Finding the native anchor of algorithmic stablecoins
Algorithmic stablecoins are expected to become a major form of currency in the future decentralized financial world.Author: Kyle, Bing Ventures
Key Points:
- Bitcoin and Ethereum are forming a robust value network. More importantly, they constitute the trust foundation of cryptocurrencies, which also means that stablecoin projects attached to the value network have solid asset backing. However, improvements in user experience and the scale of network-locked assets will be the main differentiators of their value metrics;
- Super applications with a specific user base issuing their own stablecoins essentially bypass trust intermediaries and form minting contracts directly with their users. In this case, protocols like Curve, Aave, and Synthetix will become "super pawnshops." Their users will experience customized financial services faster and more smoothly than in the real financial world. The user base and business innovation determine their ceiling, and the author is more optimistic about the development of Synthetix;
- Fully on-chain deployed algorithmic stablecoins have the potential to achieve true decentralization, cross-chain interoperability, and infinite scalability. They can be freely issued, transferred, and traded on any chain, thus achieving cross-chain interoperability and portability.
- Additionally, in future developments, the delta-neutral stablecoin model may become an important trend, but implementing this model requires corresponding futures protocol support, as well as attention to risk control and market adaptability.
Algorithmic stablecoins are a type of algorithm-based cryptocurrency that primarily relies on algorithms to maintain price stability rather than being fully anchored to a reserve asset. However, in practice, some algorithmic stablecoins have failed to maintain price stability and face risks such as insufficient market liquidity and black swan events. Some believe this is due to the original sin of the algorithms.
This Bing Ventures industry research report focuses on the field of algorithmic stablecoins, discussing the types, mechanisms, and existing issues of current algorithmic stablecoins, as well as their further development directions. The author believes that as algorithmic stablecoins evolve, they will form a global stablecoin hierarchy. Some algorithmic stablecoins will become top-tier stablecoins, while others will constitute multi-layered peripheral supplements. Of course, unlike traditional currencies, the creation and trading of algorithmic stablecoins can occur globally, without being limited by the regulatory framework of any one country. Therefore, algorithmic stablecoins are expected to become a major form of currency in the future decentralized financial world.
The Original Sin of Algorithmic Stablecoins
Algorithmic stablecoins adopt mechanisms similar to shadow banking, creating offshore currency creation space. Unlike traditional stablecoins, algorithmic stablecoins do not require centralized institutions to maintain their stability; instead, they adjust market supply and demand through algorithms to keep their prices within a certain range. This form of currency also faces various challenges, such as insufficient market liquidity and risks from black swan events.
Algorithmic stablecoins utilize different algorithmic mechanisms to adjust their supply and demand to maintain their peg to a target value (usually the US dollar). Two classic algorithmic mechanisms have emerged:
- Rebase: Rebase algorithmic stablecoins influence the price of the stablecoin by changing the base supply. When the price of the stablecoin is above the target value, the protocol issues more tokens to lower the price; when the price is below the target value, the protocol destroys or repurchases some tokens to raise the price. For example, Ampleforth is an example of an algorithmic stablecoin that uses the Rebase mechanism.
- Seigniorage: Seigniorage algorithmic stablecoins support the value of the stablecoin by issuing another cryptocurrency. When the price of the stablecoin is above the target value, the protocol uses Seigniorage tokens as collateral to issue more stable tokens and sell them to the market; when the price is below the target value, the protocol uses market income to repurchase and destroy Seigniorage tokens. For example, Basis Cash is an algorithmic stablecoin that employs the Seigniorage mechanism.
