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It’s old news by now that UST lost its dollar peg and the algorithmic mechanism printing Luna to support UST’s value resulted in a death spiral. As of June 7, 2022 @7:00 p.m., Coingecko listed LUNA (now Luna Classic (LUNC)) at $0.00006637 and UST (now TerraClassicUSD (USTC)) at $0.0138—we use the time stamp because by the time this blog is read, the value for both likely will be less. To put that in perspective, when the Reserve Primary Fund “broke the buck” in 2008, sending shockwaves through Wall St., its net asset value fell only to 97 cents per share. But the waves of repercussions of the collapse of what was sold as a “stablecoin” (in the case of UST) will continue to be felt, and the perception and reporting of the reasons for the collapse and the damage caused will likely shape the discussion of how stablecoins should be regulated, at least in the United States.

Those examining the ashes of the LUNA/UST disaster concluded it was at minimum the collapse of a flawed system1 and possibly something more sinister (Rune Christensen, creator of MakerDAO and DAI, likened Terra to a Ponzi scheme2). Now there are reports that USDT, also known as tether, the world’s largest stablecoin that briefly slipped from its dollar peg in the wake of the Terra collapse, is seeing record outflows.3 Could it slip off its peg again? Notwithstanding that there have been questions as to the collateral backing tether,4 even assuming that it is 1:1 backed with assets (and ignoring any credit risk associated with the collateral), the nature of the collateral could create issues in the case of a “run on the bank” since crypto trades 24/7 and much of the collateral backing the coin doesn’t.5


1 [https://www.bloomberg.com/news/articles/2022-05-19/luna-terra-collapse-reveal-crypto-price-volatility]

2 [https://www.coindesk.com/layer2/2022/05/20/dai-creator-rune-christensen-on-terras-collapse/?utm_source=Sailthru&utm_medium=email&utm_campaign=NODE%20MAY%20NODE%2020%20NODE%202022&utm_term=The%20Node]

3 [https://www.coindesk.com/markets/2022/06/07/morgan-stanley-sees-crypto-equivalent-of-quantitative-tightening/?utm_source=Sailthru&utm_medium=email&utm_campaign=FIRST%20MOVER%20JUNE%207%202022&utm_term=First%20Mover]

4 Cite to NYAG settlement

5 [https://tether.to/en/transparency/#reports]

6 [https://www.cato.org/cato-journal/spring/summer-2021/ten-stablecoin-predictions-their-monetary-policy-implications#prediction-5]

LEGAL TOKENS

In our mind, this highlights the fundamental question about stablecoins that needs to be resolved: what should back a stablecoin? Algorithmic stablecoins are subject to a potential death spiral á la UST, stablecoins backed by fiat equivalents may not be able to liquidate assets fast enough to meet extreme redemption demands, and stablecoins backed by crypto will hold collateral subject to significant volatility, which will require either significant over-collateralization or again face the possibility that they may have to slide off the peg if the value of the collateral drops significantly and rapidly. Some think that an ideal solution to manage the liquidity risk in stablecoins is nonlending or liquid asset banks that hold all collateral in liquid, risk free assets.6 UST was a hard lesson for many but one that may lead the market to demand more sustainable formulas for the creation and maintenance of stablecoins. Time likely will tell which formulas, if any, will prevail. But odds are that the road to that point will be littered by more stablecoin failures.

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Author's Assets

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Anthony Tu-Sekine | PARTNER

As the head of Seward & Kissel’s Blockchain and Cryptocurrency Group and a frequent commentator on all things crypto, Anthony advises clients on a wide range of evolving topics, including how to structure and issue security and utility tokens, registered and unregistered offerings of security tokenstoken custody, transfer and liquidity issues, non-security opinions, and investments in crypto assets by funds and other investors. A recognized leader on physical precious metals funds, Anthony represented APMEX Inc. and alternative asset manager Sprott Inc. in connection with the launch of OneGold.com, which allows investors to own gold documented on blockchain.

You can work with regulators or you can really try to piss them off… If you really want to do the latter, then you should expect that they will bring every tool they have against you.

Anthony’s thoughts on BitMEX indictment, as published in Law360 article “BitMEX Case Seen as Blessing in Disguise for Crypto Sector”