US regulator investigating UST stablecoin crash in fresh threat to Terra

SEC enforcement attorneys are looking into whether Terraform Labs broke rules for securities and investment products. PHOTO: REUTERS

NEW YORK (BLOOMBERG) - The US Securities and Exchange Commission (SEC) is investigating whether the marketing of the TerraUSD stablecoin before it crashed last month violated federal investor protection regulations, according to a person familiar with the matter.

SEC enforcement attorneys are looking into whether Terraform Labs, the Singapore-based firm behind the coin also known as UST, broke rules for securities and investment products, said the person, who asked not to be named discussing the confidential probe. The stablecoin was supposed to maintain a one-to-one peg to the United States dollar through an algorithm and trading in a related token called Luna.

The implosion of UST starting on May 7 sent shock waves across crypto markets. In the aftermath, Treasury Secretary Janet Yellen said the episode exposed the dangers of tokens that purport to be pegged to the US dollar, and Acting Comptroller of the Currency Michael Hsu called it a "wake-up call".

The SEC investigation may ratchet up pressure on Terraform and its chief executive officer, Mr Do Kwon, which are already facing scrutiny from the regulator for offering another crypto project known as the Mirror Protocol, which allows people to trade digital assets that track the price of US stocks. Neither Terraform nor Mr Kwon has been accused of any wrongdoing related to UST.

The SEC declined to comment. Terraform Labs said in a statement that it was not aware of an SEC investigation into UST.

"We are not aware of any SEC probes into TerraUSD at this time - we have received no such communication from the SEC and are aware of no new investigation outside of that involving Mirror Protocol," Mr Kwon said in a separate statement.

Stablecoins play a critical role in crypto because their relatively steady value can provide a safe haven for many investors in the highly volatile market. Unlike others that purport to be backed by cash and similar assets to maintain their peg, UST used algorithms and trader incentives to maintain its price.

Under the mechanism, every time a UST token was created, a dollar's worth of Luna - the value of which was determined by the market - was destroyed, or vice versa. If the price dropped below US$1, traders were motivated to swap UST for Luna, which would decrease the amount of the former in circulation and drive up its price. A computer program would work in tandem to do the same. The opposite occurred if UST's value rose above US$1.

Under securities rules, a virtual currency may fall under the SEC's remit if Americans buy the token to fund a company or project with the intention of profiting from the efforts of those involved in it. This determination is based on a 1946 US Supreme Court decision defining investment contracts. The agency has also argued that in some instances, a crypto firm may face investment company strictures if it holds assets.

In a February case, the regulator said that BlockFi, a popular crypto platform, was operating as an unregistered investment company because it was "an issuer of securities engaged in the business of investing, reinvesting, owning, holding, or trading in securities and owning investment securities". The company agreed to pay US$100 million (S$138 million) in fines to the SEC and state regulators to settle those allegations and others without admitting to the alleged violations.

Terra's unravelling marked one of the biggest crypto busts in history, wiping out tens of billions of dollars in value. Since then, Terraform has relaunched its blockchain and the Luna coin, which plunged close to zero during the debacle, under new names. The TerraUSD stablecoin was not included in the new version.

Meanwhile, in a separate development, Bloomberg News reported on Thursday that Seoul police are investigating allegations that staff of Terraform Labs embezzled Bitcoin holdings amassed to help defend the UST's peg to the dollar. The firm did not immediately respond to an e-mail seeking comment on that probe.

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