In addition to these two basic mechanisms, some emerging algorithmic stablecoin projects have attempted different innovative methods to maintain their peg. For instance, Frax is a partially collateralized algorithmic stablecoin that combines fiat collateral with the Seigniorage mechanism. Frax uses USDC as part of its collateral and dynamically adjusts its collateral ratio based on market demand. Unlike traditional stablecoins, the value of algorithmic stablecoins is not entirely supported by external reserves but is adjusted through algorithm-based market mechanisms to maintain price stability. However, in recent years, algorithmic stablecoins have faced several issues, primarily including:
- Supply and demand imbalance: When market demand for algorithmic stablecoins decreases, their prices fall below the target value, leading the issuer to destroy or repurchase part of the circulating supply to restore balance. However, this may further undermine market confidence and demand, resulting in a vicious cycle; Terra is the most notorious example.
- Governance risks: Since the operation of algorithmic stablecoins relies on smart contracts and community consensus, there may be governance risks, such as code defects, hacking attacks, human manipulation, or conflicts of interest.
- Legal regulation: Because algorithmic stablecoins do not have physical assets as collateral or anchors, they face more legal regulatory challenges and uncertainties. It is expected that more countries or regions will restrict or prohibit the use of algorithmic stablecoins in the future.
Mainstream Mechanisms: Semi-Decentralized Over-Collateralized/Fully-Collateralized
Currently, there are various algorithmic stablecoin mechanisms commonly found in the DeFi space, among which MakerDAO's collateralized lending mechanism is representative. It issues DAI stablecoins by locking collateral such as ETH while adjusting the supply of stablecoins based on market demand; and funding pool mechanisms like Aave adjust stablecoin prices in real-time based on supply and demand relationships, maintaining price stability through arbitrage across multiple stablecoins.
GHO: Aave's Deposit Support
GHO is pegged to the US dollar (USD) and is a decentralized multi-collateral stablecoin. Users or borrowers can mint GHO tokens using the collateral they provide on the Aave protocol. The collateral can be a basket of cryptocurrencies chosen by the user. When Aave's loan service users borrow GHO using cryptocurrency as collateral, Aave issues GHO tokens. When the loan is repaid, Aave destroys the GHO tokens associated with that loan, thereby reducing the number of tokens in the protocol. GHO tokens can be used for payments, lending, and other scenarios, and they can generate yields as they automatically participate in liquidity mining on the Aave protocol.
GHO adopts the Aave V3 funding pool model, with Aave as the sole funding pool provider. Users need to purchase and use GHO stablecoins through Aave V3, and in the future, more funding pool providers may be added to achieve decentralized stablecoin issuance and trading. Only assets within the Aave protocol can serve as collateral for GHO tokens. All income generated from GHO stablecoins flows directly into the Aave Treasury and then into Aave DAO. GHO is essentially a stablecoin that combines decentralization, multi-collateralization, and yield-generating features, offering certain innovative advantages, especially as it can seamlessly integrate with other services of the Aave protocol.
However, GHO's stability relies on the value and liquidity of its collateral. If the market experiences severe fluctuations or liquidity crises, GHO tokens may lose their peg and trigger liquidation. The risk management and degree of decentralization of GHO stablecoins remain issues worth paying attention to. As the number of funding pool providers increases, risk allocation and benefit distribution may become more complex, necessitating a more robust decentralized governance mechanism to ensure the long-term stability and sustainable development of GHO stablecoins.
CrvUSD: LLAMMA Algorithm
CrvUSD is an algorithmic stablecoin whose core design is the Lending-Liquidating AMM Algorithm (LLAMMA). This algorithm maintains price stability by converting collateral (such as ETH) and stablecoins (USD). When the price of the collateral rises, users convert all deposits to ETH, but when the price falls, it converts to USD. Collateral options may also include positions in liquidity pools (LP).
This is very different from traditional AMM designs, where USD is typically at the top and ETH at the bottom. In the Curve algorithmic stablecoin, the purpose of the LLAMMA algorithm is to provide users with a soft liquidation window, converting collateral into LP positions to avoid collateral being liquidated in a short time. Curve's stablecoin mechanism maintains price stability and liquidity through cross-chain liquidity and multi-strategy pool liquidity convergence, as well as collaboration with other DeFi projects. Additionally, Curve stablecoins can earn returns through trading, lending, and liquidity mining, incentivizing more users to participate in its ecosystem.
