The collapse of UST, can algorithmic stablecoins continue to play

Industry News2years go (2022)发布 Dexnav

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With the collapse of UST, can algorithmic stablecoins continue to play?

The crypto market as a whole fell after the Fed announced a rate hike, and subsequently crypto panic increased. At the same time, Terra Eco Team LFG announced the adjustment of the withdrawal gap of the UST-3Crv pool. The giant whale address dumped UST, causing the first algorithmic stable coin UST to be severely de-anchored, followed by the LUNA collapse into a death spiral. A series of operations to besiege UST further pulled down the market and made the market witness the game of algorithmic stablecoins again.

Terra (token Luna) is a public chain ecosystem built around a stablecoin (UST), and Terra has tied its stablecoin deeply to its public chain business. The demand for stable coins is high enough to attract users and start building the ecosystem. The setup mechanism is that for every UST minted, $1 worth of Luna must be burned, and Luna maintains the UST pegged to the U.S. dollar through arbitrage and minting tax mechanisms. In the process, the actual controller obtains funds by cashing out or destroying the Luna; the cash out continues to be subsidized to promote the ecological cycle. However, when the UST-3Crv mining pool was shorted during the exit period and the market was volatile, it increased users' panic and amplified the sell-off phenomenon. Meanwhile, the LFG rescue mechanism was difficult to maintain and a series of games played out in front of crypto users. Phenomena such as algorithm imbalance, stable coin de-anchoring, and project token collapse.

As the largest algorithmic stablecoin, the collapse of UST has once again sparked a heated market debate. Are algorithmic stablecoins unsustainable? Is a death spiral inevitable? Isn't an algorithmic stablecoin a good choice?

Top ranked stablecoin tokens

According to data from May 12, the top five stablecoin tokens by market cap are USDT, USDC, BUSD, UST and DAI.

From the perspective of major stablecoins, there are three main models of stablecoins: fiat-collateralized stablecoins (USDT, USDC, BUSD), cryptocurrency-collateralized stablecoins (Dai), and algorithmic stablecoins (UST). These three models also reflect the path of stablecoins from "connecting to the fiat world" to "crypto-native coins". From the current development, although the algorithmic stable coins of crypto-native coins are imaginative and disruptive innovations, it is difficult to complete the regulation based on market will and algorithm. It is filled with a lot of gaming, speculation and arbitrage, and is naturally full of controversies in the market.

Fiat-backed stablecoins

First of all, stablecoins were born in the context of the high price volatility of cryptocurrencies. As a medium of exchange, it connects the world of digital currencies with the world of fiat currencies.

Bitcoin, ethereum and other mainstream crypto assets are non-stable coins, and their values change constantly with market fluctuations. In order to better enable the trading and exchange of assets and facilitate the connection with the real world, crypto practitioners want to create a "stable coin" with relatively stable value.

This is when the most common and arguably simplest fiat-collateralized stablecoin emerged, typified by USDT. Tether Limited, founded by Bitfinex in 2014, issued USDT, a stable-value cryptocurrency that is currently at the top of the stablecoin market. depositing $1 to anchor the USD to ensure stability.

In this fiat reserve collateral model, the stablecoins held by users are actually IOUs for the stablecoin issuing company. The centralized issuing company pledges its own assets to issue stablecoins. Each stablecoin corresponds to its existence and bank. The equivalent asset ensures that the stablecoins held by the user can be converted into fiat currency in proportion to their value.

With stable coins collateralized by fiat currencies, such as USDT, users achieve two-way exchange of fiat currencies-USDT (issued by centralized companies)-crypto assets.

The advantages of the model are obvious, the process is considerable, it is secured by assets, and the technology is simple to implement. Of course, the disadvantages are also obvious. The issuing company of the stable coin is a centralized private company that cannot prove whether it is fully collateralized, and there is a risk that the centralized company will go bankrupt and run away. Once there is a lack of trust, there will be thunderstorms, plunges, etc.

Of course, regulated stablecoins such as USDC and mainstream platform stablecoins such as BUSD have subsequently emerged.

Digital Asset Collateral Model Stable Coin

If the first generation of fiat-collateralized stablecoins mentioned above was an important bridge between fiat and cryptocurrencies. Then the second generation of digital asset collateral model stablecoin (Dai) emerged, opening the way for the development of decentralized stablecoins.

Digital Asset Collateral Model The stablecoin model is to issue digital currencies anchored to fiat prices by collateralizing digital assets on blockchain smart contracts. In this model, the collateral itself is mainstream digital currencies such as BTC and ETH. Since the collateral itself is decentralized and can be executed through smart contracts, the trust risk of the fiat collateral model is eliminated.

The main advantage is that it reflects the idea of decentralization of blockchain. The collateral is locked in a smart contract, open and transparent, cannot be misappropriated or frozen, and no one or institution can control the issuance of stable coins.

However, there is a downside. Due to the huge price fluctuations of collateralized cryptocurrencies, it is easy for "bankruptcies", known as "liquidations", to occur. The occurrence of a liquidation causes prices to continue to fall, which in turn leads to more liquidations, creating a chain reaction. For example, a series of liquidations occurred after the Black Swan event of March 12, 2020. Subsequently, in response to market risk, MakerDAO introduced some centralized assets as collateral, such as USDC, wBTC, etc. For stability, MakerDAO made certain trade-offs in terms of decentralization.

