Dialogue xy: Algorithmic stablecoins can change the oligopolistic structure of stablecoin financing assets

This article is the content of the eighteenth event of the Chain Catcher community, organized by Henry.

In the fourth quarter of 2020, algorithmic stablecoins became popular, once being hailed as the slogan of the post-DeFi era. According to analysis, algorithmic stablecoins rely on algorithms designed to ensure price stability, and their existence resembles a social experiment.

Recently, the eighteenth session of the Catcher Academy, hosted by Chain Catcher, invited xy from xy Studio to give a thematic presentation on "Understanding the Logic and Potential of Algorithmic Stablecoins from 0 to 1."

During the event, xy shared with community users the essence and operational mechanisms of algorithmic stablecoins, investment strategies, development trends, and many other valuable insights. The full text is organized below, hoping to inspire readers.

Chain Catcher: Algorithmic stablecoins are a hot topic recently; why have they become popular? Can you explain the operational mechanism of algorithmic stablecoins to us?

xy: The popularity of algorithmic coins can be traced back to ampl, which is this well-known "splitting coin" that brought continuous heat and traffic to the Rebase algorithm concept, leading to the flourishing of algorithmic coins in the fourth quarter of 2020.

Regarding the operational mechanism, algorithmic stablecoins maintain their price at the pegged target price (currently mostly USD) through a regular rebase mechanism. If the coin price is higher than its pegged target, it uses an active inflation mechanism (positive rebase, directed issuance of coins, etc.) to fill the premium. If the coin price is lower than its pegged target price, it uses an active deflation mechanism (negative rebase, selling coupons, etc.) to provide momentum for restoring the pegged price.

Chain Catcher: Many people previously believed that "algorithmic stablecoins are a false proposition," that they are unstable and lack long-term value. What do you think of this statement?

xy: Personally, I do not agree with this blunt view. If it is only aimed at the pure rebase algorithmic stablecoins during the ampl-dominated period, then such a view is tenable.

Although the pure rebase of ampl stabilizes the coin price at the pegged target price, its rebase's volatile coin supply only provides speculation and gambling opportunities for retail investors. Due to the daily rebase of the coin supply, it fundamentally lacks the premise of being an ecological financing asset.

Moreover, the team seems to have turned a blind eye to this situation, so it is reasonable to question their motives. However, as algorithmic stablecoins have developed to this point, I believe valuable projects have emerged, and we can already see products that can compete with the largest on-chain stablecoin issuance schemes in the industry. In terms of issuance methods and schemes, rebase has clearly brought richer liquidity to the issuance of collateralized assets.

Chain Catcher: Some believe that algorithmic stablecoins are "splitting coins." In your view, what is the essence of algorithmic stablecoins?

xy: First of all, the term "splitting coin" refers to pure rebase coins led by Ampl, and the baseprotocol that was extremely popular in November is also included.

However, I believe that the second phase of algorithmic stablecoins, led by esd and basis, has moved beyond merely providing splitting volatility. They have made theoretically supported improvements based on ampl's rebase, such as directing the positive rebase of inflation issuance to locked DAO, LP bonds, or equity coin holders, and improving the negative rebase of deflation by introducing coupons, selling (burning tokens), and bond exchanges (similar to the coupons mechanism) as ecological option-like bonds.

These changes have transformed "algorithmic stablecoins" from being devoid of any ecology into a foundational "on-chain stablecoin" with construction potential.

At the same time, directing rebase towards equity and bonds allows this "algorithmic stablecoin" to have the potential for ecological expansion, becoming a financing asset with stable volume and price on the user side.

Chain Catcher: How do you view the current competitive landscape of algorithmic stablecoins and the surge of projects like ESD, BASIS, and FRAX?

xy: I will summarize from the perspectives I can see, but I still maintain some distance because the market is ever-changing, and I hope everyone thinks for themselves.