Frax: The Ambition of AMO
Frax is partially backed by collateral assets and partially supported by the native Frax token (FXS). The ratio of these two in Frax's support is called the collateral ratio. In this case, the general collateral is USDC. The Frax protocol adjusts the collateral ratio based on the market price of the FRAX token. If the FRAX token trades above $1, the protocol lowers the collateral ratio, thereby reducing reliance on collateral and increasing the algorithmic portion. If the FRAX token trades below $1, the protocol raises the collateral ratio, thereby increasing trust in the collateral and reducing the algorithmic portion. In this way, the Frax protocol attempts to achieve a peg between the FRAX token and the US dollar.
In its V2 upgrade, Frax introduced an Algorithmic Market Operations Controller (AMO) mechanism that reinvests collateral into the Frax pool to create additional income to support the protocol's growth. The Frax community has agreed to abandon the dual-token mechanism and raise the target collateral ratio to 100%, making Frax a more attractive asset for long-term value preservation for users. The increase in the collateral ratio will be achieved through the AMO mechanism rather than by selling FXS tokens.
It allows for fully programmable monetary policy without lowering the collateral ratio or changing the FRAX price. The AMO controller is a self-executing contract that can perform open market operations algorithmically but cannot break the support price solely by minting FRAX. The AMO controller makes FRAX one of the most powerful stablecoin protocols by creating maximum flexibility and opportunities without altering the fundamental stability mechanism.
However, the Frax protocol still needs to rely on external stablecoins as its last line of defense. If external stablecoins fail or are frozen, such as the recent USDC de-pegging event, it will affect the stability and security of the Frax protocol and the FRAX token. Frax also relies on the FXS token as its governance and incentive mechanism, and if the FXS token experiences price fluctuations or decreased demand, it will also impact the operation and development of the Frax protocol and the FRAX token.
In summary, GHO and crvUSD have the advantage of a stable market position and multiple use cases, while also possessing investment value. Although Frax has strong technical capabilities, it has yet to experience large-scale market fluctuations, and its application scenarios and investment value remain to be observed. In future developments, GHO and crvUSD may further consolidate their competitive advantages by continuously launching new products and expanding use cases.
Current Issues
The main risk of the above stablecoins is that as the complexity of the protocols increases, the vectors for attacks also diversify, potentially leading to a "sudden attack" on the entire ecosystem. In recent years, we have seen many stablecoin vulnerabilities leading to the complete bankruptcy of protocols. Meanwhile, competition in the stablecoin space is fierce, with some decentralized stablecoins establishing significant moats in terms of on-chain liquidity and collaboration with other protocols (such as Aave and Curve). Additionally, native stablecoins from a single protocol may struggle to achieve deep liquidity, or the cost of doing so may be very high.
Currently, there are two main directions for the development of stablecoins: collateral-based stablecoins and algorithmic stablecoins. The former can also be called "pseudo-algorithmic stablecoins." However, both types of stablecoins face some issues. Collateralized stablecoins require a large amount of excess collateral, while the mechanisms of algorithmic stablecoins may lead to insufficient liquidity and unequal reward scales.
In contrast, the previously popular "liquidity collateral" model essentially places "protocol-controlled value" before "algorithmic stability." However, experiences over the past two years have shown that the design of "liquidity first, not collateral" also has its problems. For example, during market tightening, insufficient liquidity may lead to unfair rewards for holders and DAOs, which could result in market manipulation by large whales, detrimental to the long-term stability of the ecosystem.
1. Low Acceptance of Value Storage
Currently, these algorithmic stablecoins face certain difficulties in gaining user acceptance. The main reason is that their stability is not as reliable as that of mainstream fiat stablecoins like the US dollar, and they are more often used as rewards rather than as a medium for value storage by users. DAI, as a pioneer of decentralized stablecoins, has already captured a certain market share. However, with the rise of mainstream fiat stablecoins like USDC, DAI's position has also been somewhat challenged.
