Despite the collapse of TerraUSD (UST) and the presence of “many imperfect” stablecoins on the market, the industry should not abandon projects from this category. This was stated by the founder of Ethereum Vitalik Buterin.
Two thought experiments to evaluate automated stablecoins:https://t.co/gqPKb42tL8
— vitalik.eth (@VitalikButerin) May 26, 2022
According to Buterin, the UST collapse has sparked increased attention to DeFi financial mechanisms and crypto models that promise users greater returns. He emphasized that he welcomes this, but does not agree that all stablecoins are “cut with the same brush”.
“We need not boosterism or excessive pessimism about stablecoins, but rather a return to principle-based thinking,” he wrote.
The founder of Ethereum said that the stability of a “stable coin” can be determined using two thought experiments.
In his opinion, the first question worth answering is whether a stablecoin can safely “roll up” to zero users? He explained that in the event that activity in the markets of the project drops “to almost zero”, holders should be able to extract the fair value of their investment from the token.
Buterin cited UST as an example of an asset that fails this test. The reason is the stablecoin collateral structure based on LUNA quotes. According to him, the latter is obliged to maintain its price and user demand, otherwise the project will collapse.
“Price falls first [актива обеспечения]. The shock is then transferred to the stablecoin itself. The system is trying to support the demand for the stablecoin by issuing more collateral coins. Since trust in the system is low and there are few buyers, the price [актива обеспечения] falls quickly. When the price of the latter is close to zero, the stablecoin collapses,” he explained.
The Ethereum founder stressed that UST-like assets could pass a thought experiment if demand declines slowly. However, such a situation is “highly unlikely”.
As a stablecoin that is being tested, Buterin named RAI from Reflexer Labs. It functions in a similar fashion to DAI and is an over-collateralized stablecoin in ETH.
“The security of RAI depends on an asset external to the stablecoin (ETH) system, so it is much easier for RAI to safely wind down activities,” he said.
According to Buterin, the second question that will allow assessing the stability of a stablecoin is what will happen when it is tied to an index with an increase of 20% per year.
In such a situation, the project behind the stablecoin should be able to set a negative interest rate, otherwise it will turn into a Ponzi scheme, the founder of Ethereum noted.
“For a stablecoin that is trying to track such an index, there are two scenarios. It charges holders a negative interest rate, essentially balancing out the growth rate […]. It turns into a Ponzi, providing stablecoin holders with amazing income for some time,” he wrote.
Buterin stressed that a negative interest rate could be implemented in RAI. There was no such possibility in UST.
However, he added that the fulfillment of this condition does not make the asset “safe”:
“It may still be unstable for other reasons (for example, insufficient margin), have bugs or vulnerabilities associated with the management mechanism.”
Recall that earlier Tether CTO Paolo Ardoino called TerraUSD a “poorly designed” product.
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