Stable Coin regulatory new rules are in place, but the market has overlooked a small detail

Author: Ding Dang, Odaily Star Daily

On March 13, the U.S. Senate Banking Committee approved the stablecoin regulation bill by a vote of 18 to 6, bringing a milestone regulatory framework to this rapidly growing industry. The market cheered as USDT, USDC, and other mainstream stablecoins have a clearer compliance outlook. However, there is a “hidden detail” that few have discussed—the bill sets a two-year ban on stablecoins that rely solely on proprietary digital assets as collateral (such as algorithmic stablecoins) and requires the Treasury Department to study their risks.

Is it because the algorithmic stablecoin has been overshadowed since the UST crash in 2022, or is the market only focusing on good news? The details behind this clause are worth investigating.

What is the stablecoin collateralized by “self-created” digital assets?

The term “self-created” in the bill refers to a clear yet ambiguous concept. Literally, it refers to digital assets created by the stablecoin issuer within its own system to support the value of the stablecoin, rather than relying on external assets such as the US dollar, government bonds, or gold. In other words, these stablecoins are not backed by traditional financial assets, but attempt to maintain price stability through algorithmic mechanisms and their own tokens to regulate supply and demand. However, the boundaries of the term “solely dependent” are not clearly defined, which has sparked controversy over the scope of regulation.

The most classic stablecoins, such as USDC or USDT, are backed by US dollar reserves and supplemented by transparent audits, allowing them to maintain a 1:1 redemption ability even during market volatility. In contrast, ‘algorithmic’ stablecoins rely entirely on internal design for stability, lacking the safety net of external assets. The collapse of UST is a typical case, where a large number of holders selling UST led to a sharp drop in the price of the LUNA token, causing the stablecoin to lose support and triggering a ‘death spiral.’ In this scenario, algorithmic stablecoins not only struggle to withstand market shocks but may also become a source of systemic risk in the market.

The vague definition of ‘self-created’ has become a point of contention. If a stablecoin relies on both external assets and self-created tokens, is it also within the scope of the ban? This issue directly affects the implementation of subsequent regulations and brings uncertainty to the development of other stablecoins.

Which stablecoin projects may be affected?

The current stablecoin market can be divided into three categories: fiat-backed, over-collateralized, and algorithmic stablecoins, each with different design logics and risk characteristics, directly determining their fate in legislation.

Fiat Support and Collateral Support: Safe Zone

USDT and USDC: relying on the US dollar and short-term Treasury reserves, with high transparency, the asset reserves and audit requirements of the law actually pave the way for their compliance development.

MakerDAO’s DAI: generated by over-collateralizing external assets such as ETH, wBTC, etc., with a reserve ratio ranging from 150% to 300%. MKR tokens are used solely for governance rather than core support, with no regulatory pressure in the short term.

Ethena’s USDe: The main collateral for USDe is Ethereum assets such as stETH and ETH. The governance token ENA is not directly used as collateral for USDe, but is only used for protocol governance and incentives. The generation mechanism of USDe leans more towards collateralization and does not fall under the category of ‘solely relying on self-created digital assets.’ However, the stability mechanism of USDe involves derivative hedging, which may be viewed by regulators as a ‘non-traditional’ stablecoin. If regulators focus on ‘derivative risks’ or ‘non-traditional asset backing,’ USDe’s ‘delta neutral strategy’ (stability mechanism) may face additional scrutiny.

Algorithmic stablecoin: Ban Target

Stablecoins with algorithmic stability have become a key target of bans due to their “self-creation” characteristics. They rely on internal tokens and algorithm mechanisms, with very low external asset participation and concentrated risks. Below are several typical cases from the past:

Terra’s UST: Value adjusted by LUNA, which is the self-created token of Terra, completely dependent on the ecosystem. It evaporated 40 billion dollars in the crash of 2022, dragging down multiple DeFi protocols.

Basis Cash (BAC): an early algorithmic stablecoin that balances with BAC and BAS (self-created tokens), quickly collapsed under market fluctuations, and the project has long faded from view.

Fei Protocol (FEI): Regulated by FEI and TRIBE (native token), after launching in 2021, it lost market trust due to the detachment issue, and its popularity plummeted.

The common feature of these projects is that the value support depends entirely on self-created tokens, with almost no external assets. Once market confidence is shaken, a collapse is almost inevitable. Supporters of algorithmic stablecoins have shouted the slogan of ‘decentralized future’, but the reality is that their risk resistance is low, making them a focus of regulatory attention.

However, there is a gray area in between: many stablecoins do not solely rely on ‘self-created’ assets, but adopt a hybrid model. For example:

Frax (FRAX): partially dependent on USDC (external assets), partly regulated by FXS (self-created tokens). If the definition of ‘self-created’ is too strict, the role of FXS may be limited; if it is loose, there is hope to escape.

Ampleforth (AMPL): Achieve purchasing power stability through supply and demand adjustments, not relying on traditional collateral, closer to elastic currency, may not fall within the stablecoin definition in the bill.

In other words, although the bill is aimed at stablecoins backed by ‘self-created digital assets’, the use of the term ‘solely relying’ lacks clear regulations on the boundaries, leaving the fate of these hybrid projects uncertain. If the definition of ‘self-created’ by the Ministry of Finance is too broad, hybrid projects may be mistakenly affected; if too narrow, potential risks may be overlooked. This uncertainty directly impacts the market’s expectations for related projects.

Why did the regulatory authorities set up this ban?

The ban on “self-creation” in the bill reflects concerns about the present as well as expectations for the future.

First, systemic risk is a core concern. The collapse of UST is not only a nightmare for retail investors with 40 billion USD, but also triggers a chain reaction in the DeFi market, even alerting traditional finance. The closed-loop design of algorithmic stablecoins makes them extremely prone to losing control under extreme conditions, potentially becoming a ‘time bomb’ in the cryptocurrency market. Regulators evidently hope to curb this potential threat through bans.

Secondly, the lack of transparency has exacerbated the difficulty of regulation. For self-created tokens like LUNA or FEI, their value is difficult to verify through external markets, and the fund operation is like a black box, in stark contrast to the transparent ledger of USDC. This opacity not only makes regulation difficult, but also lays hidden dangers for potential fraud.

Third, investor protection is a real need. Ordinary users find it difficult to understand the complex mechanism of algorithmic stablecoins and often mistakenly believe they are as safe as USDT. After the collapse of UST, retail investors suffered heavy losses, highlighting the urgency of protecting retail investors from high-risk innovations.

Finally, the stability of monetary policy cannot be ignored. The widespread use of stablecoins may have an impact on the US dollar monetary policy. If a large amount of funds flow into unregulated algorithmic stablecoins, and these stablecoins lack sufficient external asset support, market instability may disrupt the Federal Reserve’s monetary regulation.

However, the two-year ban is not a complete denial, but rather carries an exploratory meaning. The ambiguity of ‘self-creation’ is a point of controversy, but it also leaves room for adjustment. The Ministry of Finance’s research will clarify boundaries and determine which projects are truly restricted. At the same time, these two years are a ‘trial period’ for the DeFi community. If more robust solutions can be introduced—such as Frax’s hybrid model, which buffers risks with external assets, or developing entirely new stress-resistant mechanisms—regulatory attitudes may soften. Conversely, if they still adhere to the ‘self-creation’ closed loop, after the ban expires, algorithmic stablecoins may face even stricter constraints.