Moreover, the mechanisms of algorithmic stablecoins are often complex and difficult to understand, requiring users to hold multiple tokens and engage in various operations to maintain their stability. This increases users' costs and risks, reducing their overall experience. Algorithmic stablecoins have not yet achieved widespread adoption, and their market share and liquidity remain relatively low. This limits their application in areas such as payments, lending, and cross-border remittances, affecting their attractiveness as a value storage tool.
Therefore, the development of algorithmic stablecoins needs to further address their stability issues to better serve as a medium for value storage. Additionally, algorithmic stablecoins need to focus more on user needs, such as providing higher yields to attract more users. By integrating with physical assets, the liquidity and value of algorithmic stablecoins can be enhanced, improving their market competitiveness.
2. Dependency on Diversified Collateral
Currently, algorithmic stablecoin protocols still require a certain amount of collateral such as ETH and CRV, and only with the continuous growth of collateral value can scalability be maintained. Algorithmic stablecoin protocols also face the actual risk of overall demand. Some protocols have even exhausted their insurance funds. The question of whether more collateral is always better is one that the author is quite skeptical about.
In the short term, supporting diversified collateral may enhance the network effect of the protocol, thereby gaining more liquidity, especially during bull markets. However, in the long term, this represents an irresponsible speculative attempt regarding the stability and security of algorithmic stablecoins themselves. We may need to draw more liquidity from centralized exchanges to improve the feasibility of algorithmic stablecoin protocols.
Particularly, stablecoin protocols like Frax, while employing algorithmic stability mechanisms, see their degree of decentralization decline under strong redemption pressure, leading to greater risks for holders. The essence of the algorithmic stability mechanism should be non-fully collateralized, which carries higher risks. Mainstream DeFi protocols aim to make their stablecoins competitors to centralized stablecoins like USDC, but this requires meeting regulatory requirements, which is challenging. Therefore, algorithmic stablecoins need to better address decentralization issues and find broader application scenarios to play a larger role in the future.
Exploring Decentralized Algorithmic Stablecoins
BTC/ETH Native
LUSD: Liquity's Native Stablecoin
LUSD is a stablecoin launched by Liquity. Liquity is a decentralized lending protocol that allows users to use ETH as collateral to obtain 0% interest loans. The algorithm of LUSD requires borrowers to maintain an over-collateralization ratio; otherwise, their loans may be liquidated. LUSD claims to offer rigid redemption. LUSD also benefits from some non-mandatory mechanisms, such as the protocol treating LUSD as equivalent to the US dollar and the borrowing fees on new debts. These mechanisms can influence the supply and demand of LUSD and market expectations, keeping it stable between 1.00 and 1.10.
LUSD provides an interest-free lending method, allowing users to leverage the value of ETH to gain liquidity and improve capital efficiency. LUSD also has some innovative mechanisms to ensure its security and stability, such as collateral pools, stability pools, and liquidation mechanisms. However, LUSD may face competitive pressure from other protocols offering similar services, such as MakerDAO or Compound. At the same time, it must contend with regulatory pressures from different countries or regions regarding such stablecoins, such as the United States or the European Union.
DLLR: Sovryn's Sovereign Stablecoin
Sovryn's stablecoin is called Sovryn Dollar (DLLR), which is a Bitcoin-based stablecoin composed of various Bitcoin collateral. The goal of 1 DLLR is to maintain a close 1:1 ratio with the US dollar, providing a stable means of payment or savings. DLLR is composed of various Bitcoin stablecoins, such as ZUSD and DOC, which maintain a 1:1 ratio with the US dollar through different algorithms or protocols. DLLR aggregates these stablecoins to form a more stable stablecoin that can withstand market fluctuations and collateral risks. The supply of DLLR is determined by market demand; when the price of DLLR is above or below $1, arbitrage opportunities arise to restore balance.
