Vitalik Buterin, the creator of Ethereum and an avid proponent of cryptocurrencies, recently gave his opinion on algorithmic stablecoins and their potential for the future. He said that algorithmic stablecoins need to be scrutinized based on how well they perform in difficult market situations and whether they can securely wind down when the buzz around them subsides. Although the recent collapse of UST and LUNA wiped billions off the market and pushed UST from its $1 (approximately Rs. 77) peg, Buterin maintained in an article that automated stablecoins might make sense while criticizing extravagant gains provided by those “doomed to collapse eventually.”
Buterin argues in his post that specific models of algorithmic stablecoins are possible, although traders have concluded that algorithmic stablecoins have fundamental flaws as a result of the UST catastrophe that occurred over the previous month. He also explains his reasoning as to why this is the case.
Buterin gave the example of MakerDAO’s stable token DAI and Reflexer’s RAI as practical examples of automated stablecoins that have withstood harsh market situations. Both of these stablecoins were created by MakerDAO.
Stablecoins based on algorithms are fundamentally backed by another cryptocurrency and employ calculations built into the coin itself to control its price. This is in contrast to, for instance, USDC, which is a fiat-backed stablecoin supported by actual dollars kept in a bank. Finding means to keep their dollar peg will be the most challenging problem for all dollar-pegged stablecoins.
According to the blog post written by Buterin, the first question that prospective investors should ask about a stablecoin is, “can the stablecoin safely wind down to zero users?” According to Buterin, the possibility of there being no market activity for a stablecoin at all should not be a deal-breaker for investors. Instead, it ought to be possible for customers to get a reasonable value for their assets.
Buterin explains that this was not the situation with Terra since the network used LUNA, which he refers to as a “volcoin” or volume coin, to keep the asset’s peg stable. Buterin portrayed the disaster that befell Terra as having been brought on by hyperinflation brought on by creating a large number of volcoins.
“First, the volcoin price drops,” writes Buterin. “Then, the stablecoin starts to shake. The system attempts to shore up stablecoin demand by issuing more volcoins. With confidence in the system low, there are a few buyers, so the volcoin price rapidly falls. Finally, once the volcoin price is near-zero, the stablecoin to collapses.”
Another problem that was brought to light by Buterin was the fact that the Terra’s Anchor protocol guaranteed an annual percentage yield (APY) of 20% on UST. Some investors moved their funds into USTs to take advantage of the high annual percentage yield (APY), but they did so without fully comprehending the hazards involved. Buterin appreciates the increased scrutiny of decentralized finance because of this (DeFi).
According to the well-known creator, when stablecoins try to create returns like this, they might instead turn into Ponzi schemes. “Obviously, there is no genuine investment that can get anywhere close to 20 percent returns per year,” he says. “In general, the crypto space needs to move away from the attitude that it is okay to achieve safety by relying on endless growth.”
Buterin brings the article to a close by arguing that even if a stablecoin successfully passes the aforementioned parameters test, there may still be underlying problems like flaws and governance concerns that pose a risk to the continued existence of the project. He concludes that “steady-state and extreme-case soundness should always be one of the things that we check for.”