Vitalik Buterin stressed that we do not need stablecoin boosterism and stablecoin doomerism but a return back to principles-based thinking.
Vitalik Buterin, co-founder of Ethereum, shared two thoughts experiments about how to determine whether an algorithmic (algo), stablecoin can be sustained.
Buterin’s comments were inspired by the multibillion-dollarlosses resulting from the collapse in the Terra ecosystem, and its algo stabilizecoin TerraUSD (UST).
Buterin wrote a Wednesday blog entry. He noted that there is an increase in scrutiny of crypto and decentralized financial (DeFi), but cautioned against writing off all algostablecoins.
He stated that “What we need” isn’t stablecoin boosterism and stablecoin doomerism but a return to principles-based thought.
“While there are many automated stablecoin designs which are fundamentally flawed and likely to crash, as well as plenty that can survive theoretically but could be highly risky, there is a lot of stablecoins that are extremely robust in theory and have survived extreme crypto market conditions in practice.”
His blog was focused on Reflexer’s fully Ether ( ETH)-collateralized RAI stablecoin, . It is not pegged to fiat currency but relies on algorithms for setting an interest rate. This will oppose price movements and encourage users to return RAI within its target price range.
Buterin said that the coin “exemplifies a collateralized automated stabilizecoin” and that its structure allows users to access their liquidity in ETH if they lose faith.
Two thought experiments were offered by the Ethereum co-founder to test whether an algorithmic stablecoin was “truly stable.”
1: Is the stablecoin possible to ‘wind down’ to zero users?
According to Buterin, users should be able extract the fair value from the asset if market activity for a stablecoin projects “drops to nearly zero.”
Buterin pointed out that UST does not meet this parameter because of its structure. LUNA (or what he refers to as a volume coin) must maintain its price and user demand in order to maintain its United States dollar peg. It is almost impossible to avoid the collapse of both assets if it happens.
“First, the price of volcoin drops. The stablecoin then starts to move. To increase stablecoin demand, the system issues more volcoins. The volcoin price drops rapidly because there are not many buyers and confidence is low in the system. The stablecoin also collapses when the volcoin’s price drops to near zero.”
Buterin argued that RAI, which is backed by ETH would not lead to a negative feedback loop between these assets. This would reduce the chance of a wider collapse. Users would still be able exchange RAI for ETH in vaults that back the stablecoin’s lending mechanism.
2: Option for Negative Interest Rates
Buterin believes it is also vital that an algo-stablecoin can implement a negative rate when it is following “a basket of assets or a consumer price index or some arbitrarily complicated formula” that grows by 20% annually.
“Obviously, no legitimate investment can earn more than 20% per year and absolutely no genuine investment can increase its return rate by 4% per annum forever. He said, “But what if you try?”
He said that there were only two possible outcomes in this case: either the project “charges some type of negative interest rate to holders that equilibrates basically to cancel out the USD growth rate built into it.”
Or, it can be described as “It becomes a Ponzi,” giving stablecoin holders incredible returns for some time, until one day it collapses with a bang.”
Buterin concluded by saying that even though an algo-stablecoin can handle the above scenarios, it does not necessarily make it “safe.”
“It might still be fragile for another reason (eg. “It could still be fragile for other reasons (eg. insufficient collateral ratios), bugs, or governance vulnerabilities. Stable-state and extreme case soundness should be checked first.
