Could the New House Stablecoin Bill Kill FRAX and DAI?

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Key points to remember

  • US lawmakers are reportedly drafting a bill to ban certain stablecoins for two years.
  • The House Stablecoin Bill would target “endogenously backed stablecoins”.
  • The new bill could impact decentralized stablecoins like FRAX, depending on the wording used in the final draft.

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The legislation comes in response to the May collapse of the algorithm-backed stablecoin TerraUSD.

US Proposes Stablecoin Regulations

House lawmakers take a step toward regulating stablecoins.

New bill seeks to ban ‘endogenously backed stablecoins’ for two years, draft says obtained by Bloomberg late Tuesday.

The House Stablecoin Bill would make it illegal to issue or create new stablecoins that mimic the functionality and characteristics of TerraUSD, an algorithm-based stablecoin that infamously lost its dollar peg in May, wiping out billions of dollars in value as it irretrievably collapsed to zero. Specifically, the bill would ban any stablecoin marketed as being convertible, redeemable, or redeemable for a fixed amount of monetary value, as well as any that rely solely on the value of another digital asset from the same creator to maintain a fixed price. .

In addition to the moratorium on algorithm-backed stablecoins, the bill also mandates a study of Treasury Terra-like tokens in consultation with the Federal Reserve, Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corp. ., and the Securities and Exchange Commission.

While the bill primarily focuses on restricting the entry into circulation of “unsecured” stablecoins to protect consumers, it also contains guidance on how fiat-related assets should be regulated more generally. . The bill would allow banks and non-banks to issue stablecoins. However, bank issuers would need approval from federal regulators such as the OCC. With respect to non-bank issuers, the legislation directs the Federal Reserve to establish an enforcement decision-making process.

The House Stablecoin Bill is the first piece of legislation to regulate the booming stablecoin market. According data from CoinGecko, the total stablecoin market cap is over $153 billion. The market size has grown by around 600% as the broader crypto ecosystem has grown over the past couple of years.

While the bulk of stablecoins in circulation are backed by dollars or dollar equivalents, many dollar-pegged tokens use new methods to maintain their value. Although the bill is still being drafted, many crypto users are concerned that its wording could implicate several legitimate stablecoin projects in its two-year ban.

Which stablecoins could be affected?

Although the wording of the bill is still subject to change, the current version gives some clues about the direction regulators intend to take. The term “endogenously backed stablecoins” is broad and can refer to any token that is backed or partially backed by other tokens from the same issuer.

TerraUSD, which was only backed by Terra’s native LUNA token, would almost certainly face a two-year ban if it were still operating today. However, for protocols creating dollar-pegged assets using a mix of both endogenous (created by the same issuer) and exogenous (issued by other parties) tokens, the bill is less clear.

On the one hand, previous failed stablecoin projects such as iron finance do not necessarily fit the definition of being solely backed by endogenous tokens. The protocol used an initial ratio of 75% USDC and 25% TITAN tokens to mint its IRON stablecoin. However, as history has proven, when IRON fell to zero in June 2021, this type of collateral method still poses substantial risk for investors.

Other protocols such as Frax Finance have so far successfully used a mixed collateralisation method. Frax, short for “fractional-algorithmic,” uses a variable ratio of USDC and its floating Frax stock token to mint and collateralize its dollar-pegged FRAX. This method of collateralization appears much more resilient than previous projects such as TerraUSD or Iron Finance. However, it remains to be seen whether the new stablecoin bill will recognize this difference.

Another concern with the new bill is how it might affect MakerDAO’s DAI stablecoin. Unlike IRON and FRAX, DAI is fully backed by exogenous assets, mainly USDC and ETH. For this reason, the bill’s prohibition should not involve DAI. However, like all other non-bank stablecoin issuers, if the new bill passes, Maker Protocol will likely need to register with US regulators to continue serving users in the US.

As the US government’s first foray into stablecoin legislation, the bill seems quite conservative. As stated by Treasury Secretary Janet Yellen previous comments, regulators are looking for stablecoin issuers more in tune with traditional finance. For most stablecoin issuers, this shouldn’t be a problem. However, as always, the devil is in the details, so the final version of the bill will need to be released before its potential impact becomes clear.

Disclosure: At the time of writing this article, the author owned ETH and several other cryptocurrencies.

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