Cryptocurrencies have been on an upward spiral in the past few years. They have become a reliable medium of exchange and store of value. However, while crypto becomes an integral part of the economy, volatility concerns persist. To help solve these concerns, the crypto community came up with stablecoins.
Stablecoins are cryptocurrencies whose values are pegged to other traditional assets. The stablecoins work such that the value of the token will always be the same as the underlying asset. Some of these underlying assets include fiat currencies and commodities like gold. Having been operational for some time, they are quite stable. Therefore, stablecoins provide the stability of fiat currencies while maintaining the security and fast transactions of digital currencies.
Stablecoins came into focus majorly in 2020 following the decentralised finance (DeFi) boom. There are already over 200 stablecoins with Tether (USDT) and USDC as the two most dominant stablecoins. Stablecoins have also surged in the crypto exchanges with the top trading platforms like Coinspot and Coinbase offering them.
Still, achieving stability is not a simple concept. Various ideas have since come up within the crypto community into how to maintain the peg. One such means is through algorithmic design, these types of stablecoins are dubbed “algorithmic stablecoins”.
What is an algorithmic stablecoin
Algorithmic stablecoins are the crypto token that uses price stabilisation algorithms to keep the value of an asset, usually at $1. They increase the supply of tokens when the value goes up and reduce supply when it goes down. These stablecoins operate on top of a public blockchain that has an underlying token such as Ether. This allows it to use the smart contracts on the platform to execute the price stabilisation algorithm based on underlying rules.
For most other stablecoins, their value is derived from the pegged asset such that they operate at the ratio of 1:1. For the algorithm stablecoins, they are not backed by any asset. Instead, they rely on market sentiments and momentum for stability.
The algorithmic stablecoin has undergone various changes in models as it seeks to deal with the various limitations it comes with.
The Important Algorithm stablecoin attempts
Here are the various models algorithmic stablecoins have tried out in the quest to maintain their peg.
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Rebase model
The rebase system was the first attempt at algorithmic stablecoins and is used by various stablecoins like Ampleforth (AMPL). It operates on the basis of adjusting the market supply based on the prevailing market rate for the coin. If the price of AMPL goes higher than $1.05, more tokens are included in the supply, however, when it goes down to $0.95 coins are destroyed from the supply.
Every rebase supply correction does not depend on the previous rebase actions. It doesn’t matter if the supply has been corrected multiple times before. Every action only cares about the current price.
The concern with this model is that supply can change within a short time to put more pressure on the nominal price. Also, the changes in the market supply of the tokens affect all the wallets holding the rebase stablecoin. Therefore, while the coin remains stable the value in your wallet will fluctuate with the rebases.
Generally, the rebase model works perfectly in holding the market price of tokens at $1. The automatic supply adjustments mean the price will remain the same irrespective of the forces causing the market value changes.
For the stability of a token, the supply and price both matter. However, with the frequency changes in the supply of the coins, it becomes quite volatile. The market value movements of AMPL for example have since mirrored those of the wider crypto market and other coins like Bitcoin and Ethereum. Its value increases when the market booms and decreases when the market corrects. Therefore, these stablecoins tend to serve more as speculative vehicles than they do as powerful stablecoins.
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Coupon model
The other attempt at algorithmic stablecoin is coupon-based coins. Unlike in the rebase algorithmic stablecoin model, where every wallet faces an increase or decrease of tokens, in the coupon model, the holder’s coins dont change unless they deliberately do it on their own. In this case, when the value of the token surpasses $1, new tokens are generated then given to various holders willing to join the governance of the network. Some of them are also portioned to Uniswap liquidity providers. Some of the coupon stablecoins include Empty Set Dollar (ESD) and Dynamic Set Dollar (DSD).
However, for the instances where the asset goes below $1, the holders of the algorithmic dollars receive coupons or bonds. Given the market correction, the values of the coins always recover after some time. The coupon holders can then redeem their coupons back to the dollars at an incentive predetermined based on market growth. The coupons however are designed to expire within 30 days.
The coupon algorithmic stablecoins are quite practical and are easy to integrate with the various ERC-20 platforms. The major concern though is that it’s quite unstable. Even though the coupon is an incentive enough to get buyers when the value goes down, it is never assured that the value will recover. Sometimes the market might also take longer without recovering. If it lasts past the 30-day period then the coupons become useless. Once the coupons are unusable, then there won’t be anything to redeem in case of a price recovery, therefore the market would not attain the $1 as had been planned.
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Basis cash protocol
The coupon model is generally the basis cash protocol. This is due to its being based on Basis, an algorithmic stablecoin that raised $133 million from investors in 2018 but never launched. This new model of the algorithmic stablecoin is a fork of the basis coupon model.
In this model, the token tends to keep the value in the similar way the central banks keep the value of the fiat currencies through their monetary policies. It involves the token’s network buying and selling bonds depending on the asset. By controlling the assets on the market, the network can keep its value intact. In this case, it ensures the supply keeps the value at $1.
One of the top examples of this algorithmic stablecoin model is Mithril Cash. Launched in late 2020, the token has kept its value through the strategic selling of bonds like central banks do for fiat currency value control. The only difference however is that there’s no single control authority in Mithril Cash like a currency board or the bank. Instead, it comes with smart contracts that automatically execute depending on the market movements.
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On-going attempts
The quest to find the ideal algorithmic stablecoin is still on. The available models, while having worked perfectly in keeping the value of the coins at $1, come with challenges. The issue, in this case, is what they are planning to solve, stability concerns. Therefore, the ongoing attempts at an algorithmic stablecoin are all about striking the balance between incentives and adoption.
For now, the market is yet to agree on the best way to reach the perfect algorithmic stablecoin. So far, given the results from the earlier attempts at algorithmic stablecoins, some of the market stakeholders believe there’s no perfect stablecoin. They think that it’s not possible to balance the incentives and adoption when the crypto market is still volatile. However, some of the stakeholders still believe that with the right roadmap then algorithmic stablecoins are achievable.
Algorithmic Stablecoin FAQs
What is the purpose of an algorithmic stablecoin?
The various attempts at achieving the best algorithmic stablecoin show how much the crypto world is willing to invest to attain this coin. This leads to the question, are all these attempts worth it?
Yes, an investment in having the ideal algorithmic stablecoin is worth it due to the various functionalities it comes with. The first of its main roles that currently seem more viable is for the use on Defi platforms. Given the stability and ability to exist within an inactive model, it can act as the lead token for finances.
To work in the financial segment, these algorithmic stablecoins must be capable of all money’s distinctive uses; a unit of account, store of value and medium of exchange. It can only achieve these functionalities when it becomes stable.
For now, a currency like AMPL is quite volatile and reflects the underlying crypto market movements. The coupon-based are also quite unstable with value changes never assured within a given period. That is why the attempts for the algorithmic stablecoins are still on.
What is the future of algorithmic stablecoins?
Algorithmic stablecoin has achieved massive market traction within its few years of existence. Even though it is yet to find the ultimate token, it has shown that stablecoins don’t necessarily have to depend on underlying assets for value. It can use decentralised smart contracts for that. As the Defi network grows so does the stablecoins have a role to play. Therefore the future of algorithmic stablecoins is an ultimate stable token that will be as useful as money.