The recent Luna-Terra crash has led to tens of billions of dollars of losses, which has led to wide criticism of “algorithmic stablecoins” as a category, with many considering it to be a fundamentally flawed product. Ethereum co-founder Vitalik Buterin has shared two experiments on evaluating whether an algorithmic (algo) stablecoin is sustainable.
In a blog post, Buterin writes, “While there are plenty of automated stablecoin designs that are fundamentally flawed and doomed to collapse eventually, and plenty more that can survive theoretically but are highly risky, there are also many stablecoins that are highly robust in theory and have survived extreme tests of crypto market conditions in practice. ”
He adds, “what we need is not stablecoin boosterism or stablecoin doomerism, but rather a return to principles-based thinking.” Here are some principles for evaluating whether or not a particular automated stablecoin is a truly stable one, as per Buterin.
1) Can the stablecoin safely wind down to zero users?
If any stablecoin project drops to zero, users should be able to extract the fair value of their liquidity out of the asset, according to Buterin. He highlighted that Terra coin did not allow users to extract fair liquidity due to its linked structure with Luna coin, which needs to maintain its price and user demand to keep its United States dollar peg.
“First, the volcoin price drops. Then, the stablecoin starts to shake. The system attempts to shore up stablecoin demand by issuing more volcoins. With confidence in the system low, there are few buyers, so the volcoin price rapidly falls. Finally, once the volcoin price is near-zero, the stablecoin too collapses,” he wrote.
Buterin notes that “in the non-crypto world when a product shuts down or declines, customers generally don’t get hurt all that much.” However, he says in the crypto world people take it too personally. “There are certainly some cases of people falling through the cracks, but on the whole shutdowns are orderly and the problem is manageable,” he adds.
2)What happens if you try to peg the stablecoin up 20 per cent per year?
Buterin believes that there are two scenarios if a stablecoin is giving up 20 per cent interest for investing in its project. The project will either “charge some kind of negative interest rate on holders that equilibrates to basically cancel out the USD-denominated growth rate built into the index.” or “It turns into a Ponzi, giving stablecoin holders amazing returns for some time until one day it suddenly collapses with a bang.”
“Obviously, there is no genuine investment that can get anywhere close to 20% returns per year, and there is definitely no genuine investment that can keep increasing its return rate by 4% per year forever,” he wrote.
He concluded by saying that “the crypto space needs to move away from the attitude that it’s okay to achieve safety by relying on endless growth. It’s certainly not acceptable to maintain that attitude by saying that “the fiat world works in the same way” because the fiat world is not attempting to offer anyone returns that go up much faster than the regular economy, outside of isolated cases that certainly should be criticized with the same ferocity.”
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