Stablecoins provide a false sense of security. They give the impression to the uninitiated and/or uncaring that a particular coin is pegged to the U.S. dollar, or an equivalent of the dollar in terms of value and stability, and that if you want to convert your stablecoin to dollars, you can do so easily and instantaneously. Yet, they do no such thing, as demonstrated by the recent collapse of Terra and its TerraUSD stablecoin and LUNA token and also made clear in September 2008 by the collapse of the Reserve Primary Fund money market fund during the height of the global financial crisis.
Powers On… is a monthly opinion column from Marc Powers, who spent much of his 40-year legal career working with complex securities-related cases in the United States after a stint with the SEC. He is now an adjunct professor at Florida International University College of Law, where he teaches a course on Blockchain & the Law.
Investments with full faith?
So, what are some takeaways from the UST/LUNA break the buck price collapse?
- What happened to UST/LUNA is neither new nor unique. It happened before with the Reserve Primary Fund in 2008 in spectacular fashion and with much hand-wringing at the time. And just as investors in the Terraform Labs stablecoin product were not insured by any government assistance, the same was true for the Reserve Primary Funds money market.
- There will likely be several U.S. government investigations into and/or hearings around this recent debacle. For those opposing crypto, there will likely be calls to regulate the entire nascent blockchain industry to protect investors. Yet it is important to remember that the Reserve Primary Fund was regulated by the SEC as a mutual fund. That fact did not prevent the run on the fund. So, knee-jerk over-regulation is not a panacea.
- Yes, there should be some regulation of and a regulator for stablecoins and their issuers if not the SEC or CFTC, then perhaps the Treasury. The role these coins currently play for capital markets and financial transactions in the crypto ecosystem is enormous and important. Investors should feel that when they use a stablecoin, it is properly and fully collateralized and that they have clear, unequivocal redemption rights to the collateral if requested.
- Terraform Labs and its founder, Do Kwon, will face both criminal and civil investigations and proceedings stemming from the UST/LUNA collapse. Kwon will likely end up before criminal prosecutors both in South Korea, where he is located, and in the United States. There will be class actions filed. It will not be pretty, and the cases will drag on for years. Last fall, the SEC began investigations into another Terraform Labs project, Mirror Protocol. In February 2022, a judge in the Southern District of New York held that Terraform Labs and Kwon had to comply with the SECs investigative subpoenas in that matter. Now, with UST/LUNA, things will get much, much worse for both.
- It was reported a few days after the UST/LUNA run that Coinbase (NASDAQ:COIN) added a risk disclosure in its filings. The centralized exchange noted that its customers could be considered unsecured creditors in the event of its bankruptcy. This puts front and center what I wrote about last year: Coinbase and Gemini are not registered with the SEC as an exchange they are only licensed under New York states BitLicense regime. The significance is manifold. Most importantly, it means that customer accounts are not protected by SIPC for up to $500,000 in cash and securities and that neither exchange is subject to the SECs segregation rules for customer assets and funds.
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