Treasury’s Yellen Highlights Terra Collapse in Call for Stablecoin Legislation

Treasury Secretary Janet Yellen today said that stablecoins need to be regulated by this year. In a hearing Tuesday, Secretary Yellen said that although digital assets may “promote innovation,” they could also “present risks to the financial system.”

The Treasury Secretary used the example of Terra, a blockchain which has a native stablecoin, UST. Yesterday, the stablecoin slipped below its dollar peg to $ 0.65.

For those who do not know, stablecoins are cryptocurrencies that are supposed to be, well, stable. They are often pegged to assets such as fiat currencies like the US dollar or euro, or even gold, and are extremely important in the crypto ecosystem. They are what crypto traders use to enter and exit positions in other tokens on exchanges, especially decentralized exchanges such as Uniswap or Curve.

Terra’s troubles happened because, unlike other big stablecoins (such as Tether and USDC, which are ahead of UST in terms of market cap), UST is not backed by a fiat currency in a bank or some equivalent.

Rather, UST is an “algorithmic” stablecoin, meaning code keeps it pegged to the dollar: when traders want to mint more UST, they have to burn Terra’s other native token, LUNA, meaning that some LUNA tokens are removed from circulation to create new UST. This has, in the past, worked to keep the price of UST stable to the dollar.

But this went pear-shaped at the weekend when the system could not keep up with the desires of traders. UST’s troubles persisted through Monday when the price of the algorithmic stablecoin fell to an all-time low as traders hastily sold off their tokens. The run, along with other macroeconomic factors, may also have contributed to the larger crash in the crypto market, as the price of Bitcoin and Ethereum fell by 11% and 10%respectively.

Secretary Yellen today said: “A stablecoin known as TerraUSD experienced a run and declined in value. I think that this simply illustrates that this is a rapidly growing product and there are rapidly growing risks. ”

“New products and technology may present opportunities to promote innovation and increase efficiencies,” she said. “However, digital assets may present risks to the financial system and increased and coordinated regulatory attention is necessary.”

Secretary Yellen added that “it is important, even urgent” that Congress pass stablecoin legislation by the end of this year.

The US government has had its eye on stablecoins for some time, and the Biden administration has been working to bring stablecoin issuers under the same regulatory regime as banks. In March, President Biden issued an executive order calling for the US federal government to coordinate its efforts in regulating crypto.

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