Mitchell Koch – In November 2021, the SEC brought legal action against Terraform Labs (“Terraform”) and its CEO, Do Kwon, requiring their compliance with investigative subpoenas. Founded in 2018, Terraform creates cryptocurrencies for use in blockchain-based financial infrastructures. As of September 2022, Do Kwon and Terraform remain under investigation for selling unregistered securities in the United States. Further, as of July 2022, Terraform and Do Kwon face a class action lawsuit brought by victims of Terraform’s cryptocurrency coin collapse for misleading investors.
Terraform’s controversy stems from the fact that it promised lofty returns to casual and nescient cryptocurrency investors, and was unable to deliver on those promises. While cryptocurrencies fluctuate wildly in value, stablecoins are crypto-assets whose values are, in theory, pegged to the value of a real stable asset, such as the US Dollar. While the purpose of stablecoins is to provide reliability in a volatile market, the Terraform crisis pushed this theory to its limits.
Terraform’s flagship cryptocurrency tokens were LUNA Coin and the stablecoin TerraUSD. TerraUSD was set to remain at one dollar, while the value of LUNA Coin (“LUNA”), the asset backing TerraUSD’s value, was to be determined by market cap derived from investments. Throughout 2020 and 2021, many investors saw their portfolio values increase while LUNA peaked at around $120. But in early May 2022, the value of LUNA plummeted to a fraction of a cent, losing over 99% of its value and bringing the stablecoin TerraUSD down by 86% along with it. Many LUNA and TerraUSD investors were left desolate and without recourse, especially when so many were new to cryptocurrency and were misled as to the safety of stablecoin investments. Terraform’s cryptocurrencies were marketed to casual investors as revolutionary, but when the curtain was pulled back, all that remained was the empty shell and investors holding the bag.
The SEC requires companies that sell securities in the United States to register with the SEC, and therefore are subject to financial disclosure regulations. Stablecoins represent a gray area in this context because there is not necessarily a profit incentive. Nevertheless, they exhibit qualities of a security and the SEC may consider them securities.
The results of both the lawsuit brought against Do Kwon and Terraform and the SEC investigation will likely provide valuable guidance moving forward on the regulation of stablecoins. Audits and financial disclosures are a key requirement for companies selling securities in the United States. Terraform sold its tokens to investors in the United States for years and acquired a $40 billion market cap. Though it is unclear how much of that was acquired from US investors, which the SEC investigation should reveal, this, it is clear that allowing the sale of stablecoins without proper vetting is dangerous to investors.
Critics may employ a mindset of caveat emptor—that investors ought to know that cryptocurrency is a lightly-regulated industry rife with fraud and scams. But this mindset, if adopted by regulatory agencies, would chill adoption of new technology and displace the agencies charged with consumer protection. Without an end to the Terraform controversy in sight, however, we may not have an answer on this regulatory question before another stablecoin crash leaves more investors empty handed. And for now, as of September 2022, law enforcement officials maintain that Do Kwon is on the run.
