Ethereum co-founder Vitalik Buterin has given his thoughts on judging whether an algorithmic stablecoin is sustainable, citing two characteristics that he believes are required.
This is in response to the recent collapse of TerraUSD (UST) and the broader collapse of the network’s ecosystem, which resulted in a $40 billion loss.
Buterin noted in a blog post that algorithmic stablecoins still have potential, despite the fact that many of those now in existence are “fundamentally defective and likely to collapse soon.”
“What we need is not stablecoin boosterism or stablecoin doomerism, but rather a return to principles-based thinking,” he said.
Meanwhile, RAI stablecoin was referenced in the blog post as an example of an ideal automated stablecoin. The RAI is not linked to any fiat currency. It employs algorithms to calculate interest rates automatically, oppose price fluctuations when necessary, and motivate users to keep RAI within its price range.
Buterin has two requirements for algorithmic stablecoins.
Buterin believes that there are two thought experiments that may be used to test whether a stablecoin is genuinely stable. The first question is whether users will still be able to extract fair value from the asset if market activity falls to “near zero.”
Buterin stated that UST did not meet this need. The structure relies on its volume currency (volcoin) LUNA to keep its price and demand stable. Without it, both the stablecoin and the volcoin will fail.
“First, the volcoin price drops. Then the stablecoin starts to shake. The system attempts to shore up stablecoin demand by issuing more volcoins. With confidence in the system low, there are few buyers, so the volcoin price rapidly falls. Finally, once the volcoin price is near-zero, the stablecoin too collapses.”
Furthermore, Buterin argues that if necessary, an algorithmic stablecoin should be able to incorporate negative interest rates.
He stated, in relation to Anchor’s annual percentage yield (APY),
“Obviously, there is no genuine investment that can get anywhere close to 20% returns per year, and there is definitely no genuine investment that can keep increasing its return rate by 4% per year forever. But what happens if you try?”
He responded that the initiative must charge “some form of negative interest rate on holders that equilibrates to basically cancel out the USD-denominated growth rate built into the index” or it would become a Ponzi scheme that will collapse sooner or later.
Buterin believes that this is not enough to ensure the safety of an algorithmic stablecoin. Other flaws and vulnerabilities could yet exist.