June 10, 2023

Key Takeaways

  • US lawmakers are reportedly drafting a bill to impose a two-year ban on certain stablecoins.
  • The House stablecoin bill would target “endogenously parallel stablecoins”.
  • Depending on the wording used in the final draft, the new bill could affect decentralized stablecoins like FRAX.

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The legislation comes in response to the May collapse of the algorithmically-backed TerraUSD stablecoin.

US Proposes Stablecoin Regulation

House lawmakers are taking a step toward regulating stablecoins.

A new bill seeks to impose a two-year ban on “inherently parallel stablecoins,” according to a draft. received by Bloomberg Late Tuesday.

The House stablecoin bill would make it illegal to issue or create new stablecoins that mimic the functionality and features of TerraUSD—an algorithmically-backed stablecoin that infamously lost its dollar peg in May, wiping out billions of dollars in value as it irrevocably crashed to zero. More specifically, the bill would ban any stablecoin marketed as capable of being converted, redeemed or repurchased for a certain amount of monetary value, as well as any that rely on the value of another digital asset from the same creator to maintain one. fixed price.

In addition to the moratorium on algorithmically-backed stablecoins, the draft bill mandates a study on tera-type tokens from the Treasury in consultation with the Federal Reserve, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation. ., and the Securities and Exchange Commission.

While the bill focuses primarily on restricting “unbacked” stablecoins from entering circulation to protect consumers, it also includes guidance on how fiat-pegged assets should be regulated more generally. The bill would allow both banks and non-banks to issue stablecoins. However, bank issuers will need approval from federal regulators such as the OCC. For non-bank issuers, the Act directs the Federal Reserve to establish a process for deciding applications.

The House Stablecoin Bill is the first piece of legislation directed at regulating the growing stablecoin market. According to Data from CoinGecko, The total stablecoin market capitalization is over $153 billion. The market size has grown by nearly 600% over the past two years as the broader crypto ecosystem has grown.

While most stablecoins in circulation are backed by dollars or dollar equivalents, many dollar-pegged tokens use novel methods to maintain their value. Although the bill is still being drafted, many crypto users are concerned that its wording could implicate several legitimate stablecoin projects within its two-year ban.

Which stablecoins might be affected?

While the wording of the draft bill is still subject to change, the current version gives some clues as to the direction regulators want to take. The phrase “internally parallel stablecoin” is broad and can refer to any token backed or partially backed by other tokens of the same issuer.

TerraUSD, which was only collateralized by Terra’s native token LUNA, will almost certainly face a two-year ban if it still operates. However, the bill is less clear on protocols for creating dollar-pegged assets using a mix of endogenous (created by the same issuer) and exogenous (issued by other parties) tokens.

On the one hand, previous failed stablecoin projects like Iron Finance do not fit the definition of being fully collateralized by endogenous tokens. The protocol uses an initial ratio of 75% USDC and 25% TITAN tokens to create its IRON stablecoin. However, as history has shown, when IRON crashes to zero in June 2021, such a collateralization approach still poses considerable risk to investors.

Other protocols such as Frax Finance have so far successfully used a mixed parallelization approach. FRAX, an acronym for “fractional-algorithmic”, uses a variable ratio of USDC and its free-floating FRAX share tokens and parallels its dollar-pegged FRAX. This method of parallelization appears to be much more resilient than previous projects such as TerraUSD or Iron Finance. However, it remains to be seen whether the new stablecoin bill will recognize this distinction.

Another concern regarding the new bill is how it might affect MakerDAO’s DAI stablecoin. Unlike IRON and FRAX, DAI is fully collateralized by external assets, Primarily USDC and ETH. For this reason, the bill’s ban should not implicate DAI. However, like all other non-bank stablecoin issuers, if the new bill passes into law, Maker Protocol will likely need to register with US regulators to continue serving users in the US.

The draft bill appears to be fairly conservative as the US government’s first step into stablecoin legislation. In line with Treasury Secretary Janet Yellen’s previous comments, regulators are looking for more stable coin issuers in line with traditional money. For most stablecoin issuers, this should not be a problem. However, as always, the devil is in the details, so the final version of the bill will have to be released before its potential impact becomes clear.

Disclosure: At the time of writing this piece, the author owned ETH and several other cryptocurrencies.

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