As long as “stablecoin liquidity grows in proportion to each other,” there will never be true competition between stablecoins, says Frax Finance’s Sam Kazemian.
Stablecoin projects need to take a more collaborative approach to increase the liquidity of each other and the ecosystem at large, says Sam Kazemian, founder of Frax Finance.
Speaking to Cointelegraph, Kazemian explained that as long as “stablecoin liquidity grows proportionally to each other” through shared liquidity pools and collateral systems, there will never be true competition between stablecoins.
Kazemian’s FRAX stablecoin is a fractional-algorithmic stablecoin where parts of its supply are backed by collateral and other parts are algorithmically backed.
Kazemian explained that growth in the stablecoin ecosystem is not a “zero-sum game” as each token is increasingly interdependent and dependent on the performance of the other.
FRAX uses Circle’s USD Coin (USDC) as part of its collateral. DAI, a decentralized stablecoin managed by the Maker Protocol, also uses USDC as collateral for more than half of the tokens in circulation. As FRAX and DAI continue to expand their market caps, they will likely need more USDC collateral.
However, Kazemian pointed out that one project’s decision to scrap another could have a negative impact on the ecosystem.
“It’s not popular to say, but if Maker dropped their USDC, it would be bad for Circle because of the returns they’re earning.”
USDC is the key
The current top 3 stablecoins by market cap, in order from the top, are Tether (USDT), USDC, and Binance USD (BUSD). DAI and FRAX are both decentralized stablecoins, occupying the fourth and fifth place among the top performers.
USDC has seen the most growth of all three over the past year, with its market cap more than doubling to $55 billion as of this past July, putting it almost within reach of USDT, according to CoinGecko.
Kazemian believes that USDC’s proliferation across the industry and arguably greater transparency about its reserves should make it the most valuable collaborative stablecoin within the ecosystem.
He called USDC a “low-risk, low-innovation project” and acknowledged that it serves as a foundation for further innovation from other stablecoins. He said:
We and DAI are the innovation layer above USDC, like the decentralized bank above a classic bank.
Algo stablecoins don’t work
Although the FRAX stablecoin is partially algorithmically stabilized, Kazemian says that purely algorithmic stablecoins “just don’t work.”
Algorithmic stablecoins like Terra USD (UST), which crashed dramatically in May, maintain their peg through complicated algorithms that adjust supply to market conditions rather than traditional collateral.
In order to have a decentralized on-chain stablecoin, it must have collateral. Does not have to be overcollateralized like Maker, but needs exogenous collateral.
The death spiral in Terra’s ecosystem became apparent when UST, now known as USTC, lost its bond.
The protocol started minting new LUNA tokens to ensure there are enough tokens backing the stablecoin. The rapid minting drove the price of LUNA, now known as LUNC, down, triggering a full retail token sell-off and shattering any hopes of re-binding.
In the weeks leading up to the UST deprecation, Terraform Labs founder Do Kwon stated that his project would need to partially back the stablecoin with various forms of collateral, most notably BTC.
In the end even Terra realized their model wouldn’t work,” added Kazemian, “so they started buying up other tokens.
By the end of May, Terra had sold almost all of its $3.5 billion worth of BTC.
Terra has subsequently brought down other projects, including Deus Finance’s other algo stablecoin DEI, which has also not reverted to dollar pegs at the time of writing.
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