Algorithmic stablecoins are typically undercollateralized – they don’t have independent assets in reserves to back the value of their stablecoins. In fact, “undercollateralized stablecoins” and “algorithmic stablecoins” are often used interchangeably.
I published this piece for CoinDesk on May 13, 2022. Please follow the link to read it in full. If you’re interested in working with me as a crypto writer and/or consultant, please get in touch.
What are algorithmic stablecoins?
Algorithmic stablecoins typically rely on two tokens – one stablecoin and another cryptocurrency that backs the stablecoins – and so the algorithm (or the smart contact) regulates the relationship between the two.
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To prevent the price of a stablecoin depegging – moving away from $1 – while subject to market conditions, algorithms regulate supply and demand. When there’s too much demand for an asset but little supply of it, the price of that asset goes up – and vice versa.
How is UST designed to maintain its peg?
TerraUSD (UST) maintains – or is supposed to maintain – its 1:1 parity with the U.S. dollar via an algorithmic relationship with Terra’s native cryptocurrency, LUNA. Behind the relationship is an arbitrage opportunity that presents itself every time UST loses its peg in either direction.
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When the UST supply is too small and demand for it is too high, the price of UST goes above $1. To bring UST back to its peg, the Terra protocol lets users trade 1 USD of LUNA for 1 UST at the Terra station portal. This trade burns 1 USD of LUNA and mints 1 UST, which users can sell for 1.01 USD and pocket a profit of 1 cent. It doesn’t sound like a lot, but these profits add up when done in large quantities.
Some blame the events that led to UST’s depegging on a coordinated attack. Others think it was a series of spontaneous panic-ridden withdrawals due to the souring wider market conditions, especially in the price of bitcoin that LFG has added to its reserve to back UST.
ok here is how the $luna $ust attack was coordinated & executed. 🧵 (quoted from a friend)
– attacker OTC accumulated $1bn of UST
– borrowed $3bn in $btc
– spread around some fud about peg and bank runs
– dumped the fuck out of their $3bn $btc on market to trigger wider panic— 4484 (@4484) May 10, 2022
In either case, the stablecoin hasn’t withstood the pressure enough to maintain its peg, eventually falling as low as $0.29 on May 11.
I published this piece for CoinDesk on May 13, 2022. Please follow the link to read it in full. If you’re interested in working with me as a crypto writer and/or consultant, please get in touch.