I’m not a LUNA holder, but the past week of Terra madness has been gut-wrenching. As someone who will be in this space for the long term, it’s more than just what happened. It’s about what will happen moving forward. Terra’s fall from grace has dealt a major setback for the adoption of stablecoins - and more specifically, algorithmic stablecoins. It’s got governments and central banks around the world talking more about regulating these assets.

• TerraUSD (UST) lost its peg to the US dollar when it was never supposed to deviate from that value.

• That marked a huge collapse of its sister token LUNA to a $0 value. (Note that at one point LUNA was worth more than $100.)

• More than $200 billion of wealth was wiped out in a single day.

The crash sent ripple effects throughout the crypto market, dragging down Bitcoin and others. It then escalated into a series of posts and threads on social media with many investors threatening suicides (some went through with it). It’s not unbelievable that the already questionable mechanics of UST would face such visceral reactions. Even Terra founder Do Kwon’s hard fork proposal was met with some push backs from the community.

While UST was struggling to retain its peg, US Treasury Secretary Janet Yellen renewed calls for a “consistent federal framework” on regulating stablecoins. Britain announced plans to legalize the asset as a form of payment. South Korea also hopped on the bandwagon, reportedly accelerating emergency talks to implement the so-called “Digital Asset Basic Act”. Meantime, some guidelines have already been published by a range of regulatory bodies from the Financial Action Task Force to the Bank for International Settlements. Conspiracy theories about concerted attacks aside - it’s only a matter of time before official measures are introduced.

While I’m all for libertarianism, there’s no denying that regulation is inevitable. The question is no longer about whether there should be rules in place. It’s now a question of how those rules should look like. There’ve been several ideas out there floating online, like regulating stablecoins as securities. It remains uncertain whether such a system that makes stablecoins operate more like banks is possible (or even welcomed). As a starting point, however, it is important to have some guiding principles on how we can navigate this unchartered area:

1/ Regulators must understand the effects that stablecoins have on the financial system before setting the rules.

Extremely broad terms like “stablecoins” can be misleading. A 1:1 fiat-backed coin and an algo stablecoin, for instance, are two hugely different assets. The latter is fundamentally different from its collateralized counterpart mainly because it doesn’t have a strong link to the traditional finance sector. As such, any regulation must focus on the technicalities of each asset. The EU has proposed a good approach. It’s charting out specific requirements for different instruments, dividing stablecoins into e-money tokens and asset-backed ones among others. Different mechanics mean different risks, which call for different policy approaches. Rules for Tether may not necessarily be the same as those for MakerDAO’s DAI. The fine points matter.

2/ There should be an appropriate body that focuses on monitoring and gathering crucial information on stablecoins.

Without tracking data, potential risks may grow insidiously without warning. Plus, due to the intrinsic cross-border element of investing, there should be formal agreements made to share information between researchers. The US could be on the right track. Under Joe Biden’s Executive Order, a set of reports on the future of money infrastructure will be made through the collaboration of different agencies and stakeholders. Washington’s next move will most likely depend on the data provided in those documents.

3/ More informal means of participation should be implemented.

There needs to be channels for alternative voices, including the stablecoin community, developers, and blockchain evangelists. If their perspectives are involved in the process, overregulation could be reined in. We may be able to achieve the sweet spot of high innovation with minimal risks. Though, the challenge remains how to bridge these informal community forums with the more formal regulatory domain.

When it’s all said and done, we can’t deny that external factors also play a prominent role in how regulations will turn out. Different political and regulatory regimes will determine the kinds of policies set out.

China and the EU will likely retain some level of control over stablecoins through central banks. Beijing, for one, is prioritizing the launch of its CBDC (e-CNY) over releasing any private stablecoins on public blockchains. On the other hand, the US and Britain may take a more liberal approach. Washington’s EO has outlined several principles for digital assets, such as democratic values, entrepreneurialism, competition, and interoperability. Since the US dollar is practically the currency of the world, Washington will probably move to ensure that it remains at the forefront of digital innovation.

It will be crucial for regulators to take note of how these differences will likely impact the market. There could be increased risks of regulatory arbitrage and market fragmentation. Standard-setting bodies should consider areas where international cooperation could be useful.

Those who are adamant against regulation should recognize that DeFi isn’t truly decentralized, at least for now. In many cases, there exists some level of centralized governance, which is a natural point of entry for public policy. Current blockchain consensus mechanisms can also easily concentrate power into the hands of some fixed participants. Perhaps I’ll save this debate for another post.

The desire for stability should be acknowledged, especially in the current market wrought with FUD. If on-chain mechanisms are not able to sustain their own price controls, then an outside actor will no doubt swoop in to establish standards. As Terra’s fallout has shown, there should be regular checks on reserves and actions taken to ensure unaccountable projects don’t cost people their life savings.

