Mahi Sall, Advisor, Fintech-Bank Partnerships, Payments and Financial Inclusivity
January 25th, 2023
Anthony Pompliano | March 21, 2022
Algorithmic stablecoins elicit intellectual curiosity from people across disciplines. Whether you are coming from the technology industry, finance, or academia, creating a digital currency that holds stable value without being pegged to another asset is a fascinating problem. The value of this type of asset is obvious, but no one has been able to figure it out.
In November, Ryan Clements published a paper tilted Built to Fail: The Inherent Fragility of Algorithmic Stablecoins, where he argued:
“Algorithmic stablecoins are inherently fragile. These uncollateralized digital assets, which attempt to peg the price of a reference asset using financial engineering, algorithms, and market incentives, are not stable at all but exist in a state of perpetual vulnerability. Iterations to date have struggled to maintain a stable peg, and some have failed catastrophically. This Article argues that algorithmic stablecoins are fundamentally flawed because they rely on three factors which history has shown to be impossible to control.
First, they require a support level of demand for operational stability. Second, they rely on independent actors with market incentives to perform price-stabilizing arbitrage. Finally, they require reliable price information at all times. None of these factors are certain, and all of them have proven to be historically tenuous in the context of financial crises or periods of extreme volatility.”
This is important context because there is an experiment underway in crypto that is worth paying attention to.
Terra is undergoing a transition from a dollar-pegged stablecoin to a bitcoin-backed stablecoin. There is a lot to unpack here, so let’s start from the top. Terra is described as a public blockchain protocol deploying a suite of algorithmic decentralized stablecoins which underpin a thriving ecosystem that brings DeFi to the masses. The stablecoin at the heart of this ecosystem, TerraUSD (known as UST), sits at more than $15 billion in market cap.
So what is Terra going to do differently with UST moving forward? They are going to back UST with bitcoin.
So what are the ramifications of this decision by Terra? First, Terra is becoming a persistent buyer of bitcoin. Second, Terra is highlighting the opportunity for bitcoin-backed assets. Third, bitcoin gets a credible layer two in Terra, one of the largest smart contract platforms in the world.
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