How to create algorithmic stablecoins that won’t scam or crash

How to create algorithmic stablecoins that won’t scam or crash

The co-founder of EthereumVitalik Buterin has shared two thought experiments on how to assess whether an algorithmic stablecoin (something) is sustainable.

Buterin’s comments were prompted by the multi-million dollar losses caused by the collapse of the Terra ecosystem and its TerraUSD (UST) stablecoin..

In a blog post on Wednesday, Buterin noted that the increased scrutiny of cryptocurrencies and decentralized finance (DeFi) since the fall of Terra is “very welcome,” but cautioned against writing off all algoblecoins entirely..

“What we need is not stablecoin reinforcement or stablecoin doomerism, but a return to principled thinking”added:

“While there are plenty of automated stablecoin designs that are fundamentally flawed and doomed to eventually collapse, and many more that can theoretically survive but are highly risky, there are also plenty of stablecoins that are highly robust in theory, and have survived testing. extremes of cryptocurrency market conditions in practice.”

His post focused on Reflexer’s RAI stablecoin, fully collateralized with Ether (ETH), in particular, which is not pegged to the value of fiat currency and relies on algorithms to automatically set an interest rate.proportionally opposing price movements and incentivizing users to return RAI to their target price range.

Buterin claimed that it “exemplifies the pure ‘ideal type’ of a collateralized automated stablecoin,” and its structure also gives users the opportunity to mine their liquidity in ETH if faith in the stablecoin falls significantly apart..

The Ethereum co-founder offered two thought experiments to determine if an algorithmic stablecoin is “truly stable.”

1: Can the stablecoin “shrink” to zero users?

In Buterin’s opinion, if the market activity for a stablecoin project “falls to near zero”, users should be able to extract the fair value of their liquidity from the asset.

Buterin highlighted that UST does not meet this parameter due to its structure in which LUNA, or what he calls a volcoin, needs to maintain its price and user demand to maintain its peg to the US dollar.. If the opposite happens, then it is almost impossible to avoid a collapse of both assets:

“First, the volcoin price falls. Then the stablecoin starts to shake. The system tries to prop up the demand for the stablecoin by issuing more volcoins. As confidence in the system is low, there are few buyers, so the volcoin price falls rapidly. Eventually, once the price of the volcoin approaches zero, the stablecoin crashes as well.”

Instead, as RAI is backed by ETH, Buterin argued that decreased confidence in the stablecoin would not cause a negative feedback loop between the two assets, leading to less chance of a crash. wider. In the meantime, users would still be able to exchange RAI for ETH locked in vaults that support the stablecoin and its lending mechanism.

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2: Negative interest rate option

B.uterin also considers it vital that an algorithmic stablecoin be able to implement a negative interest rate when it is following “a basket of assets, a consumer price index, or some arbitrarily complex formula.” grow 20% a year.

“Obviously, There is no genuine investment that can come close to a 20% return per year, and there is definitely no genuine investment that can keep increasing your rate of return by 4% per year forever. But what if you try?“, said.

I affirm that There are only two outcomes in this case, either the project “charges holders some kind of negative interest rate that balances out to essentially cancel out the dollar-denominated growth rate built into the index”.

Either “it becomes a scam, giving stablecoin holders unbelievable returns for some time until one day it suddenly collapses with a bang”.

Buterin concluded by noting that just because an algorithmic stablecoin is capable of handling the above scenarios, does not make it “safe”:

“It could remain fragile for other reasons (for example, insufficient collateral ratios), or have governance flaws or vulnerabilities. But steady state and extreme case robustness should always be one of the first things we check.”

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