Why do we need algorithmic stablecoins with elastic supply?

Editor's Note: This article comes fromIOSG（ID： IOSGVC）, reprinted by Odaily with authorization.

, reprinted by Odaily with authorization.

At the end of 2020 that just passed, U.S. lawmakers drafted the Stablecoin-related Act (STABLE Act), requiring stablecoin issuers to obtain a banking license. After that, the U.S. President’s Financial Market Working Group issued a new statement on the regulation of stablecoins. The document stated that stablecoins must meet appropriate anti-money laundering and supervision requirements, and currency holders should accept user identity verification KYC. With the cryptocurrency market snowballing in full swing, as an integral part of the market, the total market value of stablecoins has recently exceeded 21 billion US dollars. At the other end, algorithmic stablecoins, including the launch of ESD and BAC, have a large number of natural eye-catching games, speculation, arbitrage and other behaviors, which further push the currency experimentation in the encrypted world to a new peak.

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1. The Past and Present of Stablecoins

2. Stablecoins are fiat currencies used in the blockchain network. They are usually riveted with the price of the fiat currency, audited by a third party, and have real US dollars as reserves or complex algorithms to guarantee their prices. According to the different ways of guaranteeing prices, we can divide stablecoins into three categories: stablecoins collateralized by US dollars, stablecoins over-collateralized by multi-asset pools, and algorithmic stablecoins.

3. USD-collateralized stablecoins: such as USDT and USDC, but also stablecoins issued by exchanges, such as BUSD, HUSD, etc. They are centrally managed, backed by U.S. dollars, and convertible at a 1:1 exchange rate. The question is, who can guarantee sufficient dollar reserves for these centralized institutions backed by brand and trust. Tether, the USDT issuer, admitted in 2019 that the USDT supply has not been 100% rigidly paid in USD. USDT accounts for about 73% of the on-chain transaction volume of stablecoins exceeding $1 trillion this year. At the same time, supervision is also the sword of Damocles hanging over the heads of centralized institutions, and when it will fall has become an increasingly imminent issue.

Multi-asset pool over-collateralized stablecoins: such as MakerDAO’s DAI and Synthetix’s sUSD, they are over-collateralized by encrypted assets, and both rely on price oracles to maintain an anchor to the US dollar. Unlike centralized tokens like USDT and USDC, they can be minted without permission. The advantage of the over-collateralization model is that there is no need to price assets and quickly provide liquidity. But at the same time, the nature of the over-collateralization mechanism means that it is too capital-intensive, and the highly volatile and highly correlated nature of encrypted assets has made these stablecoins vulnerable to shocks that rippled through the entire encrypted market in the past.

Algorithmic Stablecoin: It is a currency that automatically adjusts the currency supply mechanism according to an algorithmic program. Increase the market supply when the price of the stablecoin is higher than the anchor price, and recover the supply when the price of the stablecoin is lower than the anchor price, or balance the price of the stablecoin by providing arbitrage space. The establishment of this model does not anchor real legal currency and does not need to mortgage stable currency. It is regulated by market will and algorithms, and the market is also called elastic currency. Algorithmic stable currency is the most important effort in the pursuit of native stable currency in the encryption field. It does not need to be generated through asset mortgages, but is realized by making full use of people's profit-seeking characteristics. At the same time, it has features that previous stablecoin experiments did not have. It is crypto-native and has the opportunity to realize a truly decentralized stablecoin for the first time. Since the beginning of this year, the skyrocketing markets such as ESD and BASIS FRAX led by AMPL have reshuffled the trading list, making the industry start to look at algorithmic stablecoins with admiration.

Several algorithmic stablecoins in the market have borrowed from the market operation mode of the central bank of the traditional fiat currency institution. They have weak price anchors because there is no real arbitrage in their price anchors, and they work more like a central bank setting a price range target. Monetary policy runs slowly, and central banks do their best to react in real time when currencies are detached from their pegs. The mechanics behind a decentralized price peg can work in highly volatile markets.

Taking BASIS as an example, there are three roles in the system: BAC (Basis Cash), BAB (Basis Bond), and BAS (Basis Share). The simplest analogy is that BAC = US dollar, BAB = US dollar treasury bonds, and BAS = Federal Reserve stocks. The ingenuity of this design is that it moves the entire US dollar issuance system into the BASIS design. Among them, Basis Share and Basis Bond are designed to promote Basis Cash to always be anchored to the price of $1.

When Basis Cash trades below $1:

Users can enjoy a certain discount to purchase Basis Bond. The purpose of this is to establish the price stability of Basis Cash (increase the purchase demand to increase the price of Basis Cash to $1), and users who purchase Basis Bond through the discount will redeem tokens in the future A certain amount of profit can be obtained from time to time.

When Basis Cash trades above $1:

• The contract will allow Bond redeemers to directly redeem Basis Bonds. If Basis Cash is trading above $1 after redeeming Basis Bond, this will lead to an increase in demand for Basis Cash, then new Basis Cash tokens will need to be minted (increasing the supply of stablecoins will bring the price of Basis Cash back to $1) , these tokens will also be distributed to Basis Share holders as dividends.

• However, although the algorithmic stablecoin considers currency elasticity, this elasticity may be a zero-sum game. New credit creation (whether it is stablecoin or bonds or shares) is not supported by full redemption rights and profits, and completely depends on Later people's capital investment. Therefore, most of the current algorithmic stablecoins have fallen into a fateful cycle:

• Rising currency prices and high yields attract more funds to enter the pledge, and the market reflexively enters into a positive feedback mode of rising currency prices + increasing quantities. More money came in and the market went into a frenzy.

There is no more funds to maintain high returns, enter the death spiral of currency price decline + quantity deflation reduction, stable currency prices are no longer stable (below 1 US dollar for a long time), speculative funds retreat, and accelerate the possibility of project collapse.

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Stablecoin Endgame or Ponzi Scheme?

It is foreseeable that algorithmic stablecoins and algorithmic synthetic assets will have great development in the future. On the one hand, it is due to regulatory reasons, which are one-way development: the integration and impact of the traditional financial world and the blockchain financial world are bound to impose more and more restrictions on centralized stablecoins, thus pushing the encrypted economy towards decentralization stablecoins. On the other hand, the stable currency cross-border payment business will continue to grow. Making cross-border payments using stablecoins or any crypto asset is easier and cheaper than traditional methods. In this regard, crypto-assets are more efficient than traditional fiat payment methods. This will be the driving factor for the increasing adoption of stablecoins in the future.