ZoneBitcoin EditorialThe cryptocurrency market has always been criticized by crypto skeptics for its volatility. And the enthusiasts retort thatit is largely counterbalanced by the existence of stablecoins.
Stablecoins have often been presented as the link between crypto and traditional financial markets. But history seems to have proved the skeptics right a few days ago by proving that the stability of stablecoins is entirely relative.
However, be careful do not draw too hasty conclusions of the bad fortune of one of the most famous stablecoins: TerraUSD. We will then focus specifically on this algorithmic stablecoin. This seems simpler to us for a better understanding of the thing.
What is an Algorithmic Stablecoin?
Even if we tend to talk about stablecoins as one single entity, this is not the case. There are different types of stablecoins. Among the variety of stablecoins, we have the so-called algorithmic stablecoins.
These are designed to ensure price stability. The algorithmic stablecoin is linked to a reserve asset such as the US dollar, another FIAT currency or theor, for example.
In fact, the algorithmic stablecoin uses an algorithm that can issue more coins when its price rises and buy them back from the market when the price falls. This is why we talk about an algorithm. It is according to a mathematical equation that the stablecoin will decide whether it will buy or sell to balance its price.
The oldest algorithmic stablecoin is Ampleforth (AMPL). Many such cryptos have entered the crypto industry.
Each blockchain has one, because it is essential for traders. One of the best known algorithmic stablecoins is certainly DAI with MakerDAO.
Until now, few have managed to reach the heights that Terra recently reached. Traditional stablecoins are generally backed by reserves to ensure their value. But algorithmic stablecoins operate on a much more delicate balance. In this case on algorithms and smart contracts which encourage traders to maintain a stable price.
⚡️ UST: the stablecoin that predicted the storm
We can say thatTerra Blockchain UST marked the history of cryptos. In any case, we all had a good booster shot. Last week, the value of TerraUSD, a stablecoin whose value is indexed to the dollar, completely collapsed.
In reality, another stablecoin had shown its flaws a few weeks earlier: this is the stablecoin USDN from Waves...It had lost 80% of its value in less than 24 hours. It was the first time we saw a stablecoin disappear like this.
The UST now hovers around 17 cents (according to CoinMarketCap). A tumble which only adds to the decline that Bitcoin is currently experiencing. And the ever-increasing pressures to regulate the crypto market in general, and that of stablecoins in particular.
La current crisis of the crypto market - formerly considered as an alternative to the traditional financial system - follows that of the classic financial market. Cryptos are becoming more widely adopted by institutional investors and traditional financial companies. But unlike stocks, bonds and other traditional investment instruments, cryptocurrencies are largely unregulated.
The rise of algorithmic stablecoins…And the inevitable fall?
The reason for stablecoins to exist is tobe the bulwark that protects the market against the volatility supposedly inherent to cryptocurrencies. From a practical point of view, this makes trading with pairs exchanges easier. This is only the first advantage of using stablecoins.
Last April, Terra became (briefly) the third main stable coin by market capitalization. He then arrived behind Tether (USDT) Circle (USDC) with around $18 billion.
As already mentioned, UST is a decentralized algorithmic stablecoin. Which means it is not backed by centralized entities such as a bank or corporation. It is also not subject to the control that these actors could exercise.
The algorithm behind UST and LUNA token
TerraUSD depends on another coin – Luna. Every time a UST is minted or created, a Luna is "burned". Understand that they will be radically removed from circulation.
(🤓You can learn more by reading the article on the principle of “ burner » tokenss).
The same thing happens in reverse when a Luna is hit. This system allows create trade margins and supply and demand models which stabilize the value of a coin at $1.
The failure of the peg to the Fiat currency
Some still consider stablecoins decentralized as inherently risky investments.
The failure of UST to maintain its foothold was predictable for many specialists. Although, some people like to think they are Madame Irma. Beware of gossipmongers and those who think they can read the future in charts…However, some were suspicious of the mechanism of algorithmic stablecoins. Lthe economy adopted by Terra, that of algorithmic stablecoins, presents many flaws.
