The Decoupling of UST Triggered a Deluge of Regulation | What is the Future of Stablecoin?

1. After UST decoupling and LUNA collapse, several regulators, including the Federal Reserve, began to consider the regulation of stablecoins again.

2. At the Capitol Hill hearing, the US Treasury Secretary called for the adoption of stablecoin legislation by the end of the year to establish an appropriate framework to control the "rapid growth risk of financial stability".

3. Technically, stablecoins can be divided into three types: Off-Chain-Backed Stablecoins, On-Chain-Backed Stablecoin and Algorithmic Stablecoin.

4. The fiat-backed stablecoins and digital asset-backed stablecoins have real-world and on-chain assets as the value basis respectively, while the price of algorithmic stablecoins is driven by the supply and demand adjustment of tokens.


On May 8, UST, the fourth largest algorithmic stablecoin project, began to decouple from the US dollar. Within a few days, UST fell below 0.2 against the US dollar. The decoupling of UST triggered a crypto space storm. The value of LUNA (a UST-related token), was close to zero in just 10 days, which exacerbated the downward trend of the cryptocurrency market caused by the Fed's interest rate hike, and the price of Bitcoin once fell to $25000.


With the continuous development of the cryptocurrency market, its impact on the real world is also expanding. Enron's market value was $80 billion when it collapsed in 2001 due to financial fraud. Presently, the market value of LUNA+UST is close to $40 billion, almost half of that of Enron. The influence of cryptocurrency stablecoins is expanding day by day, which may even lead to spillover effects and affect the stability of the whole financial system, which makes many regulators, including the Federal Reserve, begin to consider the regulation of stablecoins.

On May 10, after UST decoupling fell to $0.62 and LUNA plummeted, the Federal Reserve issued the financial stability report, emphasizing the market run risk of the stablecoins. The report believes that the financing risk of domestic banks in the United States is low, but some money market funds, bond funds and stablecoins still have structural vulnerabilities. On the same day, the U.S. Treasury Secretary Janet Yellen also called on Congress to approve stablecoin legislation by the end of the year to establish an appropriate framework to control the "rapid growth risk of financial stability". On May 12, the European Commission also issued a document and began to consider limiting the wide use of the stablecoins. Specifically, if the market value of a stablecoin project exceeds 200 million euros (approximately $211 million) or the daily trading volume exceeds 1 million, the regulator will have the right to stop its issuance.

In fact, as early as 2021, the regulation of stablecoins has entered the agenda of regulators including the Federal Reserve. In June 2021, the Basel Committee on Banking Supervision (BCBS) issued the consultation document "Prudent Treatment of Cryptocurrency Assets Exposure", which believed that without a specific prudent treatment, the continuous growth and innovation of cryptocurrency assets and related services may increase the problems of global financial stability and the risks of the banking system, and put forward suggestions to bring the exposure of banking financial institutions to cryptocurrency assets into the regulatory framework of the Basel agreement. It is proposed to treat the stablecoins with assets such as stocks and bonds. In the stablecoin report issued by the US President's Working Group (PWG) in November 2021, it has been mentioned that it calls on Congress to legislate to ensure that the stablecoins are subject to "consistent and comprehensive" supervision, and regard the stablecoin issuer as an institution at the same level of the bank to fulfill relevant audit and legal obligations.


Stablecoin Classification

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Stablecoins are the common value target of many assets in the cryptocurrency market, which expands the boundary of fiat currency and is a bridge between the blockchain and the real world. As a means of payment, the price change of stablecoins is smaller than that of other digital assets, which is closer to the real currency. In addition, since the stablecoins are based on various blockchains, no matter where it is located in the world, anyone can accept or send the stablecoins by simply connecting to the blockchain network. The stablecoins also have a variety of possibilities in cross-border payment, inclusive finance and so on.

Technically, stablecoins can be divided into Off-Chain-Backed Stablecoin, On-Chain-Backed Stablecoin and Algorithmic Stablecoin. Among them, the Off-Chain-Backed Stablecoin is the most popular. Currently, the two largest stablecoins USDT and USDC belong to this type. This kind of stablecoins are generally issued and managed by a centralized organization, and there are real financial assets such as US dollars as value endorsements. With real assets as the value support, the price change of such stablecoins is generally only affected by short-term supply and demand, and generally fluctuates less. However, due to the high degree of centralization of such stablecoins, the issuer also has some problems in the transparency and openness of these assets. For example, TEDA, also known as Tether, the issuer of the USDT coin, has long been accused of being an "unsecured money printer".


Off-Chain-Backed Stablecoins involve real assets, while the remaining two stablecoins are more "pure" cryptocurrencies. The On-Chain-Backed Stablecoins are to issue the digital currency with the fixed fiat price by staking digital assets such as BTC and ETH on the smart contract.This mode is represented by the DAI token, released by Maker.

Algorithmic stablecoins are special in mechanism. This kind of stablecoins have no value support, but adjust the relationship between supply and demand through algorithms to maintain their own price stability. This process is somewhat similar to that of the central bank in the real world. A typical example of this model is the launch of AMPL in 2018, which is also the originator of algorithmic stablecoins. UST, which was seriously decoupled in this event, also belongs to algorithmic stablecoins. Algorithmic stablecoins generally control the supply of stablecoins through open market operation, Rebasing and issuing secondary tokens. Because there is no other value base and only rely on its own consensus, the algorithmic stablecoins have great resistance to price fluctuations caused by speculation. According to the rumor, a major reason for the serious decoupling of UST this time is that LUNA has been attacked by Wall Street financial giants in a form of short position.

For algorithmic stablecoins, instability is a very common thing. Only a few days after the UST incident, on May 17, another algorithmic stablecoins, the DEI launched by Deus Finance, was also decoupled. So far, the DEI/USD is still around 0.6. In addition, new algorithmic stablecoins using new control mechanisms are also emerging, of which the more representative is Olympus, which is called the DeFi2.0 project.



Conclusion: the opportunity still exists

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At a time when there are frequent stablecoin collapses, the supervision of various countries is tightened, and the public distrust of the stablecoins is growing, the opportunity for standardization still exists.

On April 6, the UK Treasury confirmed that it was ready to bring the stablecoins into the regulatory scope to help create a recognized payment method in the UK, increase consumers' choices and improve payment efficiency, which is also part of the technological innovation of the UK financial services industry. Even after the UST storm, the UK Treasury confirmed that it would continue to bring the stablecoins into the regulatory scope.


Over the past year, the types of stablecoins have increased over 10 times, and the total supply has exceeded 280. As a key application of decentralized finance, the importance of stablecoins is self-evident. Perhaps what’s really important is to be more open than blocked, accept technological innovation, give some fault-tolerant space, and test the regulatory framework.



Author: Gate.io Researcher: Edward H. Translator: Joy Z.
* This article represents only the views of the researcher and does not constitute any investment advice.
*Gate.io reserves all rights to this article. Reposting the article will be permitted provided Gate.io is referenced. In all other cases, legal action will be taken due to copyright infringement.



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