TerraUSD: regulatory and compliance implications

Last week saw the collapse of TerraUSD (UST), an algorithmic “stable money” created by Terraform Labs. Intended to maintain its peg to the US dollar, the value of 1 UST fell from $1 to a low of just 9 cents – leading to billions of dollars in losses for UST holders.

But what are the regulatory and compliance implications of this story?

• The Terra case will ignite a major fire in the already intense regulatory debate about it consumer protection, market behavior and financial stability risks crypto.
• Elliptic’s analysis shows that investors may have lost as much as $42 billion due to the decline in the value of UST and LUNA – the original assets of the Terra ecosystem. While Terra poses no systemic risks to the wider financial sector, regulators will see the scale of these losses as a major warning sign of possible future worst-case scenarios they will be desperate to avoid. Treasury Secretary Janet Yellen and many other policymakers who were close to the global financial crisis think so crypto regulation cannot wait until the problems become systemic. This case will only reinforce that mindset.
• This is a case where investors would be better served by a clear and well-defined regulatory framework that held innovators accountable. It also shows that in some cases regulation is not keeping pace with the speed of innovation in the space. The crypto industry was quick to make light of the Terra episode, and many in the industry seem to recognize this as an opportunity to expel irresponsible actors and encourage greater responsibility.
• We can expect this to lead policymakers and legislators in the US, EU and elsewhere to accelerate efforts already underway to introduce greater oversight of the use of these types of products – including improved standards of governance, disclosure and record-keeping. Certain jurisdictions, such as the EU and Dubai, have considered banning the trading of algorithmic stablecoins on exchange platforms, and this episode is likely to only reinforce that stance.
• While concerns about risk are real, the answer is not to regulate new innovations that don’t exist. Instead, regulators can promote responsible innovation and encourage the maturation of these types of products by providing clear rules and guardrails.
• It is also important that regulators do not confuse algorithmic stablecoins with reputable asset-backed ones stablecoins such as USDC and Gemini Dollars (GUSD), which are issued by regulated entities that already comply with a significant number of regulatory requirements.
• Stablecoin issuers can take steps to ensure that their tokens comply with new regulatory compliance expectations. For example, they can ensure that their coins are covered blockchain analytics capabilities which enable compliance with against money laundering, against the financing of terrorism and sanctions requriements. Cryptoasset exchanges that list stablecoins for trading may also use leverage blockchain analytics to identify fraud and other illegal activities while demonstrating compliance with their regulators.

Many commentators will argue that they have seen problems around algorithmic stablecoins and therefore the likelihood of systemic risk is low. However, compliance and risk teams are reminded of the importance of keeping up with rapid regulatory developments.