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The Defiant

Algorithmic Stablecoin Landscape Suffers Tremors After Terra Crash

Terra’s UST collapse has shattered the foundations of the algorithmic stablecoin market.

By: Jason Levin •  

Algorithmic Stablecoin Landscape Suffers Tremors After Terra Crash

Terra’s UST collapse has shattered the foundations of the algorithmic stablecoin market.

After the collapse of Terra, algorithmic stablecoins have been experiencing jitters across the market – a sign that investors are losing confidence that this model of creating stable cryptocurrency can be sustainable in the long term.

Vai (VAI) fell from its peg down to as low as $0.87 on May 10, Fei USD (FEI) dropped to $0.97 on May 11, and Neutrino USD (USDN) fell to $0.70 on the morning of May 12. While FEI is now hovering around its peg, VAI and USDN are now sitting at $0.93 and $0.95 respectively.

Algorithmic stablecoins are managed by a set of operations encoded in smart contracts to keep the currency as close to their peg as possible. The target peg is typically set at $1 dollar. While issuance, collateralization and rewards vary from project to project, at their core, algorithmic stablecoins rely on mint and burn mechanisms to control their supply without the need of a centralized entity.

Terra Contagion

Terra’s algorithmic stablecoin UST made headlines after it de-pegged this week, its blockchain was halted, resumed, and now sits at $0.15, while LUNA, the volatile asset backing UST, has been inflated away to fractions of a penny. The purpose of UST was to create a decentralized stablecoin that offered a high yield to its users and an alternative to asset-backed stablecoins like MakerDAO’s DAI. But, billions of dollars of value were wiped out.

UST wasn’t the first algorithmic stablecoin to implode. It turns out that Terra’s founder Do Kwon was allegedly the pseudonymous founder of Basis Cash, a completely different failed stablecoin, as reported by CoinDesk. Basis Cash was a fork of Basis, a VC-backed stablecoin project that also failed due to regulatory concerns.

On top of the billions lost in value, there is growing concern over regulations to be handed down from Washington. But, there is a big difference between algorithmic stablecoins and asset-backed stablecoins.

Asset-Backed Stablecoins Hold Up

On the flip side from algorithmic stablecoins, asset-backed stablecoins are backed by assets such as fiat currency, bonds, or even other cryptocurrencies. Some of the largest asset-backed stablecoins are DAI, Tether (USDT), and USD Coin (USDC).

“UST was in a category of its own, relying solely on its algorithmic mechanism, a risky model that many predicted might fail”, tweeted Jake Chervinsky, Head of Policy at the Blockchain Association. “That’s far different from the many collateralized stablecoins, custodial & decentralized, which all performed well during this week’s high volatility.”

As Chervinksy alluded to, despite algorithmic stablecoins’ shakiness, asset-backed stablecoins have remained steady for the most part. Over the last seven days, USDC hasn’t fluctuated more than a thousandth of a penny while Binance USD and MakerDAO’s DAI haven’t moved more than a hundredth of a penny. USDT did lose its peg for a moment and fell to $0.95, but quickly shot back up to $1.00.

Is it the end of algorithmic stablecoins? Messari analyst Dustin Teander told The Defiant that it depends on the definition. If you classify algo stables with zero or less than 20% of collateral, then it’s a resounding “yes”. He clarifies that he thinks models like Frax – which have high collateral factors – are here for good.