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Stablecoins continue to play a crucial role in the cryptocurrency world. While recent incidents involving Terra/UST, USDD, DEI and NIRV have shown that these assets are not always stable, they will remain relevant for some time to come. However, the future of stablecoins could look a little different than what people are used to today.
What are stablecoins?
A stablecoin is a blockchain-based asset that maintains a value of 1$ – or 1 EUR/GBP/regardless of the currency it is pegged to – at all times. Centralized stablecoins like USDT and USDC rely on bank reserves to ensure that every asset in circulation has equivalent backing in fiat currency or other financial instruments. Although these stablecoins include an intermediary — Tether for USDT and Circle for USDC — they are also the “safest” stablecoin options due to their fiat currency hedging.
Other projects may explore an algorithmic approach to maintain their bond. A good example is DAI, the native stablecoin of the Ethereum ecosystem. Users can provide cryptocurrency collateral to purchase DAI, although the MakerDAO protocol forces users to adhere to a 150% collateral ratio. You must provide $1.5 worth of crypto assets to purchase $1 DAI. Over-collateralization always ensures enough reserve money to convert from DAI to crypto assets.
Users often use stablecoins to trade against other cryptoassets – looking for a profit, to pay back borrowed stablecoins – or for yield farming by providing liquidity on decentralized exchanges. In addition, a stablecoin can be used as a means of payment for goods and services since they are not subject to fluctuations in value.
Unfortunately, other stablecoins attempt to maintain a peg to fiat currency without fiat currency reserves or over-collateralisation. Numerous currencies that have attempted this approach have failed spectacularly, yet developers continue to attempt the impossible. This goal may not be impossible, but the approaches tried so far have failed miserably.
The spectacular fall of Luna/UST
2022 has gotten off to an interesting start for the stablecoin industry. While these tied assets maintain relatively large market caps – at least as far as USDT and USDC are concerned – the algorithmic versions pose some serious problems and risks. This became even more evident when UST, the algorithmic stablecoin on the Terra Network, crashed from its peg to levels below $0.01 in a matter of days.
Several factors are contributing to the demise of this popular stablecoin. The ongoing market volatility has been a concern as UST has been mostly backed by other cryptocurrencies. As this collateral began to decline in value, maintaining market peg became increasingly difficult. Omid Malekan, a professor at Columbia Business School, went one step further and labeled UST as an “inevitable death spiral”.
More specifically, using an algorithm and a sister currency – LUNA – to maintain a $1 peg is virtually impossible. Users could imprint UST and see the corresponding value in destroyed LUNA. However, merchants can always discount 1 UST for $1 in LUNA, regardless of whether UST is worth $1. This eventually became a major problem leading to massive LUNA inflation while UST continued to depreciate. Eventually both currencies lost all value]and the stablecoin was abandoned altogether.
UST’s demise was not entirely unexpected. Various stablecoins have tried an algorithmic approach without much success. UST lasted much longer than previous attempts, but complete collapse brings the same fate. Additionally, UST depegging forced more users to cash out their stablecoin in favor of LUNA, inflating the value of this asset and perpetuating the vicious cycle.
Learn from past mistakes
It is obvious that the problems affecting LUNA and UST must not be repeated. Unfortunately, it seems that algorithmic stablecoins are not going away either. Despite the recent problems NIRV and OF, there is still hope that such currencies can maintain their fiat currency peg through algorithms. Again, this isn’t an impossible goal, but the previous approaches clearly don’t work.
Joining the ranks of crypto-collateralized stablecoins is the GTON Capital Dollars (GCD). It maintains a soft peg to the US dollar through smart contracts and can be minted by providing cryptocurrencies as collateral. Additionally, GCD will become the gas currency of GTON Network, a bullish rollup network built on top of Ethereum. Instead of using volatile crypto assets to cover transaction fees, they can do so with a stablecoin.
It makes sense to create a way to reduce the proliferation of GCDs by tying them to transaction fees. The success of this stablecoin will depend on the level of interest in the GTON Network, which will enter beta in September 2020. Other Optimistic Rollups solutions and crypto-backed stablecoins are competing for similar traction, but GCD will be the first asset to be used as a gas currency for rollups, which may give it a competitive edge.
Other projects releasing a new stablecoin are Aave Protocol (GHO, overcollateralized with crypto assets), newly launched stablecoin Beanstalk Farms (BEAN, previously hacked for over $75 million), Stablesats (Lightning Network-based Derivatives to create a Bitcoin-backed synthetic coin). US Dollars), etc. The space continues to heat up and become more competitive with different ideas and approaches, no doubt creating a lot of new opportunities.
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