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Analyzing Algorithmic Stablecoins: A Beginner’s Guide

Stablecoins have emerged as one intervention in the crypto world for addressing the amount of volatility within the market. Anyone following the crypto price action lately would find that coins and tokens are considered volatile due to a variety of reasons. The value of crypto fluctuates profoundly in accordance with changes in a variety of market conditions including supply and demand.

Today we will cover the basics of a subset of stablecoins called algorithmic stablecoins to provide our community more education about these types of digital assets.

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🔹 1. What is an algorithmic stablecoin? How does it work? How are algorithmic stablecoins different from collateralized stablecoins?

Most stablecoins maintain a 1:1 peg with the currency they track through a collateral mechanism. The stablecoin in circulation are backed by either cash or other assets to support the stablecoin’s valuation. For instance, Tether (USDT), the largest stablecoin by market cap, is collateralised by off-chain assets like cash (USD) and cash-equivalent bonds stored in a bank or another centralized entity.

However, it is not always feasible to follow this approach as protocols need to keep adding to their collateral stockpile as the stablecoin’s circulation increases. This is where algorithmic stablecoins enter the picture.

Algorithmic stablecoins function a bit differently. They usually do not have any collateral backing and instead use complex algorithms to maintain their peg with the fiat currency they track.

Algorithmic stablecoin’s value stays stagnant when a computer program running a preset formula is used. Algorithmic stablecoins achieve price stability by pegging to a reserve asset like gold, a foreign currency, or even USD. These tokens are designed to help balance the supply and demand of the asset in circulation. To add they may or may not have reserve assets behind them.

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🔹 2. Why do we need algorithmic stablecoins? What value does it bring to the market?

Algorithmic stablecoins are important for DeFi. The steady value created by stablecoins make them an important primitive block for decentralized finance (DeFi), allowing investors to transact in cryptocurrencies and digital assets. They are used in a wide variety of lending, borrowing, trading and yield farming programs.

Algorithm-based stablecoins do not have any associated collateral. Therefore, they are also referred to as non-collateralized stablecoins. Algorithm-based stablecoins are completely new variants of cryptocurrency tailored for offering improved price stability. In addition to price stability, it can also help balance supply and demand for the asset in circulation. Most importantly, algorithm-based stablecoins offer considerably improved capital efficiency in comparison to collateralized stablecoins.

The algorithm or the protocol backing up these stablecoins works as the ‘central bank.’ It helps in increasing supply in event of the deflationary tendency of the token or reducing the supply in event of a decline in purchasing power. The algorithm rules for such actions are embedded in smart contracts. It is possible to change the rules only by leveraging social consensus or through governance votes associated with governance or seigniorage tokens.

A decentralized currency protocol like USDD with a stable price will expand use cases for cryptocurrency, making it truly accessible with far-reaching implications for the blockchain space and the real economy.

🔹3. Are there any risks in algorithmic stablecoins?

Algorithmic stablecoins are stablecoins that aren’t backed by fiat, crypto, or physical assets. Instead, they create price stability based on “specialized algorithms and smart contracts that manage supply of the tokens in circulation”

First and foremost, algorithmic stablecoins are prone to devaluation risk and speculative attacks when they are under-collateralized. One natural solution is to be backed fully by stable collateral, ideally liquid US dollar reserves, or its equivalent in stablecoins on the blockchain.

When the United States began printing dollars, it maintained a stock of gold and silver intended to support the dollar’s value. If someone wanted to bring a silver certificate or gold certificate to the government and exchange them for silver or gold, they were able to until 1964, when the dollar moved to be backed by the “full faith and credit of the United States government.”

Several stablecoins use similar systems and maintain reserves in dollar-denominated assets to support the value of their currencies. However, that’s not the case with algorithmic currencies like TerraUSD. Because it’s only backed by the community that uses the currency and computer algorithms designed to keep the market demand for the currency balanced at one dollar, there’s no guarantee that the currency can maintain its peg.

Some algorithmic stablecoin resolves short-term price fluctuations and cyclical price risks with its responsive monetary policy and mintage mechanism. Here use the case of USDD:

First, the USDD stablecoin protocol decides which asset USDD should be pegged to because stability is relative, and pegging to a specific asset will meet the demand of more users. Second, the USDD protocol runs on the TRON network. TRON is a decentralized network where the external market decides token prices. Therefore, an efficient and stable price feed mechanism is needed to ensure the smooth running of the stablecoin system. Last but not least, the protocol should be equipped with the tools to regulate the market against any price deviation from the predetermined value to maintain the stability of the currency price.

As the early custodian, the TRON DAO Reserve manages USDD, ensuring price stability and decentralization by collateralizing USDD with its reserves. TRON DAO Reserve has over $10 billion in the reserve, enough to cover all the deviations now. It will continue to attract more liquid assets and whitelist more compliant institutions on board as stakeholders to better manage USDD and guarantee its price stability.

🔹 4. What is considered a Stablecoin 3.0? How is it different from its peers?

The decentralized algorithmic stablecoin has been hailed as one of the industry’s most disruptive and boldest concepts. TRON pooled all its resources to create USDD, a fully decentralized stablecoin underpinned by mathematics and algorithms, to bring stablecoin development to the next level. By building the project on the most efficient and affordable stablecoin network in history, TRON aims to usher stablecoins into the era of Stablecoin 3.0, led by the TRON-based USDD.

🔹Three Stablecoin Eras:

In the Omni-USDT 1.0 era, stablecoins relied entirely on the Bitcoin network, where transfers would take over 30 minutes and handling fees would cost an astonishing 100 dollars. With maximum daily transfers on the network capped at 200,000, the total market cap of stablecoins stood at $1 billion, and the associated dollar reserves were redeemed, managed, and stored by centralized institutions.

The TRON-USDT 2.0 era was carried by TRC20-USDT, TRON’s biggest contribution to the crypto industry. Transfers of TRC20-USDT are completed within seconds with extremely low transaction fees, which completely transformed the industry and redefined how users use stablecoins. Nevertheless, the stablecoin reserves in this era were still redeemed, managed, and stored by centralized institutions.

In the Stablecoin 3.0 era, centered on TRON’s USDD, despite inheriting the high speed, low handling fees, and large scale from the 2.0 era, USDD will not rely on any centralized institutions for redemption, management, and storage. Instead, it will achieve full on-chain decentralization. USDD will be pegged to the underlying asset, TRX, and issued in a decentralized manner.

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Anti-censorship that eliminates the entry barrier. As a decentralized stablecoin, USDD no longer needs to meet the regulatory requirements raised by centralized institutions, and therefore anyone can hold USDD without any entry barrier.

The inviolability of private properties in its full sense. USDD will not be frozen or confiscated as is done by any centralized institutions, which guarantees that it is a private property and completely inviolable.

Low volatility to retain the asset value. USDD will be able to retain the asset value to the greatest extent possible since it is immune to the price swings other cryptocurrencies face.

The potential applications of USDD are immense. We foresee USDD being used as a medium of exchange for online payments and allowing people to trade freely at a fraction of the fees charged by other payment service providers. As society’s paradigm shifts more towards decentralization, we will see more dApp platforms adopting USDD due to its decentralized nature. With the USDD protocol, a robust and stable financial infrastructure powered by blockchain technology is on the horizon. USDD will propel stablecoins to enter a new era where mathematics and algorithms lay the foundation for decentralized financial accessibility and stability.

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Risk Reminder: This post is sponsored by usdd.io. Trading digital assets comes with high risks due to significant price volatility. Please fully understand all the risks and make prudent decisions before trading.

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