Despite the recent collapse of Terra and general concerns about stablecoins, DeFi proponents continue to advocate for algorithmic stablecoins.
After the collapse of the stablecoin Terra (UST), supporters of DeFi, especially algorithmic stablecoins, reject amortization, believing that the future of DeFi depends on the existence of the stablecoin.
“In the next five to seven years, the known stables will exist,” says Hassan Bassiri, who works at Arca, a patron of Terra.
Algorithmic stablecoins are a subset of stablecoins or special digital assets pegged to some fiat currency. To remain pegged to fiat, stablecoin issuers typically have funds available to satisfy large withdrawals from holders who wish to exchange their coins for cash.
At least that’s a theory.
On the other hand, algorithmic stablecoins are a mix of smart contracts and computer code that remain pegged to fiat.
“If you really want to make something like this, you have to have some really agile tech, and you have to have this crazy, marvelous look in your eyes.” say Tarun Chitra, CEO of crypto financial modeling platform Gauntlet.
Volume Key to DeFi and Terra’s Disintegration
Terraform Labs, the company behind UST and Luna, relied on deposits deposited on the Anchor protocol, a sort of cryptocurrency bank, to maintain a balance between Terra and Luna. Terraform Labs is offering a 20% annual return on staked Terra tokens, encouraging investors to invest in UST with funds made possible by the stimulus package following the COVID-19 pandemic.
High yields depend on many deposits. However, as stimulus funds were exhausted as central banks halted their stimulus plans, investment in decentralized projects, including the UST, began to decline, removing an important pillar of decentralized finance. – Volume in and out of the Anchor. However, UST-related deals were taking place elsewhere on DeFi.
The first red flags for UST occurred when an entity or group of entities using the DeFi protocol curve swapped UST for other stablecoins USDC, Tether and Dai. As a result, this led to a fall in the price of UST on the dollar peg.
When UST falls below the $1 peg, traders can “burn” 1 UST by purchasing a sister token called Luna for $1 worth, effectively increasing the scarcity of UST and pushing the price back to $1. When the value of UST exceeds $1, Luna tokens can be burned to generate 1 UST, increasing circulation and lowering the price of UST.
As UST holders started burning UST for the crashing Luna, more Luna was needed to make up for $1. This algorithm created more Luna, but this further lowered Luna’s price, requiring more Luna to make $1.
Eventually, the perpetual algorithm caused UST to drop to $0.20 on May 11th.
The “sun” will shine again
Tron founder Justin Sun defended Terra in a recent interview with Bloomberg, acknowledging that there are problems with algorithmic stablecoins that new projects can learn from.
He described Tron’s foray into USDD, an algorithmic stablecoin that uses a Terra-like algorithmic arbitrage mechanism to keep a peg on the US dollar. The stablecoin’s peg is maintained by Alameda Research and Amber Group funding, and returns are adjusted “market conditions”.
Sun believes in algorithmic stablecoins with no government oversight and does not believe the ban will help the industry.
“If regulators decide to ban stablecoins tomorrow, such as when China announced a cryptocurrency ban, it would pose a major risk to the entire cryptocurrency system,” he said. He said, referring to the stablecoin USDC issued by Circle, “there should be a stablecoin that is not controlled by a third party outside of the cryptocurrency.”
But not everyone is sure. Ryan Watkins, co-founder of crypto hedge fund Pangea Fund Management, said the sector is over.
“I was hoping that Terra could turn in time.”
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