Yellen, Cryptocurrencies, and the Risk of Loss

Individuals should be free to invest as they see fit, rather than the government trying to shield them from loss.

The crypto markets have had a difficult week. The most significant development has been the performance of TerraUSD, which "broke the buck" earlier this week, falling below its $1 price goal, to borrow a word from money market funds. This is a concern for TerraUSD, an algorithmic stablecoin that relies on a complicated programming process linked with another crypto token to balance supply and demand and keep the value of TerraUSD at $1.

Washington, predictably, has taken notice. Treasury Secretary Janet Yellen was asked about the recent significant decrease in the value of cryptocurrencies during yesterday's House Committee on Financial Services meeting on the Financial Stability Oversight Council. "We've got a real life demonstration of the hazards," Yellen added, referring to the TerraUSD crisis. She urged for a "complete structure so that there are no gaps in the regulation" to protect against "the risks." Yellen did concur, though, that the larger financial system is not in immediate danger.

While the media and some authorities appear to conflate the two, it's critical to distinguish between algorithmic and collateralized stablecoins. All stablecoins attempt to link their value to another asset, most commonly a fiat currency. However, algorithmic stablecoins are not collateralized and rely on an algorithm to preserve their value, whereas collateralized stablecoins are supported by a fiat currency reserve (or commodities). These are two completely distinct creatures.

Norbert Michel and I have developed a legal framework to address the unique risk that collateralized stablecoins present: whether the issuing firm has the reserves it claims to have. Several sensible pieces of legislation have been introduced in Congress to address similar issues with collateralized stablecoins.

However, algorithmic stablecoins, which operate without reserves, do not have this risk. The hazards that algorithmic stablecoins may pose are more in line with other digital assets, which are assessed based on their code strength, among other things.

Yellen, on the other hand, did not appear to be referring to any more complex dangers than the most obvious: the risk that some people will lose money by investing in cryptocurrency. The government, on the other hand, should not aim to protect people from loss. Individuals should be able to invest their money however they see fit. Furthermore, risk is an inherent feature of markets, and failure is frequently required for growth. "Failure should be an option," declared Senator Patrick Toomey (R-PA) earlier this week. In order for the market to figure out what works in this field, there will almost certainly be some failures." Americans should be able to take part in that process, for better or worse, without the government intervening to protect them.

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** Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of USA GAG nor its advertisers. The author will not be held responsible for information that is found at the end of links posted on this page.

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