Gate.io AMA: Are Algorithmic Stablecoins Really Stable?

2022-10-09, 10:01

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**Q: As an innovative type of stablecoin in the DeFi world, the question is how algorithmic stablecoin can realize a low or even zero mortgage rate step by step under the design of DeFi excess mortgage, and finally change the currency supply through automatic algorithms. This will involve maintaining the relative stability of the cryptocurrency anchor price and the market price based on the economic law of supply and demand and the arbitrage behavior of rational economic people. So is it really stable?**
A: Some people think that the algorithmic stablecoin has no mortgage and no value support. It only anchors the price to fluctuate around a certain value by flexibly adjusting the supply, and is vulnerable to the price fluctuation caused by speculation. From the previous attempts of some algorithmic stablecoins, they deviate from the anchor price for more than 50% of the time, so it seems unstable which is the normal state.
![](https://gimg.gateimg.com/image/16653095982951554621.PNG)
**Q: Is there a big algorithmic stablecoin market?**
A: In May 2022, the algorithmic stablecoin market had gained remarkable growth, from 1% to 11%, a big increase in the large share of the whole stablecoin market. From the perspective of the whole market, the total market value of stablecoin has actually increased from $80 billion a year ago to nearly $160 billion. The  main reason for the increase is that Terra has issued a large amount of UST.
This was the market scale before the UST crash, but after the crash, the algorithmic stablecoin market shrunk to about 1%. The crash of Luna and UST had a great impact on the whole algorithmic stablecoin market.

**Q: How many types of decentralized stablecoins?**
A: First, the one with an excess mortgage. That is, by depositing excess collateral, one can withdraw a part of stablecoins. For example, both Maker and Liquity belong to stablecoin with an excess mortgage.
Second is the type without collateral. Although Terra does not have a strict mortgage mechanism, and it is mentioned in the official statement that Terra USD has no collateral, it can actually be considered as another asset. Luna also plays the collateral,  so we can regard the coin itself as a type of collateral. However, in terms of total supply, it can also be regarded as the type without collateral. In addition, BASIS, empty set dollar, and Ampleforth are all categorized as stablecoin without collateral. Although these projects had some unique designs, they all ended in failure because they had no collateral.
Third, the type with the collateral. Relatively speaking, the stablecoin with collateral, such as Frax, Fei Protocol, Float, and Reflexer will be relatively stable in performance, but it still has no way to compare with the type with an excess mortgage.
![](https://gimg.gateimg.com/image/1665309598976790762.PNG)

**Q: How to regulate and control the algorithmic stablecoin?**
A: All kinds of projects will adjust the token supply under the condition of decoupling to the market price and target price of stablecoin, by following the economic laws:
When there is too much money in the market, i.e. the supply exceeds the demand, the money in the market will be buy-back/burned;
When there is too little money in the market, i.e. supply is less than demand, more money will be issued to the market.

**Q: How to adjust the price of UST through algorithmics?**
A: In the case of inflation: when the UST market price is less than the target price, they start to issue additional shares and recover money, and arbitragers use stablecoin to exchange for newly issued shares (for example, if the current UST market price is $0.9, and the arbitrager exchanges 1 UST for Luna with a value of $1, that means the arbitrager gets a Luna at the price of $0.1 cheaper than the market price).

**Q: What about deflation?**
A: When the UST market price is higher than the target price, new money will be issued and the stock will be buy-back. Arbitragers will exchange the equity token $Luna for new money (for example, if the current UST market price is $1.1, and arbitragers exchange the Luna with a value of $1 for a UST, it means they will get a newly issued UST at a price of $0.1 cheaper than the market price).
During inflation, the price of UST in the market keeps falling from 0.9 to 0.8, 0.7 to the point far below the target price (the target price is $1). At this time, Luna began to issue additional shares.
This worked pretty well in the past. However, if there is a relatively large downward pressure on the market, and some institutions seize the chance to make a large short of Luna, 5% of UST will become decoupled shortly. In this case, arbitragers are no longer satisfied with arbitrage through this mechanism. They start to short Luna, which directly leads to the emergence of the death spiral.

**Q: How do you think that Terra community has raised the supply limit of Luna to 1200m, to encourage more arbitragers to carry out arbitrage?**
A: In essence, this is the way to stabilize the price of Luna, because the market has to work to stabilize either Luna or UST, so that the other can be saved. The reason for issuing Luna is that before the crisis, the additional issuance of Luna left about $2 million arbitrage profit to all arbitragers while there are a large number of UST waiting to be exchanged back to Luna in the current market. LFG can speed up the whole process of burning UST by raising Luna's additional issuance limit, and finally push the UST back to $1.
However, the attempt still failed, because they issued too much UST.

**Q: Collateral is closely related to linking users' confidence, and the design of agreed stock right and seigniorage is crucial.**
A: Of course, Terra's arbitrage mechanism has actually failed due to extreme market conditions and targeted short selling, combined with various practical reasons. As a result, it can only rely on external forces to save the market. In theory, composite collateral can enhance the robustness of the system. Of course, LFG rescued BTC too late, which still made it impossible to resist the power of short selling.
Terra actually moves closer to the target than other stablecoin projects, and performs well in terms of issuance volume and stability. It may fail in the end, but it has been proven to have its unique value.

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