Vitalik Buterin Shares His Take on Algorithmic Stablecoins and Their Future

Ethereum founder and cryptocurrency enthusiast Vitalik Buterin recently shared his year on algorithmic stablecoins and their future adding that they should be examined based on how they perform under harsh market conditions, and whether they can safely calm down when the hype wears off. Despite the recent collapse of UST and LUNA, which wiped out treasuries of $1 (about Rs 77) and wiped billions from the market, Buterin argued in an article that automated stablecoins could make sense while criticizing the exorbitant returns offered by those “condemned to “Finally collapse.”

Buterin points out in his thought article that while the treasury disaster over the past month has led traders to form the opinion that algorithmic stablecoins are fundamentally flawed, some models of algorithmic stablecoins are feasible and illustrate his reasoning.

Citing an example, Buterin points to MakerDAO DAI’s stablecoin and Reflexer RAI, both of which survive harsh market conditions as successful stablecoins.

Algorithmic stablecoins are inherently backed by other cryptocurrencies and use baked-in formulas to regulate the price. This differs, for example, from USDC, which is a legal fee-backed stablecoin backed by real dollars in a bank. The biggest challenge for all stablecoins pegged to the dollar is finding ways to maintain their peg.

According to Buterin’s blog, the number one question that investors ask about stablecoin is “Can a stablecoin safely end up with zero users?” For Buterin, the event of a stablecoin market activity dropping to zero should not be a fatal blow to investors. Instead, users should be able to get a fair value for their assets.

Buterin notes that this has not been the case with Terra because the network relies on LUNA, which he calls a “volcoin,” or a high-volume coin to maintain the peg of the asset. Buterin painted the Terra tragedy as being caused by hyperinflation caused by printing too many volcanoes.

“First, the price of the volcano drops,” Buterin wrote. “After that, the stablecoin begins to vibrate. The system tries to support the stable demand for the coins by releasing more volcanoes. With confidence in the system going down, there are few buyers, so the price of the volcano drops rapidly. Finally, once the price of volcoin approaches -Zero, the stablecoin will collapse.”

Another issue Buterin highlighted is that Terra’s Anchor Protocol promised 20 percent annual return (APY) on terrestrial reservoirs. Some investors have funneled their savings to floor treasuries to earn high APY without fully understanding the risks involved. This is one reason Buterin welcomes the greater level of scrutiny in Decentralized Finance (DeFi).

The popular developer says that when stablecoins try to generate these kinds of returns, they can instead switch to Ponzi schemes. “Obviously, no real investment can generate close to 20 percent returns per year,” he says. “In general, the crypto space needs to move away from the position that it is okay to achieve security by relying on endless growth.”

Buterin concludes the article by saying that even if the stablecoin passes the aforementioned parameter test, there may still be underlying issues such as bugs and governance issues that threaten the project’s survival. However, he concludes, “steady state and extreme state safety should always be one of the things we check.”

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