Powers On… When will we learn from recent history to protect our crypto and ourselves? – Cointelegraph Magazine
Bitcoin is here to stay. The decentralized nature of the token makes it vulnerable and thus, susceptible to hacks and scams. Governments have been using this opportunity as a chance to take advantage of these vulnerabilities by taxing cryptocurrency transactions with new taxes or banning them altogether.
Register now on Binance, add 50$ and get 100$ bonus voucher!
The “is cryptocurrency legal” is a question that many people have been asking. The Cointelegraph Magazine has an article on the legality of cryptocurrencies.
Stablecoins provide the illusion of security. They offer the uninformed and/or indifferent the notion that a certain currency is tied to the United States dollar, or an equivalent in terms of value and stability, and that converting your stablecoin to dollars is simple and rapid. However, as seen by the recent collapse of Terra and its TerraUSD stablecoin and LUNA token, as well as the collapse of the Reserve Primary Fund money market fund in September 2008 amid 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.”
So, to state the obvious, if you own or invest in cryptocurrencies, you must be aware of the absence of protection and take steps to preserve the percentage of your money held in digital assets. You may keep these assets safe by storing them in cold digital wallets, on exchanges registered with the US Securities and Exchange Commission, or with another SEC, CFTC, or Treasury-regulated firm. Even BitLicensed organizations and exchanges, such as Coinbase and Gemini, may not offer enough safety.
UST is now trading at about As I write this column, UST has a value of about $0.07. One month ago, it was one of the top 10 cryptocurrencies by market cap and maintained a steady value of $1. It was perceived as a reliable, “safe” cryptocurrency for trading activities, where transaction risks were eliminated and liquidity was provided to the trading parties, both for trading occurring on centralized exchanges and decentralized platforms. Not anymore..07 as I write this piece. It was one among the top ten cryptocurrencies by market cap a month ago, and its price remained stable at $1. It was seen as a trustworthy, “secure” cryptocurrency for trading operations, with transaction risks reduced and liquidity guaranteed to trade partners, both on controlled exchanges and on decentralized platforms. Not any longer.
Register now on Binance, add 50$ and get 100$ bonus voucher!
Cryptocurrencies are speculative in both value and usefulness, despite what some may believe. Their prices are volatile, and they’re best understood as a fledgling alternative economic, capital markets, and financial system underpinned by cutting-edge technology that’s currently being created and tested in a variety of ways. Criminals test crypto to see if it can be used to hack weak blockchains for unlawful gain, governments study it to see if it can be regulated or banned, and developers work on it constantly to enhance the open-source code. As a result, it belongs to the category of “alternative assets.”
Those involved with investment management and analysis have been led to believe that stablecoins are a viable solution to avoiding the risks associated with cryptocurrencies — no differently than the SEC-registered Reserve Primary Fund touted its money market fund, with over $60 billion in assets at its peak, as a safe haven to park money and earn interest. In the early 2000s, the Reserve Primary Fund, like most other money market funds, marketed itself as a superior option to putting cash in bank deposit accounts and a method to earn higher interest rates than banks were offering. Because it was reportedly backed one-to-one in U.S. bonds, which are guaranteed by the full confidence and credit of the United States Treasury, its share price was intended to always retain a $1 net asset value (the metric by which mutual funds are publicly traded). Despite the global crisis, the Reserve Primary Fund “broke the buck” on Sept. 16, 2008, the day after the legendary investment company Lehman Brothers declared for bankruptcy. From a high of $1, its NAV has dropped to as low as Those involved with investment management and analysis have been led to believe that stablecoins are a viable solution to avoiding the risks associated with cryptocurrencies — no differently than the SEC-registered Reserve Primary Fund touted its money market fund, with over $60 billion in assets at its peak, as a safe haven to park money and earn interest. The Reserve Primary Fund, and most of the other money market funds in the early 2000s, promoted themselves as an alternative to keeping cash in bank deposit accounts and a way to earn better interest rates than banks were providing. Its share price was supposed to always maintain a $1 net asset value (the measure by which mutual funds are publicly traded) because it was supposedly backed one-to-one in U.S. bonds, which are guaranteed by the full faith and credit of the U.S. Treasury. Yet amid the financial crisis, on Sept. 16, 2008 — the day after the venerable investment firm Lehman Brothers filed for bankruptcy — the Reserve Primary Fund “broke the buck.” Its NAV fell to as low as $0.97 from its $1 peg..97.
Why? Well, for similar reasons as the UST’s demise. As it turns out, a part of the Reserve Primary Fund was invested in commercial paper issued by companies rather than the government, rather than US-backed bonds and treasuries. This was done to increase the money market’s return — to provide investors who wanted to store their money in the fund rather than a regular bank a better competitive interest rate. However, as Reserve Primary Fund investors would discover, this strategy had two major flaws. Money market funds were neither guaranteed and protected by the Federal Deposit Insurance Corporation, as were bank accounts, nor were they covered for losses by the Securities Investor Protection Corporation, as were equities kept in brokerage accounts, at the time.
