As Terraform Labs and community members scramble to rescue stablecoin TerraUSD, regulatory experts say the collapse might be the end of algorithmic stablecoins as we know it. 

“It is a sad ending to this innovative algorithmic stablecoin experiment,” Adil Abdulali, head of portfolio management at Securitize, said. “Algorithmic incentives for stablecoin pegs remain an unsolved problem.” 

UST collapsed dramatically this week, de-pegging its goal base-price of $1 and reaching a low of $0.298 earlier today, according to CoinGecko. The token’s adjacent cryptocurrency, LUNA, plummeted from $86 last week to around $1.27 at time of publication.

The situation is real-time proof that lawmakers’ concerns about the stablecoin industry are justified, according to US Treasury Secretary Janet Yellen.

“It’s quite common that we wake up to regulation only when we have a crisis,” said Jonathan Dharmapalan, CEO of eCurrency, which provides technology for central banks to issue and distribute central bank digital currencies, or CBDCs. “A ‘call to action’ is probably what I would call this situation.” 

For months, regulators have promised that rules to protect investors are coming, but lawmakers across government agencies cannot seem to agree on a path forward. 

“Stablecoins are a form of private money,” Dharmapalan said. “The trouble with that is that stablecoin issuers make up their own rules, and nobody knows whether the rules are appropriate.” 

Other stablecoin issuers should expect greater regulatory scrutiny, Abdulali agreed, but it is also important to consider the type of stablecoin. Reserve-backed tokens such as Circle and Tether have, at least according to the teams behind the coins, robust reserves of safe-haven assets, such as cash and cash equivalents. Algorithmic tokens, such as UST, rely on smart contacts that put incentives in place to maintain the price. 

“Algorithmic stablecoins still need work,” Abdulali said. “None have worked.” 

A recent research report from Wake Forest Law Review went further, claiming algorithmic stablecoins are inherently designed to fail. These tokens require a support level of demand for operational stability and rely on independent actors with market incentives to perform price-stabilizing arbitrage, the report said.

“None of these factors are certain, and all of them have proven to be historically tenuous in the context of financial crises or periods of extreme volatility,” the report noted. 

Other issuers should consider UST’s collapse as a warning, Dharmapalan said. 

“One would assume, in good faith, that all stablecoin issuers have actually thought through what the risks are, and that managing those risks is an active part of what they are doing every day,” Dharmapalan said. “However, I’m going to guess that that is not really the case.”

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