Are Algorithmic Stablecoins The Answer To Government Regulation?
A Deep Dive Into The Algo Stables
It seems like regulators have set their sights on cryptocurrency. We all knew this day would come, we just weren’t sure when it would come. One of the main targets of regulators is DeFi. Stablecoins are the backbone of DeFi. This places stablecoins directly in the SEC’s crosshairs. We’ve already seen this with Tether being investigated by the SEC (here’s an article detailing the investigation if you would like to gain more context: link).
The SEC’s regulatory arguments against stablecoins is that due to lack of regulatory frameworks, there are no auditing and reporting requirements, nor any reserve investment requirements. You can imagine that this could leave investors vulnerable. So, there is indeed some merit to their argument. However, that is one of the costs of full decentralization. The Tether investigation paired with Gensler’s appetite for DeFi regulation paints a pretty grim and bearish picture for stablecoins….or so it seems.
The Different Types Of Stablecoins
Not all stablecoins are created equal. There are four different types of stablecoins:
Fiat Collateralized Stablecoins: These are stablecoins that are pegged 1:1 to fiat currencies like the US dollar, the Euro, etc. These stablecoins are highly centralized. Examples of Fiat Collateralized Stablecoins are: $USDT, $USDC, $USDP, and $GUSD.
Commodity Collateralized Stablecoins: These are commodity backed stablecoins. Their value is pegged to assets like gold, silver, oil, etc. These are also highly centralized. One example of a Commodity Collateralized Stablecoin is $PAXG.
Crypto Collateralized Stablecoins: These are stablecoins that are pegged to a diversified reserve of cryptocurrencies. Crypto Collateralized Stablecoins are overcollateralized (for every stablecoin, the crypto backing it is worth twice the value) to ensure stability. These are considered to be the most transparent stables because of the open source nature of the blockchain. These stablecoins are also decentralized. Examples of Crypto Collateralized Stablecoins are $DAI, Synthetix, and $RSV.
The last type of stablecoin is the Algorithmic Stablecoin, which we will get into below.
What Are Algorithmic Stablecoins?
Algorithmic Stablecoins are also known as Non Collateralized Stablecoins.
There is no collateral backing issuance. Instead, these coins run off of a series of smart contracts that rebase the coins to maintain stability.
The most popular algorithmic stablecoins are $UST, $AMPL, and $FRAX.
Cardano has recently become the talk of the town with its announcement of its new algorithmic stablecoin, $DJED
The Benefits Of Algorithmic Stablecoins
The main benefits of algorithmic stablecoins is that they are believed to be regulation-proof.
This is due to the decentralized nature of the coins. Technically, there is no regulatory body maintaining the asset, as they are maintained by a series of smart contracts.
However, algorithmic stablecoins are still very experimental and do not come without their own set of risks.
Are They Safe?
While algorithmic stablecoins may seem like the perfect stablecoin solution, there have been some disasters that have taken place.
One of the more recent events was the rug pu…*ahem* I mean the “bank run” that occurred with Iron Finance that ended up plunging the TVL from $2B all the way to nearly $0.
Mark Cuban happened to be one of the customers that took on the brunt of the alleged bank run.
Some members of the community took this as the opportunity to turn this mishap into a teachable moment.
This also presents another risk to take into consideration. There is no accountability if an Algorithmic Stablecoin’s smart contract misbehaves or if you become a victim of a rug pull or bank run.
You have a better chance of being made whole with Collateralized Stablecoins.
Mark Cuban recently released an interesting thread detailing his predictions and thoughts on stablecoin regulation.
While I do understand his prediction, I can’t help but feel like there is just a little bit of saltiness left over from the Iron Finance debacle that he fell victim to.
We’ve covered the different stablecoins, as well as the pros and cons of algorithmic stablecoins. Now the question is, could algorithmic stablecoins be the safest answer to regulation?
Until we have full regulatory clarity, I’m not comfortable trusting any of the non-algorithmic stablecoins.
I do realize that trusting algorithmic stablecoins comes with a healthy set of risks. However, crypto is a very innovative space with some of the brightest minds working around the clock to perfect these revolutionary assets that have been brought into fruition.
Also, the purpose of diversification is to limit risks. Will I take profits into algorithmic stablecoins? More than likely. However, those profits will be spread among a myriad of different assets (NFTs, BTC, ETH, etc).
I think it will only be a matter of time until a team creates the perfect algorithm. Apparently, Nick Cote agrees.