Yesterday billionaire Mark Cuban called for stablecoin regulation after algorithmic stablecoin IRON dramatically lost its peg falling to 66 cents on the dollar. The value of the associated crypto-asset TITAN went from $64 to close to zero in a matter of hours.
This isn’t an analysis of algorithmic stablecoins but a look at the challenges of stablecoin regulation and an area that regulators might have missed so far.
Cuban lost money, but those who experiment in DeFi acknowledge the risks. “The thing about defi plays like this is that it’s all about revenue and math and I was too lazy to do the math to determine what the key metrics were,” he told Bloomberg.
Some have misconstrued his comments about regulation as a demand for DeFi regulation in general. But that’s an inaccurate portrayal of his statements.
The issue is stablecoins are designed to be used for everyday payments. So unlike your average DeFi participants, a mainstream consumer using a ‘stablecoin’ might take that term at face value and have no clue about potential risks.
“There should be regulation to define what a stable coin is and what collateralization is acceptable. Should we require $1 in us currency for every dollar or define acceptable collateralization options, like us treasuries or ?, ” wrote Cuban. He went on to ask what should be allowed to be called a stablecoin.
Some regulators have started to explore the stablecoin area, particularly the EU and the UK. Hence we took a look at how this sort of risk has been covered.
EU, UK stablecoin regulation plans
The regulator’s focus is on both consumer protection and financial stability. But the consumer protection side emphasizes the stablecoin’s asset backing. However, when it comes to stablecoins, there’s a marketing or terminology issue.
Notably, the UK’s discussion of stablecoins only considers fully collateralized digital currencies which are redeemable.
The EU’s approach is far more nuanced and acknowledges three types of stablecoins. In the EU’s draft regulations for Markets in Crypto-Assets (MiCA), we didn’t find a restriction on what something could be called in marketing material, but rather different classifications for regulatory purposes. But Cuban is correct. It’s the name in the marketing material that matters. And expecting a consumer to read the details is unrealistic.
EU’s three stablecoin types
MiCA’s three types of stablecoins include e-money tokens which are tied to a single currency and fully backed and redeemable. Additionally, there are ‘asset-referenced’ stablecoins that are linked to multiple currencies, commodities or other crypto-assets. This might include the original Libra concept and the DAI stablecoin. And finally, there are algorithmic stablecoins which “should not be considered as asset-referenced tokens, provided that they do not aim at stabilising their value by referencing one or several other assets.”
Even though IRON is algorithmic, for MiCA purposes, it would be considered as asset-referenced because 75% of its asset backing was another stablecoin USDC. In fact, some believe that the IRON peg was deliberately broken in order to force IRON’s value below 75 cents and create an arbitrage opportunity to acquire USDC at a discount. Despite dropping to 66 cents, the price of IRON is now hovering around the 75 cent mark.
Meanwhile, the MiCA rules state e-money tokens issuers have to be regulated, tokens have to be compliant and have the sort of backing Cuban was calling for. In other words, bank balances and government treasuries. But other low-risk investments are also allowed.
The challenge with MiCA is non-crypto savvy consumers will have no clue about the difference between the three types of tokens if they’re all allowed to call themselves stablecoins. If only e-money tokens are permitted to use the stablecoin term, it may impact innovation. But in this case, perhaps consumer protection should win.
IRON highlights another stablecoin risk
Terminology is not the only issue highlighted by the RISK implosion. The question is whether the rapid decline in the price of the IRON stablecoin could be repeated on a mainstream stablecoin.
IRON lost its peg at 10 am but quickly recovered. Perhaps a trial run. According to a blog post from the Iron.finance team, “Later, at around 3pm UTC, a few big holders started selling again. This time, after they started, a lot of users panicked and started to redeem IRON and sell their TITAN.”
If the big sellers were also the ones benefiting from the sub-75 cent prices, then that would appear to be market manipulation.
But a more serious issue is panic. If someone starts a rumor about a fully backed e-money stablecoin or a group of whales coordinates redemptions, it could cause a run, triggering mass redemptions. And this is what really concerns the regulators. Rapid liquidation of money market funds or short term securities to meet redemptions could cause market dislocation. If recent stablecoin growth continues, we can expect stablecoins in the not-too-distant future to have market capitalizations substantially higher than today, increasing the risk.
The current largest stablecoins have market capitalizations of $63 billion (Tether) and $24 billion (USDC). A year ago, USDC’s market cap was less than a billion to give a sense of the growth rate.
While that growth may have been significantly driven by DeFi, stablecoins offer potential advantages for mainstream users by reducing frictions and enabling stable payments for blockchain applications.
However, there’s no shying away from the significant risks, and regulators have their work cut out.
