This crypto looking to solve the SEC crackdown is up 6,000% in 2021

The U.S. Securities and Exchange Commission (SEC) signaled a big change in policing cryptocurrencies last week, as one of the largest crypto exchanges in the world revealed it was blocked from launching a new crypto lending product.

As Coinbase CEO Brian Armstrong explained, the SEC took issue with the company’s plans to pay interest to customers so they could earn up to 4% on their crypto assets. The particular crypto asset Coinbase was preparing to offer 4% on was the least volatile asset it offers, a stablecoin called USDC, which attempts to stay pegged in value to $1.

As Armstrong also bemoaned on Twitter, other crypto companies have been lending and offering interest on crypto holdings, like bitcoin, ether, and USDC for years. BlockFi, for example, currently offers 8% interest on the stablecoin issued by the famed Winklevoss twins. But as anyone watching the crypto space would know, regulators have increasingly been talking about a need to crack down on exactly that practice. Officials at the Federal Reserve, for example, have even called out USDC’s competitor, Tether, for potentially posing a risk to the traditional financial system if investors ever rushed to redeem their tether tokens for $1.

The reason being, as Boston Fed President Eric Rosengren laid out back in June, is that neither Tether nor USDC were fully backed by an equivalent amount of dollars in a bank. While Coinbase and Tether’s issuer each marketed that both coins were backed 1-for-1 by dollars in the bank, in reality they both held a mix of cash and assets that included bonds and corporate debt that could decline in value. Theoretically, if those other assets were to rapidly drop in value, investors might rush to redeem tokens for dollars sparking the crypto equivalent of a bank run, Rosengren said.

Circle, the company behind USDC, recently announced it would be shifting to only holding cash and short-term Treasuries to back its stablecoin. That same day, Coinbase apologized for marketing that USDC was safely backed by dollars in the bank even though it wasn’t. Tether still holds riskier assets as collateral though it has published more information on what it holds to back its stablecoins as part of a settlement with the New York district attorney’s office.

And frankly, it’s all a problem for crypto.

Not just the fact that an industry that’s so proud of breaking away from the chains of the traditional financial system is still so dependent on it — but also the fact that regulators could have an easy way of blocking the stablecoin on-ramp that has fueled the flow of cash into crypto. In total, the market cap of stablecoins has swelled from about $20 billion at the start of the year to $120 billion now. Most of that has been driven by Tether and USDC, growing their market caps this year by 221% and 538%, respectively. While they remain the two largest stablecoins at about $66 billion and $26 billion, respectively, there is a newcomer that’s growing quicker than both of them.

Top stablecoins Tether and USDC have seen their market caps swell so far in 2021. Investors often shift to holding stablecoins during times of volatility instead of cashing out into physical dollars.

Top stablecoins Tether and USDC have seen their market caps swell so far in 2021. Investors often shift to holding stablecoins during times of volatility instead of cashing out into physical dollars.

As its founder Do Kwon told Yahoo Finance this week, it’s not backed by cash. It’s not backed by bonds. It’s not backed by anything that would touch the traditional banking system. Instead, Terra Labs’ UST stablecoin is backed by another paired cryptocurrency which gets burned or converted to maintain the same $1 peg.

“The reason why this is valuable, is there’s a lot of regulatory movements coming from jurisdictions all across the world to sensor the underlying bank accounts under stablecoins,” he said. “The reason why the decentralized currencies like Terra are important and gaining lots of attention is because it’s free from those things in the sense that because there’s no underlying censorable deposit, the logic that’s governing the monetary policy of these stablecoins are entirely free from censorship.”

Terra’s UST has seen its market cap swell from $181 million at the start of the year to $2.5 billion as of September, a growth rate of more than 1,200%. It’s now the world’s fifth largest stablecoin and is making inroads at becoming more frequently used in decentralized finance, or DeFi, applications that enable investors to earn interest on their crypto holdings, similar to what Coinbase was setting out to do before being blocked by the SEC. As Kwon notes, while some decentralized applications might not be able to get shut down by regulators like Coinbase, they could still be censored if the stablecoins they use on their platforms are attached to the banking system.

“Even if the sort of the logic for these DeFi applications are decentralized, if the underlying money can be censored, then it kind of defeats the purpose entirely,” he said.

Terra's UST stablecoin has seen its market cap grow much faster than the rate posted by the two largest stablecoins this year.

Terra’s UST stablecoin has seen its market cap grow much faster than the rate posted by the two largest stablecoins this year.

Of course, it’s worth noting that stablecoins like UST that aren’t backed by real assets (dubbed algorithmic stablecoins) are inherently risky. Earlier this year, one such project, IronFinance, saw the cryptocurrency backing it crash from $60 to $0. It even ensnared the likes of Shark Tank’s Mark Cuban, who lost money in the project and later called on regulators to do more to protect investors. For a number of reasons though, including a $25 million investment from crypto power broker Galaxy Digital and Terra’s robust payment system used by more than 3 million people in South Korea, Kwon says his project is different from others that have failed.

“There are a lot of algorithmic stablecoins out there and to our critics’ credit, most of them have failed,” he said. “The reason for that is in building an algorithmic stablecoin, the main challenge isn’t to design some clever algorithm… but it’s really about building the use cases around the economy.” 

To that end, Terra has built out an ecosystem to leverage its UST stablecoin. It now offers a savings platform that offers 20% interest on its stablecoins called Anchor. It also offers tokens that mimic exposure to U.S. stocks, giving access to investors around the globe that otherwise might not be able to trade in the country. Its payment app through South Korea’s PayPal-like Chai, which launched about two years ago, powers more than $1 billion in payments a year.

“I think these use cases sort of reinforce the stability of the Terra stablecoin and make it more useful as a currency overall,” Kwon said.

As more money has flowed into UST, the cryptocurrency backing it, Luna, has appreciated nearly 6,000% year-to-date. In May, however, when bitcoin’s price collapsed by about 40%, Luna suffered a nearly 80% crash. Investors began to panic as the UST stablecoin deviated from its $1 peg to fall to about 89 cents. For comparison, during the financial crisis in 2008, the U.S. financial system nearly entered meltdown mode when one popular reserve fund “broke the buck” to fall from its $1 net-asset value peg to just 97 cents. The Fed stepped in to save the day, but no such central bank exists for crypto.

During last week’s crypto flash crash, which saw bitcoin briefly collapse more than 10%, Luna dropped about 20%, but UST held steady at $1, prompting a one-word tweet from Terra’s founder.

“Poetry,” he tweeted.

Zack Guzman is an anchor for Yahoo Finance Live as well as a senior writer covering crypto, cannabis, startups, and breaking news at Yahoo Finance. Follow him on Twitter @zGuz.

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