In terms of market capitalization, esd > basis > frax; in terms of the simplicity of the token economic model, frax > esd > basis; in terms of volatility observed in the mechanism setup, I believe it is basis > esd > frax.

The community categories and economic mechanisms behind the rise and fall of these projects are different; the fluctuations are based on speculative views. Overall, it is driven by the influx of hot money into new concept tracks.

However, if they can remain after entering, it indicates that the project ecology has opportunities. This opportunity could be a construction opportunity or a speculative opportunity, but it all indicates the vitality of the project.

Chain Catcher: What dimensions would you analyze to decide whether to invest in an algorithmic stablecoin project? Can you review a process where you successfully profited from an algorithmic stablecoin project?

xy: The dimensions for analyzing algorithmic stablecoins are no different from those for analyzing general projects. They can be divided into three aspects: first, whether the project's economic model is logically coherent; second, whether the basic improvements to rebase are driven by real demand; third, fundamental information (team, development, token distribution, etc.).

I do not have experience in discovering a project from scratch; rather, I have gained returns by studying its economic model and token distribution after its popularity increased.

For example, before the last round of expansion for esd, I discovered that only a fraction of its circulating pool funds could raise the coin price above water, so I bought some coupons at a 45% premium. For me, this was a high-probability investment.

Chain Catcher: What dimensions can current algorithmic stablecoin projects innovate in?

xy: I may be relatively conservative regarding innovation. From a project perspective, Frax's scheme is currently the one I am most optimistic about. This scheme should produce several competitors. I suggest focusing less on innovation and more on ecological development. If only pseudo-demand innovations akin to brainstorming are pursued, it will only lead to foolish money Ponzi schemes. Of course, this is good news for gamblers who enjoy speculative trading.

Chain Catcher: As a pioneer of the three-coin separation model, BASIS has brought many opportunities to newcomers, but there are still loopholes in its model. What areas need improvement?

xy: Basis has not yet entered a development phase with a viable ecology. If one were to challenge its model, it would need to wait until it completes a full cycle of above-water/below-water operations.

However, in terms of economic mechanisms, basis provides the most elastic mechanism among these projects. For example, the separate coinization of equity and debt, as well as the indefinite nature of bonds and the violent algorithm of bac redeeming bab, indeed make it the most refined in terms of high volatility and elasticity.

Chain Catcher: The speculative nature of algorithmic stablecoins is inevitable. Will it always be constrained by extreme expansion and contraction cycles? Why?

xy: Due to the absence of a limit-up/limit-down mechanism, it should be said that the speculative nature of developing projects is unavoidable.

I also do not believe that algorithmic stablecoins will always be constrained by such unhealthy cycles. For instance, frax has shifted the long and irregular expansion and contraction periods to the market value of its equity tokens. Moreover, in my view, esd has already entered a relatively stable cycle, and what it faces now is more likely a ceiling issue.

Chain Catcher: Investors face very low costs when entering the stablecoin mining field, which is currently a highly rewarding investment method in the market. What risks do they face? What are some good strategies and suggestions?

xy: Since all data is on-chain, the risks investors face are clearer than those of other projects. Therefore, when rationally investing in such projects, there are actually more clear opportunities. The suggestion is to observe more and act less; understand it before entering.

I have provided examples of investment strategies above. Once you understand its operational mechanism, at least you can ensure you do not lose money, and it would be better to discuss making money on that basis.

Additionally, those with strong mathematical skills may find it easier to engage with algorithmic stablecoins, as many financial outcomes can be calculated using formulas.

Chain Catcher: Algorithmic stablecoins are still in the early stages of development. What trends do you foresee for their future? How do you view the ultimate fate of algorithmic stablecoins?

xy: "Bold prediction," next year there will be 1-2 projects exceeding 10 billion USD, recognized by mainstream DeFi. What we currently see, such as esd being listed on curve trading pairs, are all proofs of ecological development.

The emergence of algorithmic stablecoin projects will fundamentally change the current situation where on-chain native stablecoin financing assets are dominated by makerdao.