Following the collapse of Terra stablecoin UST, the UK government released a consultation paper proposing safeguards to prevent stablecoin failure risks. Stakeholders have until August 2nd to share their feedback on the matter.
What is a stablecoin?
A stablecoin is a specific type of crypto asset that is pegged to a collateral asset. It can be fiat, commodities, or other crypto-assets for instance. Since stablecoins are pegged to a collateral asset, their price will fluctuate according to the price fluctuations of the collateral asset.
Today, the four biggest stablecoins by market capitalization are Tether (USDT), USD Coin (USDC), Binance USD (BUSD), and DAI.
There is a specific type of stablecoin called an algorithmic stablecoin. An algorithmic stablecoin relies on an algorithm to keep its price stable. The algorithm will manage the supply of tokens in circulation to ensure the peg. For instance,
The collapse of Terra’s stablecoin
Recently, the collapse of Terra’s stablecoin, Terra UST, made a lot of noise in the crypto industry. UST is an algorithmic stablecoin pegged to the US dollar. LUNA is the native token of the Terra blockchain that ensures the peg of UST through community arbitrage. Before UST collapse, it was the 3rd stablecoin by market capitalization. And, Terra was the 2nd biggest DeFi blockchain just behind Ethereum.
On May 9, the peg of UST began to decrease and slipped to $0.94 - $0.93. This led users to create and sell a lot of LUNA tokens trying to restore UST's original peg of $1. As a result, this in turn triggered a decrease in the price of LUNA.
However, the peg of UST couldn't be restored. From May 9 to May 13, the UST price plummeted from $0.9996 to $0.14. This collapse in the price of the stablecoin affected the entire crypto market including Bitcoin and Ethereum prices for example.
UK Treasury proposing safeguards against stablecoin failure risks
In the UK, the government is consulting stakeholders regarding safeguards against stablecoin failure. A document released by the HM Treasury on May 31, proposes several approaches for “Managing the failure of systemic digital settlement asset (including stablecoin) firms”. This document follows a consultation on stablecoin regulation carried out in January, and its response that was published in April.
The document states that recent events in crypto markets have reinforced the need for appropriate regulation of certain types of stablecoins to mitigate consumer, market integrity, and financial stability risks.
It proposes to include the “arrangements that facilitate or control the transfer of digital settlement assets” in the definition of payment systems in an effort to mitigate risks related to the failure of a systemic stablecoin firm. This means that the Bank of England would be granted regulatory powers on systemically important payment systems and service providers as designated under Part 5 of the Banking Act 2009.
In the document, the government estimates that the Financial Market Infrastructure Special Administration Regime (FMI SAR) would be the most appropriate regime for systemic digital asset settlement (DSA) firms, here referring to stablecoin firms. However, the government also states that as it is, the FMI SAR cannot address ”all of the financial stability risks associated with a systemic DSA firm’s failure”.
The public can share their feedback on this document’s proposals until August 2nd.
Adopting a risk-based approach to stablecoins transaction monitoring
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The suite provides compliance teams with tools to perform holistic risk assessment analyses on stablecoins. Scorechain Analytics includes for example risk indicators and risk scoring for the origin and destination of funds.
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About Scorechain
Scorechain is a Risk-AML software provider for cryptocurrencies and digital assets. As a leader in crypto compliance, the Luxembourgish company has helped more than 200 customers in 45 countries since 2015, ranging from cryptocurrency businesses to financial institutions with crypto trading, custody branch, digital assets, customers onboarding, audit and law firms, and some LEAs.
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