March 24, 2023

key takeaways

  • U.S. lawmakers are reportedly drafting a bill that would impose a two-year ban on certain stablecoins.
  • The House Stablecoin Bill would target “endogenously collateralized stablecoins.”
  • The new bill could affect decentralized stablecoins like FRAX, depending on the wording used in the final draft.

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The legislation was in response to the debacle of the algorithmically backed TerraUSD stablecoin in May.

US proposes stablecoin regulation

House lawmakers are taking a step toward regulating stablecoins.

A new bill is seeking a two-year ban on “endogenous collateralized stablecoins,” according to a draft by getting Bloomberg Tuesday night.

The House Stablecoin Bill would ban the issuance or creation of new stablecoins that mimic the functions and features of TerraUSD — an algorithmically-backed stablecoin that infamously lost its peg to the U.S. dollar in May, erasing it when it irretrievably fell to zero went to billions of dollars in value. More specifically, the bill would prohibit any stablecoin that can be converted, redeemed, or repurchased for a fixed amount of monetary value, and any other stablecoin that relies solely on the same creator The value of digital assets to maintain the behavior of stablecoins. Fixed price.

In addition to the moratorium on algorithm-backed stablecoins, the draft bill would require the Treasury Department to conduct research on Terra-like tokens 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 limiting the entry of “unsecured” stablecoins into circulation to protect consumers, it also contains guidance on how to regulate fiat-pegged assets more broadly. The bill would allow banks and non-banks to issue stablecoins. However, bank issuers need approval from federal regulators such as the OCC. As for non-bank issuers, the legislation directs the Fed to establish a process for making application decisions.

The House Stablecoin Act is the first legislation aimed at regulating the emerging stablecoin market.according to Data from CoinGecko, The total market capitalization of stablecoins exceeds $153 billion. As the broader crypto ecosystem has grown over the past two years, the market size has increased by around 600%.

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

Which stablecoins will be affected?

While the wording of the draft bill is still subject to change, the current version offers some clues about the direction the regulator intends to take. The term “endogenously pledged stablecoin” is broad and can refer to any token that is backed or partially backed by other tokens of the same issuer.

TerraUSD is fully backed by Terra’s native token, LUNA, and if it were still operating today, it would almost certainly face a two-year ban. 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, previously failed stablecoin projects such as Iron Finance do not necessarily meet the definition of being collateralized only by endogenous tokens. The protocol uses an initial ratio of 75% USDC and 25% TITAN tokens to mint its IRON stablecoin. However, history has proven that when IRON falls to zero in June 2021, this method of staking still poses a huge risk to investors.

To date, other protocols such as Frax Finance have successfully used the hybrid collateral approach. Frax, short for Fractional Algorithm, uses a variable ratio of USDC and its free-floating Frax Shares tokens to mint and stake its USD-pegged FRAX. This staking method appears to be more resilient than previous projects such as TerraUSD or Iron Finance. However, it remains to be seen whether the new stablecoin bill will acknowledge this difference.

Another concern about the new bill is how it might affect MakerDAO’s DAI stablecoin. Unlike IRON and FRAX, DAI is fully collateralized by exogenous assets, Mainly USDC and ETH. Therefore, the prohibition of the Act should not involve DAI.However, like all other non-bank stablecoin issuers, if the new bill is passed into law, the Maker Protocol may need to register with U.S. regulators to continue serving U.S. users

As the U.S. government’s first foray into stablecoin legislation, the draft bill appears quite conservative. Based on previous comments by Treasury Secretary Janet Yellen, regulators are seeking stablecoin issuers that are more in line with traditional finance. For most stablecoin issuers, this shouldn’t be a problem. However, as always, the devil is in the details, so the final version of the bill needs to be released before its potential impact becomes clear.

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

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