Terra crisis fans regulatory concerns over $180bn stablecoin market

A crisis engulfing one of the world’s biggest stablecoins has worsened, inflaming regulators’ concerns over the assets that underpin the global cryptocurrency market.

TerraUSD, which seeks to consistently track the dollar with a value of $1, slumped to a low on Wednesday of 30 cents in one of the highest-profile examples to date of a stablecoin breaking its so-called peg. Attempts at stabilisation by the Luna Foundation Guard — acting akin to a central bank for the token — have failed.

The episode has poured fresh fuel on worries among financial regulators over the rising risks the $180bn stablecoin industry poses to traditional markets as crypto becomes more integrated with conventional payments and banking systems.

“A stablecoin known as TerraUSD experienced a run and declined in value,” US Treasury secretary Janet Yellen said on Tuesday. “I think that this simply illustrates that this is a rapidly growing product and there are rapidly growing risks.”

Stablecoins are meant to provide a safe harbour for crypto investors, allowing them to stash digital cash and hop easily between different cryptocurrencies. Generally, they claim to be backed by a basket of dollar assets.

Terra, which ranked among the top-five stablecoins on the market at the start of this week, is different. It is a so-called algorithmic stablecoin, which seeks to track the buck by raising or cutting the amount of its coin in circulation as it diverges from the dollar’s value, in part through a relationship with Luna, a cryptocurrency.

Whatever the structure behind stablecoins, regulators have been concerned about their role for some time. The Federal Reserve, European Central Bank and Bank of England have all issued warnings on the risks of stablecoins, and particularly on their links to the traditional financial system.

In its regular financial stability report this week, the Fed noted that just three — Tether, USD Coin and Binance USD — make up about 80 per cent of the overall market.

It warned that even stablecoins backed by reserves “may lose value or become illiquid during stress”, adding that “these vulnerabilities may be exacerbated by a lack of transparency regarding the riskiness and liquidity of assets backing stablecoins”.

Ilan Solot, partner at crypto group Tagus Capital, said “the gut reaction is to cast the [TerraUSD] debacle as bad news from a regulatory standpoint — and it might turn out to be”. However, he said that it could also highlight the differences between algorithmic coins and those backed by a basket of reserves.

The TerraUSD situation, which came during a week of intense volatility in crypto markets, adds to broader worries about the largely unregulated stablecoin industry. Tether, the market leader, provides only limited details about the specific holdings of traditional financial assets that underpin its peg with the US dollar. In October 2021, the US Commodity Futures Trading Commission fined Tether $41mn after the company allegedly made “untrue or misleading statements and omissions of material fact” regarding its reserves.

In a research note on Wednesday, UBS said the TerraUSD episode “will also likely heighten regulators’ focus on USDC and Tether, which, though not yet systemically important to the broader financial payments, clearing and settlement, are linchpins of the crypto trading industry”.

In a series of Twitter messages on Wednesday, Terra co-founder Do Kwon told members of the “Terra community” that “I understand the last 72 hours have been extremely tough on all of you — know that I am resolved to work with every one of you to weather this crisis, and we will build our way out of this. Together.”

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