Stablecoins are an important component of the cryptocurrency ecosystem and have been instrumental in the DeFi boom from 2020 to the present, providing the majority of liquidity for various DeFi projects. According to The Block’s stablecoin report Stablecoins: Bridging the Network Gap Between Traditional Money and Digital Value, 110 million stablecoin transactions took place on the public chain in 2020, with over $1 trillion in stablecoin transactions. Stablecoin trading volume exceeded $1 trillion.
The Block reports that 93.6% of the total current stablecoin supply is fiat-collateralized, 4.8% is crypto-asset-collateralized, and only 1.4% is algorithmic.
Although the market share is small, algorithmic stablecoins, an important part of the blockchain ecosystem, have come back into the public eye since the summer of 2020, as people begin to explore a more decentralized, more capital-efficient, and even unanchored stablecoin model.
Image from The Block’s Stablecoin Report
Algorithmic Stablecoin Classification
Algorithmic stablecoins are sometimes referred to as non-collateralized stablecoins, but this is not an accurate term, as non-collateralized stablecoins are only one type of algorithmic stablecoin. According to the current market situation, Ryan Watkins, an analyst at Messari, classifies algorithmic stablecoins into three categories.
Uncollateralized, such as ESD
Protocol-held collateral, such as FEI
User-held collateral, such as RAI
Uncollateralized – ESD
ESD is known as Empty Set Dollar, and its anonymous development team, ESS (Empty Set Squad), believes that collateralized stablecoins have low capital utilization and pose a risk to collateralized assets. Therefore, they hope to stabilize the price at 1 USDC by tracking the USDC-ESD liquidity pool on Uniswap for elastic supply.
When the market demand for ESDs increases and the price is above 1 USDC, ESDs will be issued more and thus lower the price. When the market demand for ESDs decreases and the price falls below 1 USDC, users who are willing to destroy ESDs are rewarded with coupons (also called bond ESDs), which drive the price up by reducing the supply of ESDs after destruction.
The reason why coupons are an incentive to destroy ESDs is that when the price of ESDs is increased above 1 USDC again in the future, the coupon holders can use the coupons to buy ESDs at a price lower than 1 USDC, thus making a profit.
The price of the ESD is determined by the 8-hour weighted average price of the ESD in Uniswap (TWAP: Time Weighted Average Price).
However, there is a risk of destroying the ESD, the coupon obtained from the destruction must be used within one month (90 Epochs), if the TWAP price stays below 1 USDC within one month, the coupon will be invalidated.
The above is the single token mechanism design of ESD V1, in which ESD acts as both the stable coin and the governance token of the protocol, and users can participate in the governance by holding bond-type ESD. ESD V2 was originally planned to go live in August this year, but in order to return to the anchor value as soon as possible, ESD started the development of V1.5 in January.
V1.5 will introduce the ESDS token, transforming it into a dual token model, with ESDS as the governance token and ESD as a pure stablecoin. v1.5 will transform ESD into a collateralized stablecoin, with users pledging USDC to the ESD DAO to lend out an equal percentage of ESD. The ESD DAO will use the deposited USDC for liquidity mining to earn revenue, and a portion of the revenue will be used to buy back the ESDS on the market and destroy it. When the ESDS goes live, the V1 ESD and bond ESD will be converted to ESDS at a certain percentage.
Due to the large number of changes in this series of upgrades, the development team recently decided to change the version naming from V1.5 to V2.
Agreement to hold collateral – FEI
The name FEI is derived from the stone coin of Yap Island, which is called Fei by the indigenous people of Yap Island.
The Fei Protocol uses a dual token mechanism, with FEI being a stablecoin 1:1 anchored to USD and TRIBE being the protocol’s governance token, with TRIBE rewards for liquidity providers in Uniswap’s FEI/TRIBE pool.
Users can pledge ETH to the protocol in exchange for FEI, but the pledged ETH will be owned by the protocol and is referred to as Protocol Controlled Value (PCV). PCV is used to provide liquidity to ETH/FEI pairs on Uniswap. Users who want to redeem ETH can only do so by going to a secondary market like Uniswap and exchanging FEI for ETH.
The FEI protocol is anchored to $1 through direct incentives, penalizing users when their transactions move the FEI further away from $1 and rewarding them with minting when their transactions move the FEI price closer to $1. For example, if a user sells FEI on Uniswap for $0.98, because this action moves the FEI further away from the $1 anchor, the FEI burn mechanism is triggered, burning off an additional 4% of the FEI’s stable coins, so the actual price of the user’s transaction becomes approximately $0.94. However, the direct incentive only applies to specific Uniswap ETH-FEI pairs, all other exchange pairs and transfers are not affected.
