not an issue with current stablecoins. Instead, basically all the risk now comes from their collateral design.
The riskiest stablecoins are obvious: they are severely under-collateralized (less than $1 of collateral is needed to mint a $1 of stablecoin), and they rely on "endogenous" collateral (collateral created by the issuer, e.g. Governance tokens voted by holders).
Endogenous collateral makes the danger explosive: users can mint more stablecoins as the issuer’s governance token appreciates in value. This sounds good when other risks are not considered; but when prices fall - as happens during bank runs - collateral liquidations can trigger a death spiral, UST is the best example.
In order to prevent similar accidents,regulation is necessary, but overly strict rules are counterproductive. The truth is, enforcement actions under existing securities laws and anti-fraud regulations may have stemmed the proliferation of nearly all failed stablecoins to date.
Even so, fresh, targeted regulation could be beneficial. While it’s difficult to pinpoint exactly where regulators should establish collateral requirements, it’s clear that without guardrails, stablecoin issuers could once again be taking unreasonable risks.
Tailored rules can support the crypto ecosystem and protect consumers. Blanket changes — such as a complete ban on the use of algorithms and cryptoassets as collateral — would place a huge burden on the burgeoning DeFi industry, disrupt the digital asset market, and hinder Web3 innovation.
This is because stablecoins can indeed remain stable if their collateral is properly managed. For “centralized” stablecoins backed by real-world assets, reserves may be less liquid and less transparent, so collateral should include less volatile assets such as cash, treasuries, and bonds. Regulators could establish parameters and require regular audits regarding these types of collateral.
For "decentralized" stablecoins, there are trade-offs in using almost exclusively blockchain assets such as Bitcoin or Ethereum as collateral. Cryptoassets, while highly volatile, are also highly liquid and can be transparently managed algorithmically. Decentralized stablecoins may end up being more resilient than centralized stablecoins.
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