Those of you following cryptoasset markets over the past week have seen one of the most dramatic events to date in an already volatile asset class.
Terra non firma
Terra's UST stablecoin is (well, was) pegged to the US Dollar. It is part-algorithmic (via creation and burning of the LUNA governance token), and recently the Luna Foundation Guard (LFG, would you believe) part-collateralised it with Bitcoin.
Turns out collateralising a "stable" asset with volatile assets isn't a great idea.
Over the last couple of days, during and following widespread cryptoasset price declines, UST de-pegged and has stayed stubbornly de-pegged despite the Luna Foundation Guard apparently starting to sell substantial quantities of its bitcoin at a significant loss, and LUNA collapsing in value.
This is one of the largest cryptoasset implosions to date and it certainly has implications across the cryptoasset space. So far so good, right? Everyone knows crypto is volatile and risky. It's early days and some experiments are bound to fail.
But imagine a future where stablecoins have a material share of payments services (not to mention savings) across the wider economy. In that world, a UST-style collapse could have real economic implications.
So, where do you put up the perimeter?
The UK Government proposes to address such risks by regulating stablecoins as e-money and subjecting the largest stablecoins to prudential regulation. Sounds very sensible at times like these.
But the Government proposes to exclude "algorithmic stablecoins, or those that may be linked to assets other than fiat currency" from scope, on the grounds that they are similar to unbacked cryptoassets i.e. do not reference fiat currency and may not offer sufficient price stability. Coins like UST. In time, it's possible that such stablecoins could grow sufficiently to impact systemic stability despite being excluded from the regulatory perimeter. What's a regulator to do? Try to ban them outright? Require consumer warnings wherever they are used? Both may prove difficult!
And there's the potential for problematic edge cases to emerge. A stablecoin regulated as e-money would need to be backed 1:1 with GBP, whether by way of GBP bank account balances, investments in high quality liquid assets, or appropriate insurance coverage or guarantee. But high quality liquid assets can fluctuate in value (witness US Treasuries recently) and insurance policies and guarantees have counterparty risk.
Despite these difficulties, the UK regulation of stablecoins could provide welcome certainty to market entrants as well as important protection - to the extent possible in a brave new crypto world - to UK retail customers. Hopefully by the time the next UST arrives.
As trades go, it hasn’t gone great. And once a central bank is on fire, it’s an open invitation to Soroses either actual and imagined.