If the direct incentive does not fully correct the price, FEI will activate a second price correction mechanism – peg reweights. At this point the protocol will withdraw ETH from the Uniswap pool and use it to buy FEI on the open market to bring it back to the anchor price.
However, the reality was not ideal, as FEI prices were underwater for a long time after launch due to giant whale sell-offs (FEI prices < $1 are called underwater, FEI prices > $1 are called above water). Some engaged users even teased that the diagram on the FEI’s official website had actually foreshadowed that it was a water prison for a long time.
Chris Berg and Sinclair Davidson, researchers at the Royal Melbourne Institute of Technology, believe that the FEI anchoring mechanism failed because there was a far greater than expected influx of investors buying FEI for the governance token TRIBE. and in a bull market, no one wants to hold a lot of stable coins, thus triggering the FEI sell-off.
To mitigate the sell-off in FEI and get it back to $1, the community passed the FIP-2 proposal, which contained two main elements.
Take 30w ETH from PCV and allow users to exchange FEI for ETH at $0.95. 5000 ETH can be exchanged per hour to slow down the release of ETH and avoid economic attacks on the protocol.
Increasing the FEI-TRIBE pledge pool to 100 million TRIBE, with linearly decreasing rewards over two years.
Note: FIP stands for FEI Improvement Proposal.
After the FIP-2 proposal was made, FEI prices slowly began to recover. the start-up phase of FEI was a bumpy ride, as Emin Gün Sirer, founder of the avalanche protocol, commented
In the dual-token mechanism of the Fei protocol, FEI is a stable coin that tries to anchor $1, and TRIBE is used to offset volatility. When the market demand for FEI takes it above the anchor, the measure to bring it back down is simple and effective, simply minting more FEI to bring the price back down. But the real challenge is what to do when market demand weakens and the price drops by $1.
User Held Collateral Type – RAI
RAIs are issued similar to Dai, where users overcollateralize ETH to lend out RAIs. the difference is that RAIs are not anchored in USD, so who is it anchored to? The answer is no one, RAI has no anchor, the starting “redemption price” of RAI is USD 3.14.
The market price of RAI is determined by supply and demand in the market, and the redemption price is set by the system. When the market demand for RAIs increases and the market price is higher than the redemption price, the system will lower the redemption price, providing an incentive for users to increase the market liquidity by casting new RAIs at the redemption price, thereby lowering the market price of RAIs.
When the market demand for RAIs decreases and the market price is lower than the redemption price, the system raises the redemption price. When the redemption price increases, on the one hand, users’ collateral rates will be close to the liquidation line and users under pressure to liquidate will repay some of the RAI, and on the other hand, users can get back their collateral at a redemption price higher than the market price. The amount of RAIs circulating in the market will then decrease, thus pushing up the market price of RAIs.
You may wonder if stablecoins can still be considered stable when they no longer have an anchor underlying.
We are used to measuring the eligibility of a stablecoin by whether it is anchored to a fiat currency, but there are 4 problems with this approach.
Stablecoin prices are not always pegged 1:1 to fiat currencies.
Decentralized issuance of USD stablecoins is under increasing regulatory pressure.
In times of easy monetary policy (like now), stablecoins pegged to fiat currencies will depreciate along with the fiat currency.
Given the global nature of crypto assets, it would be inappropriate to have the major stablecoins in the crypto digital economy anchored to the fiat currency of a particular country.
Stablecoins are not naturally supposed to be anchored to the US dollar, and if crypto is to create a new financial system, then it should probably be denominated in its own currency – RAI is one attempt at a native crypto stablecoin.
To take decentralization to the extreme and gradually remove human control to make it socially scalable, RAI introduced the non-governance token FLX. FLX currently has two core functions.
Lender of last resort: similar to the Maker protocol, the RAI system has the ability to auction off debt, minting new FLXs and auctioning them off to avoid running the system into trouble.
Removal of governance from the RAI system: FLX will facilitate the removal of artificial governance by allowing the community to make decisions on how to remove their discretion from the agreement.
With the non-governance token FLX, RAI hopes to become a stable asset that is completely decoupled from fiat and with minimal governance.
Compared to fiat-collateralized stablecoins and crypto-collateralized stablecoins, algorithmic stablecoins are the most decentralized, yet the most difficult to maintain stability. Due to the game theoretical complexity of the protocol, no algorithmic stablecoin mechanism has yet emerged that can anchor price stability at $1. The success of RAI as a new model without any anchor is not yet known, but it is a worthwhile cryptocurrency experiment, and even if it fails, it may become an experience for future algorithmic stablecoin development.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/is-a-stablecoin-still-a-stablecoin-when-it-doesnt-have-an-anchor/
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