Second, as previously stated, commercial paper accounted for more than half of the fund’s holdings, rather than US-backed assets. Investors were apprehensive when Lehman Brothers filed for bankruptcy because money market mutual funds owned Lehman Brothers’ commercial paper. As a result, a run on those money occurred the following day. The Reserve Primary Fund’s NAV plummeted below $1, despite the fact that it apparently owned less than 1.5 percent of its assets in Lehman Brothers paper. The fund was eventually terminated and liquidated, but not before the US government intervened with the Temporary Liquidity Guarantee Program and the Debt Guarantee Program. Both used mutual funds to secure investor money and guaranteed short-term debt issued by member banks. (These initiatives and safeguards came to an end in 2012.)
TerraUSD is an algorithmic stablecoin, meaning it is not backed by assets like cash or U.S. government bonds, but instead relies on trade and treasury management to keep its value constant at $1. This allegedly involves part-collateralizing UST with Bitcoin. The real assets supporting UST, on the other hand, seemed to be many times smaller than its market capitalisation. As a result, when there was a run on UST, everything came crashing down.
Other stablecoin issuers, such as Circle’s USD Coin and Tether’s USDT, will now claim that this will never happen to their currencies. The issue was that UST was an undercapitalized, algorithmic stablecoin, while USD and US government assets are backed one-to-one. But this isn’t totally accurate. The New York State Attorney General’s examination into Tether discovered that a significant portion of the collateral was in the form of loans or commercial paper rather than money.
This is the same kind of collateral that caused the Reserve Primary Fund to go bankrupt in a run in 2008. It’s also true that neither Circle’s nor Tether’s stablecoins are insured by a government-backed organization like SIPC or the FDIC against investment losses.
So, what can we learn from the “break the buck” price drop of UST/LUNA?
What occurred to UST/LUNA is not a novel or unusual occurrence. It occurred in dramatic manner with the Reserve Primary Fund in 2008, and there was considerable hand-wringing at the time. Investors in the Terraform Labs stablecoin product were not guaranteed by the government, and the Reserve Primary Fund’s money market was no different.
There will very certainly be multiple US government probes and/or hearings regarding the latest fiasco. Those who oppose cryptocurrency are likely to urge for the whole young blockchain business to be regulated in order to safeguard investment. It’s crucial to note, however, that the Reserve Primary Fund was a mutual fund regulated by the Securities and Exchange Commission. The fund’s run was unaffected by this fact. Overregulation as a result of a knee-jerk reaction is not a solution.
Yes, stablecoins and their issuers should be regulated and regulated by someone – if not the SEC or the CFTC, then maybe the Treasury. In the crypto ecosystem, these currencies now play a huge and vital role in capital markets and financial activities. When investors utilize a stablecoin, they should feel confident that it is properly and completely collateralized, and that they have clear, unambiguous redemption rights to the collateral if needed.
The UST/LUNA collapse will result in criminal and civil investigations and actions for Terraform Labs and its creator, Do Kwon. Kwon will very certainly face criminal charges in both South Korea and the United States, where he now resides. It is likely that class actions will be brought. It won’t be nice, and the lawsuits will take years to resolve. The SEC started looking into another Terraform Labs product, Mirror Protocol, last October. Terraform Labs and Kwon were ordered to cooperate with the SEC’s investigation subpoenas in that issue by a court in the Southern District of New York in February 2022. With UST/LUNA, things are about to become a lot worse for both of them.
Coinbase included a risk disclaimer to its files a few days after the UST/LUNA run, according to reports. In the case of the centralized exchange’s insolvency, its clients might be called “unsecured creditors.” This brings to the fore what I wrote about last year: Coinbase and Gemini are not SEC-registered exchanges; instead, they are regulated under New York’s BitLicense system. The implications are many. Most crucially, it implies that up to $500,000 in cash and securities is not covered by SIPC, and neither exchange is subject to the SEC’s segregation standards for client assets and money.
All of this implies that you, and only you, are in charge of safeguarding your crypto assets and fortune. So, be cautious and analytical about where you keep your digital assets and if it’s a good idea to store large value in stablecoins.
Marc Powers is currently an adjunct professor at Florida International University College of Law, where he is teaching “Blockchain & the Law” and “Fintech Law.” He recently retired from practicing at an Am Law 100 law firm, where he built both its national securities litigation and regulatory enforcement practice team and its hedge fund industry practice. Marc started his legal career in the SEC’s Enforcement Division. During his 40 years in law, he was involved in representations including the Bernie Madoff Ponzi scheme, a recent presidential pardon and the Martha Stewart insider trading trial.
The author’s views are his or her own and do not necessarily represent those of Cointelegraph, Florida International University College of Law, or any of its affiliates. This post is meant to provide basic information only and should not be construed as legal or financial advice.