Four Criteria for Restoring Trust in Algorithmic Stablecoins: Huobi Research Institute
Algorithmic stablecoins became the focus of the crypto industry in May, following the split of the UST from the US dollar that sparked the LUNA bloodbath. This had a ripple effect on other algorithmic stablecoins, causing the market capitalization to shrink from the top US$5 billion to under US$4 billion by May 22, a steep drop of 82, 6% in just 2 weeks.
Algorithmic stablecoins, which form an essential asset class in the crypto industry, are digital tokens that are backed by a sufficient level of cryptocurrency as collateral. This makes it possible to effectively mint stablecoins using crypto assets with high price volatility.
In the aftermath of the collapse of UST and LUNA, a report by the Huobi Research Institute titled “Revival of Algorithmic Stablecoins: 4 things to doidentified the following criteria for algorithmic stablecoins to succeed:
1. Fully backed assets (backed by exogenous or external assets)
Algorithmic stablecoins backed by endogenous assets could face a meltdown when the value of both drops simultaneously. Conversely, the risks would be limited if they were backed by exogenous assets, the price being more inclined to correct after a depeg. The rationale for burning an algorithmic stablecoin is to mint additional assets for collateral, which will cause the underlying assets to depreciate sharply or even collapse the entire system. Secured assets present a risk of default, as some users may not recover the secured assets, in part or in full.
2. Robust stabilization scheme
A robust stabilization program should work independently regardless of the status of the protocol, fulfill its purpose when the price falls below 1 USD and cover the depeg risk for the system. User transactions would trigger a system adjustment to control circulation supply, to keep the stablecoin price at $1.
When the price of a stablecoin falls below $1, the stabilization mechanism above could put considerable selling pressure on the underlying assets, further increasing the possibility of the system entering a death spiral. The degree of openness of buyout venues, however, can determine the extent of selling pressure on the underlying assets or stablecoins.
3. Flexible asset management strategies
A reserve fund, while costly, could benefit both the protocol and users in terms of improving system stability and attracting more users. Two types of strategies are most commonly seen: an Algorithmic Market Operations (AMO) strategy that absorbs profits from market making activities in DeFi protocols with reserve; and an automotive cash management strategy that takes advantage of the market using the “buy low and sell high” approach.
4. Abundant application scenarios.
An increase in application scenarios will naturally drive the demand for algorithmic stablecoins. For this to happen, a stablecoin must have high liquidity and many agreements with other protocols, so that it is compatible in various scenarios in different environments.
As an example, UST has seen substantial growth thanks to the 20% fixed interest rate on the Anchor platform. Tron’s USDD also created various potential earning scenarios: an official liquidity pool including SunSwap, Sun.io, Justlend, Poloniex, and Ellipsis; and liquidity mining through collaboration with Tron Reserve. NEAR USD could receive interest from lending protocols such as Burrow, Bastion and Aurigami.
Commenting on the prerequisites for the revival of algorithmic stablecoins, Barry Jiang, a researcher at the Huobi Research Institute, said: “An algorithmic stablecoin can achieve short-term capital efficiency, but its long-term success depends on profitability. In addition, a reserve fund is essential for an algorithmic stablecoin, where a high level of liquidity must be maintained by a certain amount of funds from reserves. the protocol bears the burden instead of the users.
“Capital efficiency at issuance – and over the long term – must be considered separately; only one can survive at the expense of the other. For users more bullish on an asset’s upside potential, the using to oversize can preserve the right to future earnings.If one is more confident about the short-term development and relatively stable returns of a certain ecosystem, algorithmic stablecoins are a better choice.
To download the full report, click here.
About Huobi Research Institute
Huobi Blockchain Application Research Institute (referred to as “Huobi Research Institute”) was established in April 2016. It is committed to researching and exploring new developments in the global blockchain industry. Its goal is to accelerate the research and development of blockchain technology, promote its applications, and improve the global blockchain industry ecosystem. Huobi Research Institute covers industry trends, emerging technologies, innovative applications, new business models, and more. The Huobi Research Institute partners with governments, companies, universities and other institutions to create a research platform that covers the entire blockchain industry. Its professionals provide a solid theoretical basis and analyze new trends to promote the development of the industry.
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