Terra Collapse Could Spell End for Algorithmic Stablecoins

The UST situation is real-time proof that lawmakers’ concerns about stablecoins are not unfounded


Source: Shutterstock


key takeaways

  • Algorithmic incentives for stablecoin pegs remain an unsolved problem, head of portfolio management at Securitize said
  • Regulators have promised rules to protect investors, but lawmakers haven’t yet found a path forward

As Terraform Labs and community members scramble to rescue stablecoin TerraUSD, regulatory experts say the collapse might be the end of algorithmic stablecoins as we know it. 

“It is a sad ending to this innovative algorithmic stablecoin experiment,” Adil Abdulali, head of portfolio management at Securitize, said. “Algorithmic incentives for stablecoin pegs remain an unsolved problem.” 

UST collapsed dramatically this week, de-pegging its goal base-price of $1 and reaching a low of $0.298 earlier today, according to CoinGecko. The token’s adjacent cryptocurrency, LUNA, plummeted from $86 last week to around $1.27 at time of publication.

The situation is real-time proof that lawmakers’ concerns about the stablecoin industry are justified, according to US Treasury Secretary Janet Yellen.

“It’s quite common that we wake up to regulation only when we have a crisis,” said Jonathan Dharmapalan, CEO of eCurrency, which provides technology for central banks to issue and distribute central bank digital currencies, or CBDCs. “A ‘call to action’ is probably what I would call this situation.” 

For months, regulators have promised that rules to protect investors are coming, but lawmakers across government agencies cannot seem to agree on a path forward. 

“Stablecoins are a form of private money,” Dharmapalan said. “The trouble with that is that stablecoin issuers make up their own rules, and nobody knows whether the rules are appropriate.” 

Other stablecoin issuers should expect greater regulatory scrutiny, Abdulali agreed, but it is also important to consider the type of stablecoin. Reserve-backed tokens such as Circle and Tether have, at least according to the teams behind the coins, robust reserves of safe-haven assets, such as cash and cash equivalents. Algorithmic tokens, such as UST, rely on smart contacts that put incentives in place to maintain the price. 

“Algorithmic stablecoins still need work,” Abdulali said. “None have worked.” 

A recent research report from Wake Forest Law Review went further, claiming algorithmic stablecoins are inherently designed to fail. These tokens require a support level of demand for operational stability and rely on independent actors with market incentives to perform price-stabilizing arbitrage, the report said.

“None of these factors are certain, and all of them have proven to be historically tenuous in the context of financial crises or periods of extreme volatility,” the report noted. 

Other issuers should consider UST’s collapse as a warning, Dharmapalan said. 

“One would assume, in good faith, that all stablecoin issuers have actually thought through what the risks are, and that managing those risks is an active part of what they are doing every day,” Dharmapalan said. “However, I’m going to guess that that is not really the case.”

Don’t miss the next big story – join our free daily newsletter.


Upcoming Events

Hilton Metropole | 225 Edgware Rd, London

Mon - Wed, March 18 - 20, 2024

Crypto’s premier institutional conference returns to London in March 2024. The DAS: London Experience: Attend expert-led panel discussions and fireside chats Hear the latest developments regarding the crypto and digital asset regulatory environment directly from policymakers and experts.

Salt Lake City, UT

WED - FRI, OCTOBER 9 - 11, 2024

Pack your bags, anon — we’re heading west! Join us in the beautiful Salt Lake City for the third installment of Permissionless. Come for the alpha, stay for the fresh air. Permissionless III promises unforgettable panels, killer networking opportunities, and mountains […]

recent research

Research report - cover graphics (1).jpg


In this report, we dive into crypto private market data to gather insights on where the future of the industry is headed. Despite a notable downturn in private raises, capital continues to infuse promising projects that aim to transform payments, banking, consumer experiences, community, and more, with 2023 being the fourth-largest year for crypto venture capital.


Plus, Sotheby’s auctions an EtherRock and telecom giants get in on Web3


Elsewhere, Cowen’s crypto employees moved to StoneX and Nomura’s crypto custody firm CEO stepped down


If DeFi can just figure out how to improve both security and compliance, nothing would stop traditional finance from entering the game


Earnings from Coinbase and Robinhood boosted stock prices, while bitcoin’s open interest hits highs not seen since 2021, 2022


Ethereum Dencun will enable Ethereum transactions to be submitted as blobs, potentially alleviating the costs of posting data on the blockchain


After a rocky start, bitcoin ETF shareholders are now well in the green