The United States will introduce a stablecoin bill. Which stablecoins are at risk?

The U.S. House of Representatives has proposed a draft stablecoin bill, arguing that the issuance and creation of new "endogenously collateralized stablecoins" is illegal.

After the collapse of the Terra/UST algorithmic stablecoin system, the United States has intensified its attention on stablecoins. On September 21, the media reported the content of the stablecoin bill proposed by the U.S. House of Representatives, which imposed a ban on algorithmic stablecoins similar to TerraUSD (UST).

The draft bill would make it illegal to issue or create new “endogenously collateralized stablecoins.” The definition also applies to the sale of stablecoins that can be converted, redeemed, or repurchased for a fixed amount of monetary value and rely on the value of another digital asset from the same creator to maintain its fixed price.

How to understand "endogenously collateralized stablecoins"? In addition to algorithmic stablecoins with the same mechanism as Terra/UST, what other stablecoins are facing regulation? PANews attempts to make the following interpretation.

Endogenous Collateral

a16z once mentioned "endogenously collateralized stablecoins" in an article on stablecoins. It refers to using collateral created by the issuer, such as governance tokens, as collateral for issuing stablecoins.

In a bull market, this mechanism will cause the collateral price and the number of stablecoins issued to spiral upward. Governance tokens appreciate, users can mint more stablecoins, data increases lead to governance token appreciation, and stablecoins can also be used to further purchase governance tokens.

Similarly, a death spiral may also be triggered by liquidation in a bear market. A typical example is Terra/UST, which failed in a death spiral. For legislators, such a mechanism is risky.

The following will discuss in a classified manner whether various types of stablecoins meet the description of the ban.

Overcollateralized: sUSD, aUSD

Some projects use their own governance tokens as collateral and over-collateralize to mint stablecoins. Although the projects have their own risk control mechanisms, they meet the description of “endogenously collateralized stablecoins.”

For example, in Synthetix, the governance token SNX is used as collateral to mint the stablecoin sUSD at a collateral ratio of 400%. If SNX appreciates, the collateral can mint more sUSD. If SNX depreciates, sUSD is likely to remain safe due to the higher collateral ratio.

However, according to the description of the US Stablecoin Act, stablecoins such as sUSD are likely to face regulation.

Similar mechanism to Terra: USDN

The mechanism of Neutrino Protocol is similar to Terra. It is built on the Waves blockchain and its price has been slightly below $1 for a long time, making it more likely to face regulation.

Users can lock 1 USD of WAVES tokens in a smart contract to mint 1 USDN, and can also redeem 1 USDN for 1 USD of WAVES. Over time, the value of the WAVES locked in the smart contract may no longer be equal to the issued USDN. At this time, it is necessary to adjust the value of the reserve through an auction, and the native token NSBT may be issued.

Although Neutrino, which issues USDN, and Waves, which issues collateral, do not appear to be the "same creator", given that the main function of WAVES is to serve as collateral in Neutrino, even without considering this, the value of USDN needs to be maintained by NSBT issued by Neutrino. Therefore, Neutrino's information is more consistent with the judgment of the ban.

The USDD, which is similar to USDD, avoids this problem because of the abundance and diversity of collateral. According to the official website of TRON DAO RESERVE, the issuer of USDD, the current issuance of USDD is 725 million, and the total value of collateral is about 2.2 billion US dollars, including 990 million USDC. The official website has also opened the PSM function, which can be used to exchange USDD with other centralized stablecoins.

Some algorithmic stablecoins: Frax

Although Frax’s current collateralization ratio is as high as 92.5% and there is a large amount of liquidity on Curve, the possibility of a death spiral is low, but Frax may also meet the definition of the bill’s ban.

Frax is a partially algorithmic stablecoin. It takes a total of $1 USDC and FXS to mint 1 FRAX, with USDC as collateral and FXS representing the algorithmic part. If the demand for FRAX is high, the weight of the algorithmic part will increase and the weight of USDC will decrease; otherwise, the weight of the algorithmic part will decrease and the weight of USDC will increase.

There are two extreme cases. When the collateral ratio is 100%, Frax is the same as MakerDAO's PSM, directly using 1 USDC to mint 1 FRAX. When the collateral ratio drops to 0, Frax uses the same mechanism as Terra, minting 1 FRAX with 1 USD of FXS, and 1 FRAX can also be redeemed for 1 USD of FXS. In the latter case, Frax is undoubtedly prohibited by the bill.

If understood literally, since Frax contains USDC collateral, it strictly does not meet the ban’s description of “relying solely on another digital asset of the creator to maintain a fixed price.”

However, excluding the USDC mortgage part, the value of the algorithmic part does rely on the governance token FXS, so we believe that Frax may also be targeted by the US Stablecoin Act.

other

Fiat-collateralized

The draft bill also provides a legal channel for issuing stablecoins backed by fiat currencies. Banks or credit unions can issue their own stablecoins, which will be supervised by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation, both of which are federal bank supervisors in the United States. The bill also directs the Federal Reserve to establish a process to make decisions on applications from non-bank issuers. Issuing stablecoins without regulatory approval may be punished by up to five years in prison and $1 million.

Other decentralized stablecoins

From the information we have accessed so far, stablecoins such as DAI issued by MakerDAO and LUSD issued by Liquity mainly use decentralized assets such as ETH as collateral and do not fall into the category of endogenous collateral stablecoins. However, no description of this type of stablecoin has been seen so far, and it is unclear whether they are legal in the determination of the U.S. House of Representatives.

summary

For decentralized stablecoins, issuing new endogenous collateral stablecoins is considered illegal, which may include a large number of relatively safe stablecoins, such as Frax, sUSD, etc. For centralized stablecoins, the bill clarifies the regulatory agency, and it may be more common for banks to issue their own stablecoins.

The bill is still in draft form and may be discussed as early as next week. It may still change during this period, and it will take time for it to actually take effect.