Algorithm Stable Coin

As the aforementioned first and second generation stablecoins gradually became widely adopted and the vision of pursuing native coins in the crypto space continued to evolve, unsecured/algorithmic (mint power model) stablecoins were born.

The mint model of stablecoin differs from the first two collateral models. While the first two use centralized and decentralized assets as collateral, the minting model is an algorithmic central bank model. The central idea is to automatically adjust the market through algorithms. The supply and demand of tokens are then stabilized at a fixed ratio of the price of the tokens to the fiat currency.

So how is the algorithm automatically adjusted? Simply put: unsecured/algorithmic stablecoins can be called mint model stablecoins. This model, as the name implies, truly implements native tokens in the crypto space, similar to the real world. Functionally, they have a monetary policy similar to the way central banks manage money. In reality, central banks can maintain relatively stable purchasing power by adjusting interest rates (reserve ratios, benchmark rates, etc.), bond repos and reverse repos, adjusting foreign exchange reserves, etc. Adjustments mean that algorithmic banks can also sell, buy back shares, and adjust mining rewards to keep the price of stable coins relatively stable.

Algorithmic stable coins mainly want to maintain stable stable coin prices by simulating the central bank's monetary policy function, increasing market supply when the stable coin price is higher than the anchor price, and then restoring supply when the stable coin price is lower than the anchor price. Equalization. Algorithmic stablecoin is arguably one of the most imaginative and disruptive projects to date. It realizes the function of a central bank to regulate the circulation of money without a central bank, creating a "no central bank". The "central bank model".

Algorithmic stablecoins appeared in 2018, but were not as popular as they are now. The originator of algorithmic stablecoins is AMPL (Ampleforth), which is also the first generation of algorithmic stablecoins. Then came the ESD model, Basis model, FRAX partial algorithmic stablecoin, etc. Interestingly, the emergence of algorithmic stable coins attracted the attention of the industry with "unstable prices". 2020, the surging market of ESD, BASIS, FRAX, etc. led by AMPL, kept the fever of algorithmic stable coins high.

Market researchers noted that at the time it was discovered that people could speculate on the algorithmic properties of algorithmic stablecoins themselves, resulting in high returns. Algorithmic stablecoins are arguably one of the most imaginative and disruptive innovations to date, but are hardly fully regulated by the will of the market and algorithms. I want to completely offset the price control brought by centralized institutions through algorithms, but I don't have enough market acceptance to maintain my own price stability. By giving room for cold-start arbitrage, most of the users who enter are there to capture the excess returns of the early "rich spiral" rather than actually using the algorithmic stablecoin as a payment tool or store of value.

New Trends in Stable Coin Regulation

It is worth mentioning that with the rapid fermentation of the UST loss of anchor, many regulators have also put the regulation of stablecoins on the agenda.

May 12 (Bloomberg) -- U.S. Treasury Secretary Yellen: Terra is a real example of stablecoin risk. The U.S. Treasury Department is preparing a report on stablecoin risk. Yellen reiterated the need for a comprehensive stablecoin framework.

In addition, Ashley Alder, chairman of the International Securities Commission (IOSCO), an association of market regulators, said that a joint body responsible for coordinating global cryptocurrency regulation is urgently needed and could become a reality within the next year.

On May 10, the Federal Reserve released its latest financial stability report on Monday, highlighting the risk of runs on stablecoins. The report writes that some money market funds (MMFs) and stablecoins remain vulnerable to runs and that domestic bank capital risk is low, but some money market funds, bond funds and stablecoins still have structural vulnerabilities. Back in January, researchers at the Federal Reserve published a study on the risks and benefits of stablecoins, saying the Financial Stability Oversight Council could step in to oversee stablecoins if Congress does not enact new laws targeting the industry.

Speaking at a financial markets conference hosted by the Atlanta Fed on May 11, Nellie Liang, Under Secretary for Domestic Financial Affairs at the U.S. Treasury Department and head of the President's Working Group on Financial Markets (PWG) report, said that even now it is largely unaffected. Prudentially regulated stablecoins must also comply with national-level Bank Secrecy Act (BSA) and anti-money laundering (AML) requirements.

On May 12, the European Commission is considering severely limiting the ability of stablecoins to replace the widespread use of fiat currencies, according to a document. EU finance ministers have proposed tough measures aimed at preventing stablecoins from replacing the euro and called for a halt to issuance in cases where the volume of transactions exceeds 1 million or 200 million euros in a single day. The document is marked "off paper," which means it does not reflect the Commission's official position. EU lawmakers and the government are trying to finalize a landmark cryptocurrency law called the Market Regulation of Crypto Assets (MiCA), which the Commission will negotiate behind closed doors at a later stage.

In April this year, the UK Treasury also expressed its intention to pass legislation to bring certain stablecoins under regulation. Some stablecoins have the potential to be used as multiple payment methods, including for retail customers. A revised electronic currency framework could provide a consistent framework to regulate the issuance of stablecoins and the provision of wallets and escrow services.