Sovryn is a decentralized finance (DeFi) protocol based on Bitcoin that uses zero-knowledge proof technology to protect user privacy. Sovryn allows users to engage in leveraged trading, perpetual contracts, lending, and other DeFi operations, and its security is ensured by the use of Bitcoin's security. All services on the Sovryn platform are priced in Bitcoin (BTC) and are connected to the Bitcoin network. The platform's smart contracts run on Rootstock, a sidechain connected to the Bitcoin network. Sovryn is one of the next-generation permissionless financial applications that can provide cross-chain functionality.
Sovryn uses EVM smart contracts on the RSK blockchain, connecting with Bitcoin and the Lightning Network, Ethereum, and Binance Smart Chain. Most of Sovryn's features are inspired by the Ethereum protocol, and part of the codebase is built using redesigned and audited branches. Rootstock, or RSK, is a fork of the Ethereum protocol, similar to other EVM-compatible blockchains. The uniqueness of Rootstock lies in its bidirectional peg to the Bitcoin network and its merged mining with Bitcoin. Sovryn's contracts are controlled by the Exchequer multi-signature, an anonymous group of key holders, except for the Staking and FeeSharingProxy, which can be updated based on votes from SOV stakers. Changes to all contracts and project codebases can be voted on in the Bitocracy DAO, where SOV token stakers have voting rights.
The potential of DLLR lies in its being a fully transparent, decentralized, and censorship-resistant stablecoin, solely backed by Bitcoin, without any intervention or risk from third parties or central authorities. DLLR can facilitate the circulation and use of Bitcoin, increasing its value and utility. DLLR can also provide a powerful lending tool for the Sovryn platform, allowing users to use Bitcoin as collateral to lend or borrow DLLR, enjoying zero-interest rates and high yields.
Multi-Asset Type
sUSD: Synthetix Goes Out with Synthetic Assets
sUSD is a stablecoin issued by the Synthetix protocol that tracks the price of the US dollar, providing price data through a decentralized oracle network. sUSD is a stablecoin backed by native crypto assets, meaning it is issued using Synthetix network tokens (SNX) as collateral. sUSD has a wide range of applications within the SNX ecosystem, as it can be used for trading, lending, storing, or exchanging other synthetic assets (Synths), such as stocks, commodities, cryptocurrencies, etc.
The peg mechanism of sUSD primarily relies on market arbitrage opportunities and supply-demand relationships. When the price of sUSD is below $1, arbitrageurs can buy sUSD with US dollars or other stablecoins on external exchanges, then exchange it for other synthetic assets (Synths) on the Synthetix platform, or use sUSD as collateral to borrow SNX or ETH. When the price of sUSD is above $1, arbitrageurs can use SNX or ETH to borrow sUSD on the Synthetix platform and then sell sUSD on external exchanges for US dollars or other stablecoins. Such arbitrage activities increase the demand and supply of sUSD, thus pushing its price back to the pegged value of $1.
With the introduction of Atomic swaps, Curve, and Perp V2, the application scenarios of sUSD have greatly expanded. This is aided by Synthetix's multi-chain deployment strategy. Especially in the multi-chain era, the prospects for synthetic assets are very broad. Additionally, the funding efficiency issue of sUSD is expected to be addressed in the V3 version, as the introduction of collateral similar to ETH will gradually lower the collateral ratio, which will help increase capital utilization efficiency. As Synthetix gradually evolves into a super application for synthetic assets, we can expect sUSD to follow the trend of synthetic assets and introduce more solid real asset support.
TiUSD: Multi-Asset Reserve
TiUSD is an algorithmic stablecoin issued by TiTi Protocol that tracks the price of the US dollar through a decentralized, multi-asset reserve mechanism using liquidity mining to ensure its stability and growth. TiUSD is an elastic supply stablecoin, meaning its supply will automatically adjust based on market demand and price fluctuations. The reserve pool of TiUSD consists of various crypto assets, such as ETH, BTC, DAI, etc., which enhances the diversity and risk resistance of the reserve pool.
