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Ethereum co-founder Vitalik Buterin has shared two thought experiments on how to evaluate whether an algorithmic (algo) stablecoin is sustainable.<\/p>\n
Buterin\u2019s comments were sparked by the multi-billion dollar <\/a>losses caused by the collapse of the Terra<\/a> (LUNA) ecosystem and its algo-stablecoin TerraUSD (UST). <\/p>\n In a May 25 blog post, Buterin noted<\/a> that the increased amount of scrutiny placed on crypto and DeFi since the Terra crash is \u201chighly welcome,\u201d but he warned against writing off all algo-stablecoins entirely. <\/p>\n \u201cWhat we need is not stablecoin boosterism or<\/em> stablecoin doomerism, but rather a return to principles-based thinking,\u201d he said: <\/p>\n \u201cWhile there are plenty of automated stablecoin designs that are fundamentally flawed and doomed to collapse eventually, and plenty more that can survive theoretically but are highly risky, there are also many stablecoins that are highly robust in theory, and have survived extreme tests of crypto market conditions in practice.\u201d<\/p><\/blockquote>\n His blog focused on Reflexer\u2019s fully Ether (ETH)-collateralized RAI stablecoin<\/a> in particular, which isn\u2019t pegged to the value of fiat currency and relies on algorithms to automatically set an interest rate to proportionally oppose price movements and incentivize users to return RAI to its target price range. <\/p>\n Buterin stated that it \u201cexemplifies the pure \u2018ideal type\u2019 of a collateralized automated stablecoin\u201d and its structure also gives users an opportunity to extract their liquidity in ETH if faith in the stablecoin crumbles significantly. <\/p>\n The Ethereum co-founder offered two thought experiments to determine if an algorithmic stablecoin is \u201ctruly a stable one.\u201d <\/p>\n In Buterin\u2019s view, if market activity for a stablecoin project \u201cdrops to near zero\u201d, users should be able to extract the fair value of their liquidity out of the asset. <\/p>\n Buterin highlighted that UST doesn\u2019t meet this parameter due to its structure in which LUNA, or what he calls a volume coin (volcoin), needs to maintain its price and user demand to keep its USD peg. If the opposite happens, it then almost becomes impossible to avoid a collapse of both assets. <\/p>\n \u201cFirst, the volcoin price drops. Then, the stablecoin starts to shake. The system attempts to shore up stablecoin demand by issuing more volcoins. With confidence in the system low, there are few buyers, so the volcoin price rapidly falls. Finally, once the volcoin price is near-zero, the stablecoin too collapses.\u201d<\/p><\/blockquote>\n In contrast, as RAI is backed by ETH, Buterin argued that declining confidence in the stablecoin would not cause a negative feedback loop between the two assets, resulting in less chance of a broader collapse. While users would also still be able to exchange RAI for the ETH locked in vaults which back the stablecoin and its lending mechanism.<\/p>\n Buterin also feels it is vital for an algo-stablecoin to be able to implement a negative interest rate when it is tracking \u201ca basket of assets, a consumer price index, or some arbitrarily complex formula\u201d that grows by 20% per year. <\/p>\n \u201cObviously, there is no genuine investment that can get anywhere close to 20% returns per year, and there is definitely<\/em> no genuine investment that can keep increasing its return rate by 4% per year forever. But what happens if you try<\/em>?\u201d he said. <\/p>\n He stated that there are only two outcomes in this instance, either the project \u201ccharges some kind of negative interest rate on holders that equilibrates to basically cancel out the USD-denominated growth rate built into the index.\u201d<\/p>\n1: Can the stablecoin \u2018wind down\u2019 to zero users?<\/h3>\n
2: Negative interest rates option required<\/h3>\n