janet yellen us treasury secretary

The Treasury Secretary of the United States, Yanet Yellen, has deemed as “highly appropriate” the introduction of a regulatory framework for stablecoins only days after Terra’s UST token drifted over 50% off its peg.

During a hearing of the Senate Banking Committee, the former head of the country’s central bank commented: “I think [the situation with UST] simply illustrates that this is a rapidly growing product and that there are risks to financial stability and we need a framework that’s appropriate”.

Stablecoins directly compete with the US dollar in the crypto realm as their value is pegged to that of the North American currency. This allows users to easily convert their digital assets into a financial instrument that supposedly should always be worth $1.

The value of a stablecoin is typically pegged to that of a fiat currency – in most cases, the US dollar. Some of the most popular ones in the crypto market are Tether (USDT) and USDC Coin (USDC). To maintain their peg, these projects either claim to have enough cash reserves in US dollars or cryptocurrency to back every coin they issue and their reserves vary depending on the token’s circulating supply at any given point in time.

However, the organizations that issue these tokens remain largely unregulated and, in most cases, their financial reporting lacks the required transparency that such an instrument would need to be considered trustworthy.

The UST Debacle May Increase Pressure for More Regulatory Oversight

The Terra Labs-backed stablecoin project UST recently drifted significantly off its peg to the US dollar after a phenomenon similar to a run-off-the-bank occurred in one of the DeFi protocols that paid the most attractive rewards to token holders.

In the past few days, the Anchor Protocol experienced billion-dollar withdrawals that triggered the de-pegging of UST while other protocols like Curve, which also offers lending via the blockchain, experienced a similar situation.

In response, the Luna Foundation Guard (LFG) – an entity created by Terra Labs to keep UST pegged to the North American currency – was forced to drain its Bitcoin (BTC) reserves to provide the required liquidity amid the supply/demand imbalance.

However, these efforts appear to have created a chain of reactions that first pushed the value of BTC lower, which subsequently reduced the value of the remaining reserves held by LFG, which ultimately led to a more dramatic sell-off.

As of this afternoon, the value of UST is trading at 64.6 cents on the dollar while the price of Luna (LUNA), the token designed to keep the stablecoins powered by the Terra blockchain pegged, is falling as much as 87% as trust on the network’s tokenomics and ability to recover keeps deteriorating.

The co-founder of Terra Labs, Do Kwon, stated in a Twitter thread that the cost of absorbing so much selling pressure on UST ultimately led to the sharp decline in LUNA. He added that “the only path forward will be to absorb the stablecoin supply that wants to exit before $UST can start to repeg”.

What Could the UST Debacle Mean for Stablecoins?

Losses resulting from UST’s meltdown could lead to swift actions from regulators to oversee the entities that issue stablecoins and how reserves are reported.

These digital assets play a key role in facilitating crypto transactions. Only days before the collapse started, UST had a total market capitalization of over $18 billion while other projects such as Tether and USDC have market caps of around $80 and $50 billion respectively.

Many investors use these tokens to save money in the crypto ecosystem. However, in contrast to regulated bank accounts, no institution that guarantees that depositors will get their money back in case the organization in charge of overseeing these digital assets fails to deliver the expected outcome.

Cryptoassets are a highly volatile unregulated investment product. No UK or EU investor protection.