On May 12, 2022, Tether, the world's largest stablecoin by market capitalization, slipped below its "dollar peg" for a few hours, hitting a low of 95 cents. Tether since recovered, and was trading at 99.89 cents on May 16, 2022. Tether is purportedly backed by assets held in reserve accounts sufficient to support a $1.00 value for each Tether coin. Reuters reported that in December, Tether had less than half its reserves in bank deposits and US Treasury bonds and the remainder in risky assets such as commercial paper, corporate bonds, and digital tokens. Tether sought to reassure investors that it will continue to honor all redemptions, even with the market volatility.

Reuters reported that stablecoin TerraUSD (UST) first broke its dollar peg on May 9, 2022, and UST has continued to devalue, trading at 11 cents on May 16, 2022. In the wake of the collapse, the developers of Terra halted the network's blockchain to prevent attacks to the algorithmic stablecoin and related Luna token. UST was the tenth largest cryptocurrency with a market capitalization of more than $18.5 billion.

Unlike Tether, UST is an algorithmic, or decentralized, stablecoin, designed to maintain its dollar peg through a complex mechanism that involved swapping it with another free-floating token called Luna. One UST coin can be swapped for one dollar of Luna, and vice versa, and the UST is destroyed (or "burned") when it is swapped. If UST falls below one dollar, traders are incentivized to buy UST to swap it for Luna, and in the process reduce the supply of UST and push its price back to one dollar.

The co-founder of the company behind UST, Terraform Labs, announced a recovery plan in which the company seeks additional outside funding to rebuild UST so that it is collateralized. The aim is to have UST backed by reserves rather than relying on an algorithm to maintain its dollar peg.

Events including these have drawn further scrutiny from regulators, many of whom already had stablecoin on their radar (see Legal Updates, US Senator Proposes Framework for Stablecoin Regulation and US House of Representatives Committee on Financial Services Holds Hearing on Stablecoin Regulation). As the use and popularity of stablecoins has escalated in recent years, regulators have expressed concern that de-pegging may result in substantial regulatory risk for the stablecoin market and possibly for the entire crypto market.

On May 10, 2022, in testimony before the Senate Banking, Housing and Urban Affairs Committee, Treasury Secretary Janet Yellen stated that the UST de-pegging shows that urgency to develop a regulatory framework on stablecoins as they are a rapidly growing product in need of an appropriate framework. In its biannual Financial Stability Report, the US Federal Reserve warned that stablecoins are vulnerable to investor runs because they are backed by assets that can lose value or become illiquid in times of market stress.

On May 12, 2022, SEC Commissioner Hester Peirce signaled, in an online panel, that stricter rules around stablecoins may be coming. Peirce indicated that the SEC has an opportunity to capture digital currencies, and the technology platforms where they are traded, under the agency's broad rulemaking authority. In November of 2021, the President's Working Group on Financial Markets released a report on stablecoins which recommended that:

Stablecoins are digital tokens pegged to the value of traditional assets, such as the US dollar, and are therefore thought to be safer and more stable than traditional cryptocurrency such as bitcoin. For more information on stablecoins, see Stablecoins and Central Bank Digital Currencies (CBDCs): Overview.

This Update is based in part on material provided by Thomson Reuters Regulatory Intelligence (TRRI).