Can regulators prevent another US$45 billion crypto stablecoin meltdown?

Terra’s LUNA token, meant to help its UST token remain pegged to the US dollar, has lost 99.99% of its value.

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Key points

  • Regulators are discussing how to prevent the next stablecoin meltdown
  • The total crypto market lost some US$270 billion in last week's selloff
  • Most digital assets are created outside of traditional banks

Last week’s US$45 billion stablecoin meltdown rippled across almost every crypto asset.

The biggest hits came for investors in TerraUSD (CRYPTO: UST), backed by digital token Terra (CRYPTO: LUNA).

You can find the details of last Wednesday’s crypto meltdown here.

But in a nutshell, UST is an algorithmic stablecoin that’s intended to be pegged to the US dollar. Part of the mechanism intended to keep it trading in line with US$1 was a system that enabled anyone holding UST to swap it out for US$1 worth of LUNA at any stage.

However, when investors lost confidence in the peg, the token entered a rapid spiral, tumbling to 30 US cents as LUNA fell far more.

The ripple effects of the selloff hit the rest of the market, seeing even the biggest tokens like Bitcoin (CRYPTO: BTC) and Ethereum (CRYPTO: ETH) sell off sharply. By the time the smoke cleared, the combined crypto sector had shed some US$270 billion.

What’s happening now?

Despite financing efforts by Terra to regain the dollar peg, the token is currently trading for a lowly 17.7 US cents.

As for LUNA? It’s down 99.99% since this time last week, worth 0.02594 US cents.

Commenting on the carnage, founding partner of Castle Island Ventures Matt Walsh said (as quoted by Bloomberg), “It’s something the scale of which crypto has really never seen in terms of a top-five project just absolutely imploding.”

In a caution to newbie crypto investors, managing partner at Multicoin Capital Kyle Samani added, “The biggest losers from all of this will be retail [investors] that didn’t understand the risks they were taking.”

Can regulators prevent another crypto stablecoin meltdown?

When that much money gets wiped off the boards in a matter of hours, you can bet it draws the attention of corporate regulators.

Speaking at the Financial Services Institute of Australasia event in Sydney on Friday, Reserve Bank of Australia deputy governor Michele Bullock warned of increasing risks to broader financial markets as the market valuations of stablecoin and other cryptos grow.

As the Australian Financial Review reports, Bullock noted that “stablecoins are not so stable any more”, adding that “the crypto world is causing problems for everyone at the moment… Everyone is nervous about the implications, particularly for consumers.”

Bullock said stablecoins “are not big enough at the moment to cause [a] financial stability issue”. However, she warned, “Their links to the financial system are increasing, so there is potential there for risks to rise, and rise quite quickly.”

Australian Prudential Regulation Authority chairman Wayne Byres agreed that stablecoins needed stronger regulation. But with most cryptos created outside of the traditional banking industry, Byres questioned whether agencies like APRA were suited for that role.

According to Byres (quoted by the AFR):

It is not obvious to me that the role that might be needed when it comes to stablecoins is necessarily one for the prudential regulator as such. But I think it is clear – and is certainly absolutely worthy of consideration – that as these sorts of digital currencies move more into the mainstream, that there is going to be some form of regulatory requirements.

Some will be protective and some will be helpful to facilitate an orderly market developing.

While crypto investors can almost certainly expect more regulations in the stablecoin segment, those could be some time coming.

In the meantime, be aware that just because a token is pegged to a certain fiat currency or asset, it’s no guarantee it will trade for that value.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Bitcoin and Ethereum. The Motley Fool Australia has recommended Bitcoin and Ethereum. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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