Yes, Stablecoins Can Still Bring Stability

By Kaaran Kalantari, Spokesperson for WingRiders

One of money’s key functions is working as a unit of account, which takes at least relative stability vis-a-vis the products and services being traded in a given economy. This is why the most successful early currencies were asset backed, for example the British Pound and the Roman denarius. When a currency’s value is stable, it means people have faith in it and can rely on it to consistently purchase the supplies they depend on.

Stablecoins are the logical next step in this progression from shells to gold coins to gold backed paper currency. With that said, stablecoins are a cryptocurrency designed to serve as a unit of account and a medium of exchange that has a stable exchange rate against a fiat currency, another cryptocurrency, or commodity. Whether collateralized or algorithmic, stablecoins play a crucial role in the crypto ecosystem.

Or, at least they did prior to Terra stablecoin’s (UST) collapse last month. As holders of UST and LUNA lost around $42 billion in total, crypto enthusiasts and outsiders alike are wondering what, and how much, regulatory action will follow. 

Finding a balance

While crypto regulation is far from a new topic of debate, prior to the UST crash, a few top U.S. lawmakers introduced bills to establish regulatory controls for stablecoins. One of the proposed bills seeks to create a three-pronged regulatory framework for stablecoin issuers in the U.S., while the other aims at making them provide extra transparency information about the reserves backing their circulating tokens. Both measures are certainly understandable considering where the conversation surrounding stablecoins is now.

In the U.K., the government has put forward plans to amend the current rules regarding how to manage the failure of stablecoin firms because of the “systemic” risk they potentially pose to the wider financial system. Both the American and British proposals are targeting the right areas, but their initiatives lack the input from leading voices within the industry.

Long before UST’s dramatic depegging, many inside the crypto industry argued that regulatory measures go against crypto’s decentralized principles, and that any government regulation or oversight will stifle innovation and drive down the market. However, there are also experts who believe regulation can strike a healthy balance.

Finding that middle ground means lawmakers and government technocrats, whether in the U.S., EU, UK, or elsewhere, need to listen to and consider recommendations from the crypto community, including retail investors, who have already lost so much.

Preserving Stability

Since stablecoins serve as a stable unit of account or medium of exchange, their main use cases in the crypto space are to provide liquidity, serve as a hedge against market slumps, and facilitate higher trading volumes on exchange platforms. Preserving these functions is a necessity for the entire industry, and regulations must take this into account in addition to creating safeguards for investors.

U.S. Senator Pat Toomey of Pennsylvania, who drafted the bill seeking to create a three-pronged regulatory framework, said last month that stablecoins may be “inherently unstable” without specifying any difference between algorithmic and collateralized stablecoins. He did, however, refer to a “certain mechanism designed for maintaining the value.”

Certainly, the future of algorithmic stablecoins, like UST, deserves to be discussed and scrutinized. However, collateralized stablecoins have remained stable, continuing to carry out their important role in the industry, despite all the turmoil.

Collateralized stablecoins are, indeed, inherently stable because they are backed by real off-chain assets, typically dollars or cash equivalents. In fact, Circle’s USDC stablecoin undergoes monthly attestations and annual audits to provide extra assurance and transparency regarding its reserves. USDC is far from the only stablecoin that provides proof-of-reserves, but Tether, one of the largest stablecoins, has lied about its tokens being backed one-to-one by dollars safeguarded in a bank. It turned out that Tether’s reserves featured a wide range of assets including commercial paper—unsecured debt issued by companies—revealing a flaw in the stablecoin’s system.

To prevent another Terra situation, which could disrupt the crypto industry and wider financial markets even more, stablecoin regulations should center around guaranteeing periodic audits and attestations of collateralized-stablecoin reserves.

Regarding algorithmic stablecoins, figuring out the right reforms to prevent a repeat of what we saw with Terra are a little less clear-cut. Therefore the best route regulators should take is to conduct extensive research into the algorithms’ construction and use of mathematical formulas, taking into account extreme conditions that the market may undergo. This will help expose fraudulent or faulty algorithms in the future, and bypass the domino effect that Terra triggered a couple of months ago.

Stablecoins have been around since Tether’s launch in 2014, and as more entered the crypto space, their value as a safe-haven asset during volatile market periods cemented their unique role. As the market matured and the amount of money locked in decentralized finance (DeFi) exploded, the need for regulation can no longer be ignored.

With the right balance of regulations, stablecoins can maintain their irreplaceable status within crypto and blockchain ecosystems, and help the industry grind through the current challenges of the bear market while preparing for the next bull cycle. Stablecoins are still stable, and through the right regulatory actions, their future stability can be cemented. 

About the author

Kaaran Kalantari is an ex-crypto hedge fund manager with a strong understanding and knowledge of the crypto market and trading experience. Kalantari was an early investor in Web3.0 protocols, with nine years of knowledge and experience in the space. He has active experience in major sectors of the industry and is currently immersed in Metaverse, GameFi, NFTs, and DeFi 1.0 and 2.0. Additionally, he brings decades of experience in marketing, and more specifically, digital marketing to helping brands develop and meet their goals.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.