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“What we need is not stablecoin empowerment or stablecoin doomerism, but rather a return to principles-based thinking”
Vitalik Buterin evaluated whether an algorithmic stablecoin is sustainable.
Buterin’s comments stemmed from the multi-billion dollar losses caused by the collapse of the Terra ecosystem and its algo stablecoin TerraUSD.
He welcomed the increasing amount of scrutiny on crypto and DeFi since the Terra crash.
“What we need is not stablecoin empowerment or stablecoin doomerism, but rather a return to principle-based thinking”
While there are many automated stablecoin designs that are fundamentally flawed and doomed to crash, and many more that can theoretically survive but are pretty risky, there are also many stablecoins that are pretty solid in theory and have survived crypto tests.
Focused on Reflexer’s fully Ether-backed RAI stablecoin.
He stated that this is an example of a collateralized automated stablecoin, giving users the opportunity to take out their liquidity in ETH should faith in the stablecoin drop significantly.
Buter offered 2 ideas for determining whether an algorithmic stablecoin is truly stable.
1 Can the stablecoin ‘wind down’ to zero users?
If market activity for the stablecoin project approaches zero, users should be able to extract the fair value of their liquidity from the asset.
He stressed that LUNA, or what he calls Volcoin, does not meet this parameter as UST has to maintain its price and user demand to maintain the US dollar stable. On the contrary, the collapse of both assets will be inevitable.
First, the volcano price is falling. Then, the stablecoin starts to shake. The system seeks to increase the demand for stablecoins by issuing more volcoins. With low trust in the system, there are few buyers, so the price of volcoin is falling fast. Finally, when the volcoin price is close to zero, the stablecoin crashes too.
Buterin argued that waning trust in the stablecoin would not cause a negative feedback loop between the two assets, resulting in a wider collapse. Users will still be able to exchange RAI for ETH locked in vaults that support the stablecoin and lending mechanism.
2 Negative interest rates option required
He thinks it’s vital for a stable algo-stablecoin to be able to charge a negative interest rate while following a basket of assets, a consumer price index, or some complex formula that grows by 20% per year.
Clearly, there is no real investment that can generate returns close to 20% per year, and there is absolutely no real investment that can continue to increase the rate of return by 4% per year indefinitely. But what happens if you try?
He stated that in this case there are only two outcomes, either the project imposes some kind of negative interest rate on the balance holders to basically cancel the growth rate in USD placed in the index. Or by turning into a Ponzi, providing stablecoin holders with incredible returns for a while until it suddenly crashes with a bang.
Buter closed his speech with these words:
It may be fragile for other reasons, or there may be bugs, or there may be vulnerabilities in management. But steady state and state robustness should always be one of the first things we check.
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