TerraUSD and The Next Era of Stablecoins

On May 9, 2022, the TerraUSD (UST) algorithmic stablecoin crashed, losing nearly all of its value. What does this mean for stablecoins? 

Hardly the end. If anything, it reflects the continuously increasing interest in crypto that has been growing since 2009. In order for any asset to fall, it first has to rise. 

While this seems incredibly obvious, the longer context helps investors understand the “sticky” trend that is crypto. Crypto is a new asset class that investors globally are considering as part of their investment portfolios as well as for payment means. Collateralized stablecoins are primarily used for transactional purposes and in lending products.

Bitcoin’s price movement since 2009 felt haphazard and lackadaisical until 2020. In other words, naysayers appeared smart until the price reached over 61,000 USD during the height of the post-covid recovery. We also say institutional investors entered into the space strongly. Yet the pursuant correction reintroduced general skittishness into the hearts of experts and novices alike. 

Collateralized stablecoins exist to address that problem through more guaranteed stability than an algorithmic stablecoin like UST can. For transactional purposes, this means peer-to-peer payments can occur without third-party intermediaries. Unlike with payments using Bitcoin, a collateralized stablecoin does not face volatile swings and are seen more as digital fiat by many. 

We believe regulators appreciate guarantees, particularly when they come with financial backing. And in the case of collateralized stablecoins, it’s a matter of “telling, not asking.” 

Despite TerraUSD’s unfortunate crash, regulators in both the USA and the EU continue to work towards a framework that will support fiat-backed stablecoins. Why? What is fiat-backed? 

This article delves into the actually-not-so-complicated world of stablecoins. More importantly, it shows their future virtually etched into the proverbial and historical stone. 

Goodbye, TerraUSD

Maybe see you later. But likely, no. 

TerraUSD represented a keen entrepreneurial vision and the hope to stay away from all things fiat. Much of the crypto community may have seen this as admirable, and something worth supporting. 

After all, if you didn’t know what the word “inflation” meant before this year, you do now. 

Inflation shows the paralyzing dark side of fiat (traditional) currencies–that central banks control their respective supplies and demands on (educated) whims. 

Algorithmic stablecoins seek to do the same, using algorithms controlling supply and demand. Too expensive? Create some additional supply (“mint” coins). Too cheap? Retract some coins or give holders an incentive to convert other crypto into the cheaper stablecoins. Natural arbitrage helps as well. 

However, there’s a glaring weakness. You can’t dictate demand–it’s not a dictator-coin. 

For this reason, TerraUSD’s Luna Foundation Guard (LFG), or the body responsible for maintaining the stablecoin’s 1:1 peg to USD, lost the war. It held a chest once containing up to 70,736 bitcoins. 

When Bitcoin’s price did what it does (fall), this collapse in reserve value translated into UST’s collapse as well. 

While investors appreciate the idea of abandoning the “machine” of fiat currency, they evidently did not fully believe in UST’s capacity to stabilize its peg without recourse to another cryptocurrency–Bitcoin. 

Thus, TerraUSD crashed back to Earth. Fiat-biased regulators noticed. 

The Regulators’ Concerns

Even though they could have kicked stablecoins while they were down, we, surprisingly enough, observed the opposite response. 

On June 30, 2022, the EU Council released a press release effectively approving the use of fiat-backed stablecoins. 

Their point remains simple and honest: Crypto has experienced something of a “wild west,” which has no place in the future of finance. They give a slight dig by loosely tying this wild west to algorithmic or other coins having no relation to fiat whatsoever. 

Yet they also rubber stamp fiat-backed stablecoins holding reserves at least approaching 100% of the value of stablecoins in circulation. If the point is to keep a 1:1 fiat peg in the quest of guaranteeing safety in a dog-eat-dog crypto world, then keep some fiat in reserves. 

After TerraUSD, it’s clear: don’t gamble your reserve value. Even gold is down by more than five percent year-to-date, as of this writing. 

Therefore, the European Banking Authority (EBA) will require stablecoin issuers “to build up a sufficiently liquid reserve, with a 1/1 ratio and partly in the form of deposits.” 

Stablecoin issuers, crypto-assets, and crypto-asset service providers shall fall under a common regulatory framework for the first time. While this may spell doom for algorithmic stablecoins and possibly other altcoins (unbacked, alternative coins), it does bring stablecoins into the realm of permanency. 

America’s Joining the Party

On the other side of the Atlantic, the United States also signaled its implicit approval of fiat-backed stablecoins. 

Nellie Liang, undersecretary for domestic finance, remarked that a holistic approach to including stablecoin issuers into the greater banking fold remains vital. The focus seems squarely upon the quality and consistency of their reserves.

In the words of Ms. Liang, stablecoins have the “potential to really fundamentally reform payments.”

The Next Era

Stablecoins are here to stay. Stablecoins are here for tomorrow. 

As a global society, we’re evidently not yet ready for abandoning fiat currency. The term value still implies some relation to either the euro, the swiss franc, the British pound, the US dollar, and so on. We’re not at a point of saying eight terras or three bitcoins. 

However, stablecoins bring alongside them far smaller transaction fees as they eliminate the intermediaries known to bog down everyday wire transfers. Traditional banks, and their regulators, will have to adapt. 

Disclaimer: The author of this text, Jean Chalopin, is a global business leader with a background encompassing banking, biotech, and entertainment. Mr. Chalopin is Chairman of Deltec International Group, www.deltecbank.com.

The co-author of this text, Conor Scott, CFA, has been active in the wealth management industry since 2012, continuously researching the latest developments affecting portfolio management and cryptocurrency. Mr. Scott is a Freelance Writer for Deltec International Group, www.deltecbank.com.

The views, thoughts, and opinions expressed in this text are solely the views of the authors, and do not necessarily reflect those of Deltec International Group, its subsidiaries, and/or its employees. This information should not be interpreted as an endorsement of cryptocurrency or any specific provider, service, or offering. It is not a recommendation to trade.