TiUSD ensures its growth through a decentralized, multi-asset reserve mechanism using liquidity mining. TiUSD can also leverage its elastic supply characteristics to automatically adjust its supply based on market demand and price fluctuations, thereby maintaining its price stability around $1. The drawback of TiUSD is that it faces competition and challenges from other algorithmic stablecoins, especially those with more complex or advanced algorithm designs or governance models, such as MakerDAO and Ampleforth. Additionally, TiUSD needs to ensure the diversity and risk resistance of its reserve pool to avoid the risks of insufficient reserves or attacks.
Fully On-Chain Deployed
USD0: Tapioca's Algorithm
LayerZero is an innovative cross-chain messaging infrastructure that allows tokens on different chains to be securely transferred without the need for asset wrapping, intermediary chains, or liquidity pools. Big Bang is a fully on-chain currency market based on LayerZero that allows users to mint a fully on-chain stablecoin called USD0. It has no borrowing limits but does have a debt ceiling. The collateral planned for minting USD0 includes native Gas tokens (or their staked derivatives). These include ETH, MATIC, AVAX, wstETH, rETH, stMATIC, and sAVAX.
The peg mechanism of USD0 is based on an algorithm called Tapioca, which uses a dynamic debt ceiling and an adjustable stability fee to maintain a 1:1 ratio with the US dollar. The Tapioca algorithm adjusts the debt ceiling and stability fee based on market conditions and changes in collateral value, thereby affecting the supply and demand for USD0. When the price of USD0 is above $1, Tapioca increases the debt ceiling and lowers the stability fee, encouraging users to mint more USD0. When the price of USD0 is below $1, Tapioca decreases the debt ceiling and raises the stability fee, encouraging users to repay or purchase more USD0.
In theory, USD0 can be used on any chain. It does not require asset wrapping or intermediary chains, thus reducing costs. It can also leverage LayerZero for seamless token transfers and trading, and integrate with other LayerZero-based applications, such as Stargate. However, its risks stem from the security and compatibility of the LayerZero protocol itself or its underlying chains.
IST: Achieving Cross-Chain Asset Transfer
The stablecoin IST of the Inter Protocol is a decentralized stablecoin protocol built within the Cosmos ecosystem, aimed at facilitating asset transfers in a cross-chain ecosystem while maintaining a 1:1 parity with the US dollar, providing assets with minimal price volatility, which is also one of IST's goals. There are three ways to mint IST: Parity Stability Module, Vaults, and BLD boost. Among them, the Parity Stability Module mints IST using specified stablecoins (such as DAI, USDT, USDC, etc.) as collateral, while Vaults use crypto assets as collateral, with different collateral ratios set by the DAO, and BLD boost mints IST using BLD as collateral, which does not earn node staking rewards but is used for debt repayment.
In terms of IST's stability mechanism, it is quite similar to DAI, including liquidation mechanisms, collateral ratio adjustments, setting debt ceilings, and a reserve pool to urgently lower the debt ratio and BLD issuance for debt repayment. These mechanisms are controlled by fine-grained minting restrictions, creating a dynamic stablecoin model that has never existed before. The Inter Protocol is built on Agoric, a chain in the Cosmos ecosystem that allows smart contracts to be developed using JavaScript, with the token being $BLD. IST is not only a stable token but also the native fee token of the Agoric platform, providing some core functions and stability for its crypto economy.
Cosmos is known as the "Internet of Blockchains," achieving interconnectivity between blockchains through the IBC protocol, allowing for asset transfers between different blockchains, enhancing blockchain interoperability and scalability. Within the Cosmos ecosystem, stablecoins are a focal point for many projects, and IST, as one of them, will provide a more stable and reliable value exchange tool for the cross-chain ecosystem.
