October 6, 2022


Key Takeaways

  • US lawmakers are reportedly drafting legislation that would impose a two-year ban on certain stablecoins.
  • The Home Stable Money Act would target “endogenous collateralized stablecoins”.
  • The new law could affect decentralized stablecoins like FRAX, depending on the wording used in the final draft.

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The law comes in response to the May collapse of the algorithmic-backed stablecoin TerraUSD.

US proposes regulation of stablecoins

House of Representatives lawmakers are taking a step toward regulating stablecoins.

The new bill seeks to impose a two-year ban on “endogenously collateralized stablecoins,” the draft states obtained by Bloomberg late on Tuesday.

The House Stablecoin Act would make it illegal to issue or create new stablecoins that mimic the functionality and features of TerraUSD – the algorithm-backed stablecoin that infamously lost its dollar in May, wiping out billions of dollars in value as it irretrievably dropped to zero . More specifically, the law would ban any stablecoin that is sold as capable of being converted, redeemed or redeemed for a fixed amount of monetary value, as well as any that rely solely on the value of another digital asset of the same creator to maintain a fixed price.

In addition to the moratorium on algorithm-backed stablecoins, the bill also mandates a study of Terra-like tokens by 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 primarily focuses on restricting the entry into circulation of “unbacked” stablecoins to protect consumers, it also contains guidance on how fiat-related assets should be regulated more generally. The draft would allow both banks and non-banks to issue stablecoins. However, bank issuers would need approval from federal regulators such as the OCC. With respect to nonbank issuers, the law directs the Federal Reserve to establish a process for making claims decisions.

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

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

Which Stablecoins might be affected?

Although the wording of the draft law is still subject to change, the current version gives some indication of the direction regulators intend to take. The term “endogenously collateralized stablecoins” is broad and can refer to any token backed or partially backed by other tokens of the same issuer.

TerraUSD, which is solely backed by Terra’s native token LUNA, would almost certainly face a two-year ban if it were still functioning today. However, for protocols that create dollar-pegged assets using a mix of tokens that are both endogenous (created by the same issuer) and exogenous (issued by other parties), the calculus is less clear.

On the one hand, previous failed stablecoin projects, such as Iron Finance, do not necessarily fit the definition of being exclusively collateralized by endogenous tokens. The protocol used an initial ratio of 75% USDC and 25% TITAN tokens to mint its IRON stablecoin. However, as history has shown, when IRON fell to zero in June 2021, this type of collateralization still represents a significant risk for investors.

Other protocols such as Frax Finance have successfully used a mixed method of collateralization so far. Frax, short for “fractional-algorithmic,” uses a variable ratio of USDC and its free-floating Frax Shares token to build and secure its dollar-pegged FRAX. This method of collateralization seems much more resilient than previous projects like TerraUSD or Iron Finance. However, it remains to be seen whether the new stablecoin account will recognize this difference.

Another concern about the new account is how it might affect MakerDAO’s DAI stablecoin. Unlike IRON and FRAX, DAI is fully collateralized by exogenous assets, primarily USDC and ETH. Therefore, the law’s prohibition should not imply DAI. However, like all other non-bank stablecoin issuers, if the new law is passed, Maker Protocol will likely need to register with US regulators in order to continue serving US users

As the US government’s first foray into stable currency legislation, the bill appears quite conservative. In line with Treasury Secretary Janet Yellen’s previous comments, regulators are looking for stablecoin issuers to be more in line with traditional finance. 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 published before its potential impact becomes clear.

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

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