How Stable are Algorithmic Stablecoins?

What Are Algorithmic Stablecoins? 

Algorithmic stablecoins use algorithms to balance the circulating supply of the asset. In simple terms, the algorithm issues more coins when price increases, and buys them off the market when the price falls. 

For example, assume a stablecoin is priced at $1. When the price drops to $0.80, an algorithm recognizes the imbalance between supply and demand, and automatically sets a market buy order to push the price back. In case the price goes above $1, the algorithm sells assets to maintain the price on the predefined level that keeps the peg. 

The other types are fiat-collateralized, like USDC and USDT, which are backed by financial institutions; and crypto-collateralized, like DAI, which are backed by one or several digital assets instead of cash, such as ETH and BAT

The top algorithmic stablecoins in terms of market capitalization are currently Empty Set Dollar (ESD) and Ampleforth (AMPL). 

ESD’s algorithm is set to maintain its price stable around 1 USDC, which is itself pegged to the U.S. dollar. AMPL is, on the other hand, pegged to the U.S. dollar directly — with daily “rebases” to stabilize price.   

Liquidity Incentives Caused AMPL to Lose Peg and Rise to $3 

Data visualization by Connor Higgins.

AMPL has been around for a year and has had the hardest time maintaining its peg — rising all the way past $3 in July 2020.

The spike in price aligns with Ampleforth’s launch of “Geyser’”on June 23 last year — an incentive program that distributed rewards (in AMPL) for users who supplied AMPL-ETH liquidity on Uniswap, a non-custodial decentralized trading platform. 

In addition to earning liquidity provider (LP) fees on Uniswap, users who provided AMPL-ETH liquidity could take their LP tokens and stake them on the Geyser platform — thereby earning an even greater share of AMPL rewards. Lastly, users were additionally rewarded for not withdrawing their deposits. All of the above inevitably created a flood of interest in Ampleforth. 

AMPL daily transfers climbed to 4,000, ¼ coming from new addresses. 

On July 30, the number of AMPL transfers coming from new addresses reached its peak of 935 transactions. 

This is very small compared to the 40K, let alone 320K, transactions that can happen in a day for USDC and USDT respectively. 

And yet, these fiat-collateralized stablecoins are the most stable. 

Neither USDC nor USDT has varied more than 5 cents away from a dollar in the past year. 

Crypto-collateralized stablecoin DAI went up to $1.10 in March 2020 following “Black Thursday” when the price of Ethereum crashed, causing users to flock to DAI for stability. USDC was also used as leverage for a DeFI attack for $24M in Harvest Protocol, even though the price of USDC didn’t vary far away from its peg. The event marked DAI as the least stable stablecoin at the time, but the spike was relatively contained compared to AMPL and even ESD.

It is important to note, however, that algorithmic stablecoins are extremely new and these projects are positioned as experiments to grow and improve the DeFi space. It will be interesting to see over time how they adjust in order to reach the goal of algorithmic stability without collateral or debt supporting it.

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