Colossal Terra Flop Amplifies Calls to Open Stablecoin Books

The collapse of the TerraUSD stablecoin raises a question: would new auditing rules help prevent another, perhaps more destructive stablecoin death spiral?

The debacle — in which Terra went from a multi-billion dollar valuation to near zero in a matter of days — showed the need for regulatory clarity on how stablecoins are audited, said Sean Stein Smith, president of the accounting working group of the Wall Street Blockchain Alliance and a lecturer at Lehman College in New York.

“The key questions are: how do they work and how is this information communicated,” he said. “The collapse of Terra is just the most recent example of why these questions need to be asked.”

The Terra disaster has led some global financial authorities to claim that stablecoins, which are essentially unregulated now – need closer monitoring ASAP. Representatives of the industrialized countries of the Group of Seven have published a statement May 20 stating that “no global stablecoin project should begin operation until it adequately meets relevant legal, regulatory and supervisory requirements through proper design and adhering to applicable standards.”

In Washington, Sen. Pat Toomey (R-Pa.) introduced legislation in April, this would place stablecoin issuers under the supervision of federal banking authorities. The bill, which has generated considerable interest in the industry and among regulators, would require issuers to publicly disclose the assets backing their tokens each month and file quarterly certificates by a registered accounting firm. An attestation is a CPA’s statement that certain figures are accurate and reliable.

The senses. Kirsten Gillibrand (DN.Y.) and Cynthia Lummis, (R-Wyo.) are set to unveil their own proposal from this week with similar items.

Stablecoins are usually pegged on a 1-to-1 basis to an asset like the US dollar. They play a vital role in the world of decentralized finance (DeFi) by facilitating exchanges between digital assets, and between fiat currencies and digital assets on crypto exchanges. Some of these coins, backed by reserves of dollar assets, are as big as the major financial institutions. For example, Tether’s USDT, the largest, has a market capitalization of around $73 billion.

Lack of regulatory clarity

“It’s critical that Congress provide clarity in this area as soon as possible,” Toomey said during a recent hearing with Treasury Secretary Janet Yellen. He added, “Fortunately, I am optimistic that the administration is working with members of Congress and that we can find common ground on bipartisan legislation that addresses the risks of stablecoins while encouraging innovation. and competition.”

Vivian Fang, an accounting professor at the University of Minnesota, said the danger was “too big a problem to fail.” In the event of a panic, she said, a stablecoin issuer could be forced to sell its reserves in a falling market to meet redemption requests, further destabilizing asset prices.

Greater transparency about the amount and composition of their reserves would build trust, Fang said, “because if people know what’s in there, they’ll be less likely to panic.”

Markus Veith, Grant Thornton partner and head of the firm’s digital assets practice, said that in the absence of regulatory mandates, issuers have taken a “best practice” approach, turning to bodies such as the American Institute of CPA and interpreting existing accounting rules for guidance.

With most stablecoins, he said, “you have a management report that lists coins in circulation, reserve assets, and then you have a separate attestation report that basically says, ‘Yeah, we agree with management’s assertions, this is the coin count that is generally backed by at least the equivalent amount of reserve assets. ”

Stablecoin’s auditing and attestation procedures require a different level of expertise than ordinary corporate audits, Veith said, and Grant Thornton — which counts Circle’s USDC stablecoin among its clients — developed its platform. and its blockchain infrastructure over the past nine years. This, he said, means he can handle financial statement audits of digital asset companies, and also has the ability to do reserve certifications and trace digital assets on-chain. of blocks.

“We have developed our own infrastructure,” Veith said. “We work hand in hand with our audit methodology group, with our forensic practice, with our risk management group. And every time we onboard clients, we look very closely to make sure we’re comfortable with the associated risks.

Veith declined to comment on the USDC audit, saying he could not discuss individual customers. Circle’s USDC approach with Grant Thornton in accordance with AICPA attestation standards– nevertheless won praise for its transparency.

“Those that don’t like the USDC will have to answer the question ‘why don’t you?’ “Smith said.

He pointed to the timely reports from the USDC — on a monthly basis, versus Tether’s quarterly reports — as well as the “multiple caveats” related to the information in his latest report. report. Nearly $12 billion of its reserves are in secured loans, precious metals and other crypto-assets “which could still use more detail and transparency,” Smith said.

Additionally, Grant Thornton is the sixth-largest accounting firm in the United States, he noted, while Tether’s auditor seems “an unlikely choice for the auditor of the world’s largest stablecoin.”

Tether was briefly shaken from its 1:1 peg to the dollar following the Terra crisis, but has since regained it. He employs a small Cayman Islands-based accounting firm, MHA Cayman, a subsidiary of MHA MacIntyre Hudson, a UK member of Baker Tilly International. Tether and Affiliates agreed last year with New York Attorney General Letitia James to provide quarterly reports as part of a settlement over allegations that they hid the loss of funds and lied about reserves. The allegations have contributed to an aura of mystery over the most widely used stablecoin.

Tether’s latest reveal assured investors last week that “the consolidated reserves held for the issued digital tokens exceed the amount required to redeem the issued digital tokens.”

MHA Cayman declined to comment.

And then there is Terra

Terra belongs to a separate category, that of algorithmic stablecoins. Unlike asset-backed ones, this is something more exotic: an ingenious—but fatally flawed—a protocol that depended on constant arbitration between Terra and its sister token, Luna, clever programming, and user faith to keep its value at $1. When stocks and other cryptocurrencies began to fall, Luna also came under selling pressure, severing the bond between the two and sending them both spiraling lower.

“Think of it like two kids on a seesaw,” Fang said, referring to the mechanism that kept Terra in balance at $1 as long as demand for Luna tokens was strong. “If a runner went down, everything became unbalanced and it was gone.”

Having no reservations, Terra also lacked a traditional listener. It did, however, have a “code auditor” at Certik, a Goldman Sachs-backed Web3 and blockchain security company.

Ronghui Gu, founding CEO of Certik and professor of computer science at Columbia University, said Certik’s job is to ensure that Terra is as secure as possible, both before deployment and after it goes live. line, and to ensure that the code faithfully implemented the token economy. – which he says were “conceived by either a genius or a madman”.

“Most investors, retail investors, don’t have the expertise to evaluate these projects,” Gu said. “It’s our job. We will do the valuation and provide the auditor’s report for investors to read and see if there is a discrepancy between them.

Certik is not responsible for Terra’s disappearance, he said.

“Our job is to prevent code exploits or bugs in the implementation, things that can be used by hackers to attack,” Gu said. “It’s not about deciding whether it makes sense or not.”

Legislative transparency

The crypto industry would like regulatory certainty, Veith said, “Because it’s better to say, ‘Look, these are the standards that everyone has to follow,’ than to say, ‘Well, there’s no there are no standards. But, you know, be careful. ”

Toomey’s legislative proposal “is very important, it would help define audit responsibilities,” Smith said, “And if you can add some transparency and consistency on that part, it will solve 80% of the problems.”

—With help from Michael Kapoor.

About Donnie R. Losey

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