The first being that the value of these stablecoins is largely based on investor confidence. It is also necessary to take into account the economic incentives of its ecosystem. Once this trust is eroded, the fall in demand often sends algorithmic stablecoins into a downward spiral.
Should we save Soldier Terra?
Over the past few days, the stablecoin TerraUSD (UST) has suffered an abysmal fall, losing its anchor to the dollar and falling below the 3 cents mark.
UST is not the first algorithmic stablecoin to suffer such a rapid collapse. Last year, the protocol Iron Finance (in which we find IRON and TITAN tokens) also collapsed, losing nearly $2 billion in value in the space of a day.
But this collapse happens in a very specific context of Bear Market. Above all, it shows that the UST has never been truly stable, since it was never fully guaranteed. Its pseudo stability actually depended on the interest in Terra Blockchain, largely due to the unsustainable returns of its Anchor protocol….
Another key element of the Terra son ecosystemt interest rates on UST deposits offered through Anchor protocol. In theory, the system pushes traders to make quick profits by burning and minting coins. But as recent events have shown, it is far from infallible.
With a rate ofAPI at more than 20%, the protocol has attracted a huge number of investors and speculators. THE UST crash is partly explained by the unrestrained use of the protocol…
😮 Read the article: How does DeFi achieve such high APYs? Madness?
Updates to algorithmic stablecoins?
Do Kwon, the co-founder of Terraform Labs and the Luna Foundation Guard (LFG) had already announced their intention to diversify their stash by purchasing $10 billion in bitcoins. This reassured investors for a time. But LFG ended up liquidating its BTC holdings when LUNA token started to decline. The wallet was emptied of its 42 bitcoins. This literally flooded the market. Which, for many observers, explains the record fall of bitcoin, which fell to $350. This is the lowest price since December 26.
For many, it was precisely this announcement which aimed to deviate from the basic protocol to purchase several billion dollars worth of Bitcoin which raised the alarm.
We are indeed entitled to wonder why the Terra team would have done this if she really had confidence in her stabilization algorithm?
🌚 Towards regulation of algorithmic stablecoins?
However, UST is not the only one responsible for the storm that stablecoins are currently going through. THE bear market current situation is not only a matter of terra blockchain, Spread the word. Other flaws were soon revealed, such as the announcement that in the event of bankruptcy, Coinbase pourrait leave with the assets of its users. Or the fact that another algorithmic stablecoin, Neutrino (USDN), also began to slip from his anchorage. Without forgetting Tether (USDT), the leading stablecoin in terms of market capitalization, which also briefly lost its anchor. Worse still, Tether is often accused of not having the dollar assets in reserve that it claims to have…
US Treasury Secretary Janet Yellen told Congress on May 10 that the Terran debaclereinforced the need for a "coherent federal framework" to regulate stablecoins. Regulators have proposed regulating stablecoins on the same model as banks.
As stablecoins are often compared to money market funds, regulators want to ensure that their operators have sufficient assets to pay their customers in the event of a system failure.
In the case of algorithmic stablecoins, many believe that their operators should guarantee larger reserves than for traditional stablecoins.
It seems that investors have now lost confidence in algorithmic stablecoins... However, trust is the very basis of a currency, as you know...
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Indeed, since the fall of UST, I have struggled to trust algorithmic stablecoins.
When Justin Sun proposed his stablecoin USDD (which is still a copy of the ust) on his Tron network, my first reaction was: "why take this risk?!". To supposedly avoid the same mistake as Terra, he overcollateralizes by 218%. Frankly, I still don't see why this would change the game...
Then I discovered that now (even though he has been talking about it for several months) the existence of another algorithmic stablecoin for the Cardano network: the Djed. Being a cardano fan but wary, I preferred to even check what it is made of. There is a 2D animated video on how it works and it looks good to me but the safety explanation was missing. I found an article that explained that to prevent the drop, it will prevent people from buying or selling once the reserve price limit is reached. It seems like they've thought of everything. I admire it but remain wary because I don't know if I understood everything correctly. And that's why I'm writing to you to ask if you're interested in writing an article about this.