The question we aim to answer today is how safe & stable are stablecoins? Let’s dive into some failed examples of algorithmic stablecoins like UST, Basis Cash, and IRON and some new ones like USDD from Tron.

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In this part of the series, we will cover algorithmic stablecoins while mainly taking a look at past failed coins like UST that recently caused a crash in the crypto market from Terra by Do Kwan and IRON by Titan Finance which saw a similar demise heavily promoted by Marc Cuban. There are several others we’ll look at but a common theme is these coins depeg and fail.

Here’s a list of all the algorithmic stablecoins shared on CoinmarketCap: https://coinmarketcap.com/view/algorithmic-stablecoin/ - Take a look through the list to see how many are NOT pegged to $1.

First, what is an algorithmic stablecoin - https://coinmarketcap.com/alexandria/glossary/algorithmic-stablecoin. CoinMarketCap’s definition is a sound way of putting it – “designed to achieve price stability as well as balance the circulating supply of an asset by being pegged to a reserve asset such as the U.S. dollar, for example, gold or any foreign currency.” The concept is that you don’t have to provide a backing to the coin or collateralize it, but instead it can be balanced by issuing more coins when the price is over $1 or buying them off the market when it’s under $1 to keep the peg.

TLDR: The simple litmus test for a lot of these coins is to ask how they are able to provide yields. If they claim you can “stake” the cryptocurrency for inflation rewards, then you’re likely just really using a lending mechanism similar to what UST did with Anchor protocol. Every coin says they will be different, and seemingly most have not been.

Basis Cash (Failed)

This project really helps put into perspective what happened with Terra’s UST. Basis Cash was developed by Do Kwon and Nader Al-Naji (the founder of Bitclout & $DESO) created in 2020 that was swiftly cracked down on by the SEC and shut down though you still trade it today as it sits at $0.0076 at the time of writing this.

Like most algorithmic stablecoins, the concept is that while nothing is backing the stablecoin, it will be maintained through incentives to the users. Users will earn through Basis Shares or holding a Basis Bond that “promises” the holder premiums when BAC or Basis Cash returns to its 1-dollar peg. They always rely on some sort of reward mechanism or arbitrage called seigniorage.

Seigniorage is the process where the cost to mint and distribute new coins is less than their face value meaning that it’s 100% unsustainable, but many look at this instead as an economic opportunity to make profit. There is a category dedicated to this on Coinmarket and nearly every single stablecoin here is depegged except for Frax mentioned later. This is essentially the graveyard for algorithmic stablecoins - https://coinmarketcap.com/view/seigniorage/.

Not only that, but just like Terra, there was a second version of Basis Cash called Basis Dollar which attempted to revive the project and failed again.

Terra’s UST (Failed)

Now let’s talk about what happened with Terra Labs, Luna, and UST. While there isn’t definitive proof of exactly what happened and there are several theories floating around, we can definitely assume foul play to some regard here.

What essentially happened was that after UST depegged, people were trying to balance out the peg by minting one or the other coin at an arbitrage between the two, but then not enough people were willing to keep holding up the price. There is speculation and theories that massive institutions like Blackrock were involved in this, but I’m now more of the mind that Do Kwon anticipated all of this from the beginning.

Terra’s $LUNA is now called LUNC or Terra Classic while Do Kwon went on to make another version that also failed right out of the gate collapsing from just under $20 to now $3.

Many people complained about how the airdrop was handled and it goes to show what we already know. Scammers and people who run what seems to be a purposefully failed project have no problem immediately moving on to the next scam. This has been clearly illustrated by the many celebrities who have run multiple scams, projects like Basis Protocol which lead to Bitclout then $DESO, and many more countless examples. The most interesting thing about all this is Do Kwon actually worked on Basis Protocol to make Basis Cash which was a failed algorithmic stablecoin, meaning that this was Do Kwon’s second failed project. - https://www.theblockcrypto.com/linked/146380/terraform-labs-ceo-pseudonymously-co-created-failed-stablecoin-project-basis-cash-coindesk-reports

https://protos.com/basis-cash-the-failed-algorithmic-stablecoin-do-kwon-didnt-learn-from/

The really sad part about all of this is we could have seen it coming. These two individuals made a very sketchy failed project/scam then both went on to create more scams. It was as simple as looking into their history but they were pseudo-anonymous and dodged questions around their new projects for so long that they slipped through the cracks.

https://www.coindesk.com/markets/2022/05/15/the-collapse-of-terra-was-devastating-but-there-is-still-hope-for-crypto/ - In December 2021 Coindesk did some interviews with people like Ryan Clements and Do Kwon himself. Ryan explains the basic vulnerability was the concentration risk in holders of the balancer or investment token. Because of that risk, there’s the potential for individuals or groups to move markets in significant ways. This is exactly what happened to depeg UST and crash the Terra ecosystem. The reserves weren’t in the original design and Terra’s move to utilize a reserve showed they weren’t confident in their original design.