I’m not a LUNA holder, but the past week of Terra madness has been gut-wrenching. As someone who will be in this space for the long term, it’s more than just what happened. It’s about what will happen moving forward. Terra’s fall from grace has dealt a major setback for the adoption of stablecoins - and more specifically, algorithmic stablecoins. It’s got governments and central banks around the world talking more about regulating these assets.

• TerraUSD (UST) lost its peg to the US dollar when it was never supposed to deviate from that value.

• That marked a huge collapse of its sister token LUNA to a $0 value. (Note that at one point LUNA was worth more than $100.)

• More than $200 billion of wealth was wiped out in a single day.

The crash sent ripple effects throughout the crypto market, dragging down Bitcoin and others. It then escalated into a series of posts and threads on social media with many investors threatening suicides (some went through with it). It’s not unbelievable that the already questionable mechanics of UST would face such visceral reactions. Even Terra founder Do Kwon’s hard fork proposal was met with some push backs from the community.

While UST was struggling to retain its peg, US Treasury Secretary Janet Yellen renewed calls for a “consistent federal framework” on regulating stablecoins. Britain announced plans to legalize the asset as a form of payment. South Korea also hopped on the bandwagon, reportedly accelerating emergency talks to implement the so-called “Digital Asset Basic Act”. Meantime, some guidelines have already been published by a range of regulatory bodies from the Financial Action Task Force to the Bank for International Settlements. Conspiracy theories about concerted attacks aside - it’s only a matter of time before official measures are introduced.

While I’m all for libertarianism, there’s no denying that regulation is inevitable. The question is no longer about whether there should be rules in place. It’s now a question of how those rules should look like. There’ve been several ideas out there floating online, like regulating stablecoins as securities. It remains uncertain whether such a system that makes stablecoins operate more like banks is possible (or even welcomed). As a starting point, however, it is important to have some guiding principles on how we can navigate this unchartered area:

1/ Regulators must understand the effects that stablecoins have on the financial system before setting the rules.

Extremely broad terms like “stablecoins” can be misleading. A 1:1 fiat-backed coin and an algo stablecoin, for instance, are two hugely different assets. The latter is fundamentally different from its collateralized counterpart mainly because it doesn’t have a strong link to the traditional finance sector. As such, any regulation must focus on the technicalities of each asset. The EU has proposed a good approach. It’s charting out specific requirements for different instruments, dividing stablecoins into e-money tokens and asset-backed ones among others. Different mechanics mean different risks, which call for different policy approaches. Rules for Tether may not necessarily be the same as those for MakerDAO’s DAI. The fine points matter.

2/ There should be an appropriate body that focuses on monitoring and gathering crucial information on stablecoins.

Without tracking data, potential risks may grow insidiously without warning. Plus, due to the intrinsic cross-border element of investing, there should be formal agreements made to share information between researchers. The US could be on the right track. Under Joe Biden’s Executive Order, a set of reports on the future of money infrastructure will be made through the collaboration of different agencies and stakeholders. Washington’s next move will most likely depend on the data provided in those documents.

3/ More informal means of participation should be implemented.

There needs to be channels for alternative voices, including the stablecoin community, developers, and blockchain evangelists. If their perspectives are involved in the process, overregulation could be reined in. We may be able to achieve the sweet spot of high innovation with minimal risks. Though, the challenge remains how to bridge these informal community forums with the more formal regulatory domain.

When it’s all said and done, we can’t deny that external factors also play a prominent role in how regulations will turn out. Different political and regulatory regimes will determine the kinds of policies set out.

China and the EU will likely retain some level of control over stablecoins through central banks. Beijing, for one, is prioritizing the launch of its CBDC (e-CNY) over releasing any private stablecoins on public blockchains. On the other hand, the US and Britain may take a more liberal approach. Washington’s EO has outlined several principles for digital assets, such as democratic values, entrepreneurialism, competition, and interoperability. Since the US dollar is practically the currency of the world, Washington will probably move to ensure that it remains at the forefront of digital innovation.

It will be crucial for regulators to take note of how these differences will likely impact the market. There could be increased risks of regulatory arbitrage and market fragmentation. Standard-setting bodies should consider areas where international cooperation could be useful.

Those who are adamant against regulation should recognize that DeFi isn’t truly decentralized, at least for now. In many cases, there exists some level of centralized governance, which is a natural point of entry for public policy. Current blockchain consensus mechanisms can also easily concentrate power into the hands of some fixed participants. Perhaps I’ll save this debate for another post.

The desire for stability should be acknowledged, especially in the current market wrought with FUD. If on-chain mechanisms are not able to sustain their own price controls, then an outside actor will no doubt swoop in to establish standards. As Terra’s fallout has shown, there should be regular checks on reserves and actions taken to ensure unaccountable projects don’t cost people their life savings.