(Bloomberg) --

The UK’s market regulator is paying close attention to the chaos in crypto markets after the implosion of Terra, one of the biggest experiments in decentralized finance.

The recent market instability in stablecoins “will absolutely need to be taken into account” when the watchdog starts working with the Treasury to develop and implement new rules for cryptoassets later this year, said Sarah Pritchard, executive director for markets at the Financial Conduct Authority.

“Innovation lasts if it works well, and clearly, we’ve seen the consequences and some of the issues that can arise,” Pritchard, who oversees the FCA’s work on crypto, said in an interview on Wednesday. Nearly 70% of adults that are 40 or younger who bought crypto had incorrectly assumed that digital assets were regulated, she said, citing an Opinium survey published by the FCA in October. 

Pritchard’s comments come in the wake of the collapse of TerraUSD, a stablecoin which used algorithms and swaps with its sister token Luna to maintain its peg to the US dollar, rather than a reserve of dollar-equivalent assets. The two tokens had a combined market value of more than $40 billion before the wipeout, which also knocked around $380 billion off the wider crypto sector. 

Stablecoins are an essential part of the crypto ecosystem, used by traders as a means of retaining a flat value without needing to convert tokens back into fiat currency. Investors can turn to them as a safe haven for their portfolio during periods of volatility, or simply as a means of digital payment.

“It really shows at front of mind the really significant issues that exist here, both in terms of a well-functioning market and obviously consumer protection,” Pritchard said. “In the last week where we saw significant price movements, it brings that into the fore and it shows the importance of making sure that people understand that that is a risk of where they put their money.”

The Treasury said in April that it intends to amend existing legislation for electronic money and payments firms to include stablecoin issuance and the provision of wallets as well as custody services. Firms that dabble in stablecoin activities might require supervision by the Bank of England as well as authorization by the FCA if their services are used by a large number of consumers, due to the systemic risks they might pose.

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So far, the FCA has largely been limited to ensuring that crypto companies meet its standards on anti-money laundering rules. An effort to bring the industry up to scratch saw only 34 of more than 100 applicants meet the bar. The UK watchdog is set to gain new powers from the Treasury to handle cryptoasset regulation later this year, with further details to be announced in the upcoming Financial Services and Markets Bill. 

The regulator held its CryptoSprint event earlier this month to act as a listening exercise in advance of those changes. The two-day event was attended by around 100 participants including the regulator’s CEO Nikhil Rathi and senior staff, FCA-registered crypto firms, industry bodies, investment banks and firms from across professional services. The session was “significantly oversubscribed,” Pritchard said, with more than 640 applicants.

Topics that were discussed during the event included whether the FCA should create a bespoke regulatory regime for crypto and its ability to enforce rules across geographical borders, according to two attendees who were not authorized to speak publicly about the event. Participants were particularly concerned about the pace of releasing new regulation and the custody of cryptoassets, they said. They were also worried about the current environment of crypto exchanges acting as the de facto guardian for riskier areas such as decentralized finance when determining which tokens are suitable for listings.

A spokesperson with the FCA declined to comment on the discussions but said the event was “hugely positive,” with two virtual sprints to follow in early June. 

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