What are algorithmic stablecoins?
Originally Published on LinkedIn — September 15th, 2022.
The term ‘Stablecoin’ has shifted over time. Initially, the ‘stable’ was relative to the coin’s ability to maintain parity with the underlying asset (digital or real); stability = coin price/asset price. The need for stablecoins came from providing off-chain asset price feeds without compromising layer one security, including having accepted currencies as a unit of account, a medium of exchange and a store of value.
This napkin math approach to defining a stablecoin’s stability is still standard practice. The key distinction is that stablecoins have become synonymised stablecoins to fiat pegged stablecoins.
Stablecoins encompass any cryptocurrency that can maintain a stable peg to a relatively stable asset; fiat currency is currently the most suitable use case.
However, can we adopt more inventive methods to store or transfer value on-chain without relying on off-chain and centralised auditing, custody or authority?
Algorithmic stablecoins…
Algorithmic stablecoins are cryptocurrencies that maintain a tight spread from the underlying pegged asset by quantitatively minting/burning token value, altering token supply to market demand relative to the pegged price.
Quantitative mint/burning methods are the future of transferring value without requiring collateralising security. However, we are without the necessary blockchain 3.0 technology to comfortably advance purely algorithmic stablecoins further; especially if the underlying asset is off-chain.
It is difficult to define all conceivable variations of algorithmic stablecoins, as the line between structured products and algorithmic stablecoins gets blurred quickly.
On a first principles basis, these are four current variations of algorithmic stablecoins — connecting no. of tokens involved in quantitative mint/burn and collateralised status:
1) Rebasing (single token & not collateralised)
2) Basket/seigniorage (multi-token & not collateralised)
3) Fractal (single token & partially collateralised)
4) Basket-fractal (multi-token & partially collateralised)
It is a standard within web3 advising circles to steer clients away from stablecoin initiatives using an algorithm in isolation. The margin for error is significant, and after the LUNA crash, it is generally ill-advised to pursue algorithmic stablecoins.
Despite the expert steer, stablecoins should have a pathway to replacing the collateralised value for algorithm-determined value. Allowing free markets to determine the price. There is no doubt that new methods of storing and transferring value are on the horizon; we may not need to ever collateralise tokens again.
Soulbis David Lightfoot
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