Vitalik shared his views on the future of algorithmic stabilitycoins following the failure of TerraUSD. He believes that it is important to be skeptical and examine existing protocols. However, he feels that the recent attempts to permanently eliminate all automated stablecoins are not justified.
A Better Model for Automated Stables
TerraUSD (UST), an algorithmic stablecoin, was in effect backed by the LUNA governance token. Holders of UST can at any time burn their holdings to get a new minted dollar worth of LUNA. A dollar’s worth of LUNA could also be used to redeem for UST.
The two-way peg was intended to encourage arbitrage and keep the market value for UST at $1.00 all time. The system eventually unravelled after the peg was placed under pressure earlier in the month, resulting in a collapse of both UST’s and LUNA’s values.
Vitalik, however, argued in a blog post that TerraUSD is not the only stable and reliable automated stablecoin model.
RAI, an automated stablecoin backed purely with ETH, is cited by him as an example. RAI stablecoins can be created by depositing an ETH overcollateralized into a smart contract. The depositor – also known as the “lender” – is then rewarded with two-thirds of that ETH’s value.
If the price of ETH falls enough that the collateral backing RAI no longer suffices, a liquidation event is held. The ETH that has been deposited is then sold to another person who will purchase it by depositing additional collateral.
Vitalik says that RAI’s security is dependent on an asset outside of the RAI system (ETH), so RAI can have a much easier way safely winding down.” He means to allow RAI to experience declines in user demand, without threatening the reliability of a Rai holder to fairly redemption his coins.
Vitalik believes TerraUSD lacks the same level of reliability. The asset backing UST – LUNA – had an unstable value that was also dependent on activity in the Terra ecosystem. (LUNA holders could make money from the system’s transaction fees).
A decrease in demand for UST could lead to a decline in activity and a decrease in the market value of LUNA. Holders then lose trust in the stablecoin, and they redeem it for LUNA. This creates a negative feedback loop and further devaluation of the governance token.
These processes were responsible for Terra’s collapse. LUNA hyperinflating, and losing 99.9%, was one of the results. Terra’s community voted to start the network again with a new chain and drop its stablecoin project.
Stablecoins: What are the Requirements?
Vitalik concluded that stablecoin developers and the wider crypto space must stop relying on endless growth as a security assumption. Instead, they should evaluate their security assumptions based on both steady and pessimistic conditions, and whether a safe “wind down” is possible.
“A system that passes this test does not necessarily mean it is safe. It could still be vulnerable for other reasons, such as. He clarified that the system could fail because of insufficient collateral ratios, or it could have bugs or governance weaknesses.”
Vitalik’s critical views on algorithmic stablecoins are shared by many others. Nic Carter, co-founder and CEO of Crypto Intelligence firm CoinMetrics, believes the industry should adhere to standard, centralized stablecoins that are backed by reliable reserves.
He tweeted weeks before Terra’s fall that no one would ever, in their right minds, choose to hold an algostable with 100x USDC/USDT default risk.” Use crypto-backed stables that are more decentralized if you need them.
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