The Frax community has recently approved a proposal to have its FEI stablecoin fully backed by USD equivalents, rather than maintaining a partially backed, semi-algorithmic stablecoin.. With Frax’s decision, the days of experimenting with algorithmic stablecoins may finally be behind us.
The decentralized stablecoin space has only proven its worth with stablecoins backed by ETH, USDC, and BTC. The failure of algorithmic stablecoins (like UST) and the takeoff of overleveraged stablecoins (like MIM) has become one of the main reasons for the loss of confidence in decentralized stablecoins.
The decentralized stablecoin space is still tiny
Decentralized stablecoins account for 5.5% of the total stablecoin supply. MarkerDAO’s DAI takes the cake, with a 71% dominance. Decentralized stablecoin transfer volumes are largely dominated by DAI and have been declining since Q3 2022, suggesting activity across the sector is still muted.
During the bull run of 2021 and 2022, platforms like Abracadabra and Luna flourished thanks to higher returns, but when the market turned negative, these stablecoins were among the first to crash. Luna’s UST stablecoin crashed in May 2022 after large withdrawals from the stablecoin disrupted its algorithmic mechanism.
Before its collapse, UST had become the third largest stablecoin with a greater supply than BUSD and behind only USDT and USDC.. However, the ripple effect of Luna’s collapse caused Abracabra’s MIM stablecoin to lose its peg due to the widespread fall in the prices of the assets backing MIM. Sell-offs piled up on the platform with no buyers, causing frequent dips below the $1 level.
Only a few headlines left standing
MakerDAO’s DAI stablecoin is the oldest decentralized alternative, with significant market share. Although DAI’s design promoted decentralization, the token became a victim of centralization, with more than 50% of the assets backing DAI made up of USDC from Circle.
The MakerDAO community has progressively taken steps to diversify support for the platform. In October 2022, the community voted to convert USDC 500 million into US Treasuries.
Recently, MarkerDAO and the decentralized stablecoin space took another blow after a court ruling in England forced the platform to include an option to confiscate a user’s assets. This creates considerable regulatory risk for platforms using and launching decentralized stablecoins.
Apart from MakerDAO, Liquity has built a decent reputation in DeFi as a purely ETH-backed stablecoin platform. Liquity is censorship resistant as it only provides smart contracts on Ethereum, which are not managed by administrators. The total supply of LUSD is 230 million, with LQTY as the utility token of the platform.
The project’s native token, LQTY, doubled in price after it was listed on Binance on February 28, 2023. According to anonymous on-chain analysis portal An Ape’s Prologue, alleged insider trading was behind the price rise. Still, the low issuance fee of the token and the actual performance of the protocol fees could give it many advantages over sole governance tokens like Uniswap’s UNI token.
Stablecoin platforms build liquidity and trust over time
Frax’s decision to move from a partially algorithmic design to a fully backed stablecoin could see increased demand for FEIs. In addition, Frax is a significant holder of Curve’s CRV token and Convex Finance’s CVX, allowing the DAO to incentivize liquidity provision on Curve. This is notable because adequate liquidity is one of the first requirements for stablecoin success.
At the moment, Cryptocurrency market volatility deters many users from minting cryptocurrency-collateralized stablecoins. The lack of trust in decentralized stablecoins and the long permeability of centralized stablecoins across numerous exchanges makes it more difficult for decentralized alternatives to gain market share.
Even so, the long-term market opportunity for decentralized stablecoins is significant. Over time, decreased volatility and regulatory clarity around cryptocurrencies will likely increase demand for crypto-backed stablecoins.
The views, thoughts and opinions expressed herein are those of the authors and do not necessarily reflect or represent the views and opinions of Cointelegraph.
This article does not contain investment advice or recommendations. All investments and trades involve risk, and readers should do their own research when making a decision.
Investments in crypto assets are not regulated. They may not be suitable for retail investors and the entire amount invested may be lost. The services or products offered are not directed or accessible to investors in Spain.