With the growth and improvement of interoperability within the Cosmos ecosystem, there will be spillover effects on the Inter Protocol. As more protocols are built using the Cosmos SDK and utilize IBC for interoperability, the number of protocols that Inter Protocol can interact with will also increase. Through other protocols, cross-chain bridges to other blockchains will continue to increase support for more chains and allow interactions between supported chains. The overall increase in liquidity and potential user numbers is highly beneficial for the Inter Protocol. Not only will applications on Cosmos be used more frequently, but the Inter Protocol stablecoin will also see more frequent usage.
Seeking Real Anchors
Protocols like Curve are leading us into the next major paradigm shift in DeFi. Specifically, DeFi protocols are beginning to realize that they need to control stablecoin issuance, liquidity systems, and lending markets. Frax and Aave are following closely behind. As more protocols attempt to solve the trinity problem, the differentiating factor will no longer be the final business model of the protocol but rather the starting point it uses to achieve that final form. Compared to MakerDAO, Curve and Aave have stronger brand effects and team capabilities, thus their stablecoin development prospects are broader.
Currently, the demand for stablecoins is primarily divided into three categories: as value storage tools, stablecoins for trading and usage, and those who wish to avoid relationships with fiat stablecoins. Meanwhile, the application of physical assets in algorithmic stablecoins still faces many issues and challenges, such as scalability and risks associated with physical assets. At the same time, many stablecoin projects focus more on the price stability mechanisms and decentralization of stablecoins, neglecting the actual market fit of products used by users. This is also a challenge for many stablecoin projects. In summary, the author is more optimistic about the following four directions for algorithmic stablecoin protocols in the future:
- Crypto-native stablecoin protocols, as Bitcoin and Ethereum are forming a strong value network. More importantly, they constitute the trust foundation of cryptocurrencies, which also means that stablecoin projects attached to the value network have more solid asset reserves. However, improvements in user experience, the scale of network-locked assets, and robust liquidation protection mechanisms will be the main differentiators of their value metrics;
- Super applications with a specific scale issuing their own stablecoins essentially bypass trust intermediaries to form minting contracts directly with their users. In this case, protocols like Curve, Aave, and Synthetix will become "super pawnshops," and their users will experience customized financial services faster and more smoothly than in the real financial world. The user base and business innovation determine their ceiling, so I am more optimistic about the development of Synthetix;
- Fully on-chain deployed algorithmic stablecoins have the potential to achieve true decentralization, cross-chain interoperability, and infinite scalability. They can be freely issued, transferred, and traded on any chain, ensuring ample and complete liquidity. More importantly, a fully on-chain insurance mechanism is more conducive to addressing liquidity crises during runs;
- Additionally, in future developments, the delta-neutral stablecoin model may also become an important trend, but implementing this model requires corresponding futures protocol support and a large futures market, as well as attention to risk control and market adaptability.
Is there a possibility that a certain algorithmic stablecoin protocol possesses all of the above characteristics? Unfortunately, the author has not yet seen such a project. Algorithmic stablecoins need an effective and reliable algorithmic design that can maintain price stability under various market conditions and ensure that extreme situations such as loss of control or collapse do not occur. A large and loyal user base can support its economic model and provide sufficient demand and liquidity. At the same time, a strong and innovative ecosystem can integrate with other on-chain or off-chain services and provide more use cases and value creation. At this point, the diversification of collateral assets may become less important; the author values the health of the value network and pegged assets more.
The rise of algorithmic stablecoins has its own logic and background, but this does not mean they can completely replace centralized stablecoins, especially in large-scale applications. Therefore, algorithmic stablecoins may need to seek a more efficient and scalable solution while ensuring safety. Additionally, stablecoins like USDC, which are based on dollar collateral, still hold a major position in the current market because their issuers have certain legal regulatory and economic strength, enabling them to provide more reliable guarantees for users. For those looking to avoid legal regulation and centralization risks, algorithmic stablecoins remain a valuable choice. However, we need to acknowledge their limitations while actively exploring more innovative solutions to promote the development of the entire DeFi industry.
