Loyola University Chicago School of Law, JD 2024
* Please be advised, this article briefly discusses suicide.
On June 22nd, ten-year-old Yuna was reported missing by her teachers. Just one week later, the police discovered a sedan in the southernmost coast of South Korea, two hours away from Yuna’s home. The three bodies recovered belonged to Yuna and her parents, both in their thirties. The police suspected suicide. Among the parent’s last online searches included “LUNA,” “sleeping pills,” and “how to commit suicide.” Evidence further suggested that Yuna’s parents were unemployed, invested their lives savings into the cryptocurrency market, and struggled from financial debt of $100,000.
Yuna’s family is one of many victims in the cryptocurrency crash. The recent downfall demonstrates the need for change in the widely unregulated market. The lack of regulation may continue to expose consumers to the very volatility and risk they are supposed to avoid.
In theory, but not in practice
LUNA, the term that appeared in the search history, is the base currency, a staking or protocol token, to Terra, a “stablecoin” that crashed in May, 2022. The value of Terra was theoretically pegged to the US dollar, meaning 1 Terra equaled 1 USD. Other stablecoins usually maintain their values pegged to a stable form of hard asset, such as USD, gold, or oil. However, Terra bases its value on its native coin, LUNA, in a non-collateral two-token algorithm. In other words, Terra is not backed by a hard asset, but rather to a theoretical currency through an algorithm. Despite this non-traditional model, the mechanism appeared to work. When Terra went above a dollar, the algorithm burned the equivalent value of LUNA, which minted more Terra, making Terra less valuable. Likewise, when Terra dropped below a dollar, it would swap with LUNA, which in turn increased Terra’s value.
Terra attracted investors as it continued to maintain its value at a dollar even during the crypto market’s fall. Furthermore, a lending platform, Anchor protocol, had promised an insanely high APY of 20 percent to whoever bought Terra and lent it to platform. Terra was the fourth largest stablecoin and 10th-largest cryptocurrency by market value before its stumble.
The “unstable” stablecoin
However, Terra took a freefall in May of 2022, wiping out $400 billion in value in just a span of days. Investors panicked, and large withdrawals knocked the system and its algorithm out of balance. The “death spiral” caused the value of Terra to fall to just twenty cents, and LUNA followed suit by crashing to less than ten cents. Once backed by many crypto enthusiasts as the “biggest hype” in the market, Terra and LUNA, which peaked at $116 in April, are now worth less than a penny.
After Terra’s crash, authorities are calling for an even quicker adaptation of regulations and supervision, monitoring and assessing risks from stablecoins, and addressing risks to the economy, financial systems, and consumers like Yuna’s parents.
So, what’s next for stablecoin regulations?
Regulatory supervision over stablecoins is the foremost priority in cryptocurrency regulation as stablecoins may influence the entire greenback ecosystem because of their intimate nature (pegging) to the US dollar. Moreover, stablecoins account for 80 percent of cryptocurrency transactions today. Treasury Secretary Janet Yellen gave the US government’s most forceful response asserting that the Terra meltdown demonstrated the dangers of cryptocurrencies pegged to the USD with risks known for centuries in connection with bank runs.
However, crypto lobbying only continues to grow. The industry more than quadrupled in expenses in recent years. In 2021, 157 crypto-lobbyists spent $9 million, whereas just three years ago, 47 crypto-lobbyists spent 2.2 million.
Such efforts are reflected in that both parties are leaning towards a cryptocurrency-friendly direction. In April, Senator Pat Toomey (R-PA) released a draft of the Stablecoin TRUST Act, which allows more flexibility for institutions authorized to issue stablecoins. The TRUST Act reflects Senator Toomey’s intent to champion “an interoperable financial ecosystem and the US tradition of fostering technological innovation – not stifling it.” In June, Senator Cynthia Lummis (R-WY) and Senator Gillibrand (D-NY) announced a bipartisan Responsible Financial Innovation Act (RFI). The bipartisan package aims to encourage innovation in the financial sector, as well as flexibility, transparency, and robust consumer protections while incorporating digital assets into existing laws.
Regulators must juggle the positives – financial efficiency, inclusion, US leadership in global finance – with the negatives – illicit financing, regulatory arbitrage, and consumer and business abuse. President Biden’s Executive Order in March of 2022 seeks to strike a balance in “protecting consumers, businesses, and investors as well as supporting technological advances that promote responsible development of digital assets.”
Crypto must wait for its turn
Crypto experts expect the November midterm elections will interfere with further legislation. Politicians will likely tailor their campaigns to address other social and economic issues, such as abortion, gun laws, post-pandemic inflation and the economy. The Blockchain Association anticipates that if Congress acts, the earliest legislation will come in 2023.
A framework in the meantime
In the meantime, economists recommend a federal design within the existing regulatory framework. This well-designed regulatory platform could protect consumers from risks of illiquidity and losses in the event of a stablecoin issuer’s default.
Do Kwon, the inventor behind LUNA and Terra, is under investigation by the SEC for his role in the LUNA-Terra fiasco. It was revealed that, in 2020, he had anonymously launched and failed a stablecoin project called Basis Cash (BAC). However, despite the LUNA-Terra failure and the ongoing investigation, Kwon has newly announced his third coin, Terra 2.0, within just weeks after the May collapse.
To prevent another LUNA-Terra tragedy that took away Yuna’s life, a crypto agenda that places consumer protection and coin-issuer accountability at its core seems inevitable.