Vitalik Buterin listed the signs of stable algorithmic stablecoins

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 collapse of the UST caused increased attention to DeFi’s financial mechanisms and cryptographic models, promising users greater profitability. He stressed that he welcomes this, but does not agree that all stablecoins “cut under one comb.”

“We don’t need boosterism or excessive pessimism about stablecoins, but rather a return to principle-based thinking,” he wrote.

The founder of Ethereum said that it is possible to determine the stability of a “stable coin” with the help of two thought experiments.

In his opinion, the first question that should be answered is whether the stablecoin is able to safely “collapse” to zero users? He explained that in the event of a drop in activity in the markets of the project “to almost zero”, holders should be able to extract from the token the fair value of their investments.

Buterin cited the UST as an example of an asset that does not pass this verification. The reason is the structure of providing a stablecoin, tied to LUNA quotes. According to him, the latter is obliged to maintain its price and user demand, otherwise the project will collapse.

“First the price drops. [актива обеспечения]. The shock is then transmitted 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 buyers are few, the price [актива обеспечения] falls fast. When the price of the latter is close to zero, the stablecoin collapses, “he explained.

The founder of Ethereum stressed that such UST assets can go through a thought experiment if demand declines slowly. However, such a situation is “extremely unlikely.”

Data: Buterin’s blog.

As a stablecoin that is being tested, Buterin named RAI from Reflexer Labs. It operates on a similar scheme to DAI and is a stablecoin with excess collateral in ETH.

“The security of a RAI depends on an asset external to the stablecoin system (ETH), so it is much easier for RAI to safely wind down activities,” he noted.

According to Buterin, the second question that will allow us to assess the stability of the stablecoin is what will happen when it is tied to the 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 tries to track such an index, there are two options for the development of events. It charges holders a negative interest rate, balancing, in fact, leveling the growth rate. […]. It’s turning into a Ponzi, providing stablecoin holders with a terrific return for some time,” he wrote.

Buterin stressed that a negative interest rate can be implemented in RAI. There was no such possibility at UST.

However, he added that the fulfillment of this condition does not make the asset “safe”:

“It can still be unstable for other reasons (e.g., insufficient collateral ratio), have bugs, or have vulnerability management mechanism associated with it.”

Earlier, Tether CTO Paolo Ardoino called TerraUSD a “poorly designed” product.