Do Kwon originally described the way it works like this:

“The idea is that at any given time a person can burn a dollar’s worth of Luna in order to mint one TerraUSD, and vice versa you can always redeem one TerraUSD for a dollar’s worth of Luna. So insofar as the Luna token has some sort of market value, you can always try to arbitrage against the system in order to mint and redeem stablecoins.”

"Just in case a de-pegging event happens — so for example if TerraUSD is trading for $0.90 — an arbitrageur can simply buy up TerraUSD from the open market and then trade it against the protocol for a dollar's worth of Luna, thereby capturing 10% arbitrage profit that way. And vice versa, if TerraUSD is ever trading at $1.10, you can buy a dollar's worth of Luna from the open market, mint TerraUSD and then sell that to capture 10% profit on the other side." 

Essentially the price was held up by users balancing between the two cryptocurrencies and could only stay solvent given people continue to hold confidence in the Terra ecosystem. A few insiders controlled the keys for billions worth of Bitcoin which was meant to protect the peg. They started by lending $1.5 billion in Bitcoin to trading firms to support market activity and try to maintain the peg. The death spiral is created because as the price falls, people lose confidence and sell their cryptocurrency, eventually, exchanges suspend trading, and then everything falls apart.

This has led to a push to regulate stablecoins which would ultimately be terrible for decentralization -https://www.theblockcrypto.com/linked/146048/us-treasury-secretary-yellen-points-to-ust-slip-asks-for-new-stablecoin-legislation-by-the-end-of-2022 but realistically since most stablecoins are 100% centralized and unregulated, this could be necessary.

DEI (Failed)

This is DEI - https://coinmarketcap.com/currencies/dei/.

This algorithmic coin recently depegged and failed not long after UST. This coin is a perfect example of why you can’t rely on stablecoins that hold other stablecoins as a reserve. The massive hit the stablecoin market took after the failure of UST causes DEI to depeg and then also fail. - https://cryptoslate.com/another-algorithmic-stablecoin-dei-loses-peg/

It’s also worth mentioning that they had a $13.4 million hack on their Deus protocol chain in April 2022 just before this crash. One of the concerns around “decentralized” stablecoins is that a hack, error, or some kind of issue that could occur would completely destroy the stablecoin. The stability of an algorithmic stablecoin is usually largely based on confidence in it. At least for centralized stablecoins, they can prevent these things from happening or retroactively undo them.

Iron Finance Steel, Titan, & Iron (Failed)

You can find Iron & Titan here: https://coinmarketcap.com/currencies/iron-titanium-token/ & https://coinmarketcap.com/currencies/iron-finance/.

Not long after Marc Cuban endorsed Iron and Titan, the entire project collapsed dropping from about $2.18 billion locked up to less than $10.5 million. The same thing that happens to all algorithmic stablecoins happened. Iron depegged and then arbitrage between Titan and Iron became unprofitable and thus people began to sell out as it was no longer sustainable or stable. As this happens exchanges will halt trading and send it into a death spiral. Titan went from around $50 down to essentially $0 in just a few days.

Since everyone was withdrawing it essentially triggered a bank run on the coin which they couldn’t support and thus caused it to crash.

Here’s a few sources reporting on this: https://www.coindesk.com/markets/2021/06/17/iron-finances-titan-token-falls-to-near-zero-in-defi-panic-selling/ & https://ciphertrace.com/analysis-of-the-titan-token-collapse-iron-finance-rugpull-or-defi-bank-run/.

Tron DAO Reserve USDD (New)

Decentralized USD (USDD) is the first decentralized algorithmic stablecoin issued under direction of the TRON DAO Reserve. - https://tdr.org/#/ & https://usdd.io/#/.

I won’t bother getting into the finer details of this and simply say that if it follows the same mechanisms and protocols as other algorithmic stablecoins and continues Tron founder Justin Sun’s legacy or destroying every project he touches like DLive or Steemit, then I would expect this to go horribly wrong.

All you need to know is written on the front page of their Tron DAO Reserve – they provide risk-free yield and they use the word “stake.” As always, high yield staking is likely lending and any kind of staking with a stablecoin is ALWAYS lending. They guarantee a risk-free yield which is impossible and ironically offer 20% which is what Anchor offered before they failed.

Their reserves are made up of USDT, Tron and BTC which is very similar to what UST did. They had reserves in other stablecoins, their coin Luna, and BTC. Their main claims are that they are over-collateralized (so don’t worry) and decentralized (which isn’t true). Whether or not USDD is supposed to be decentralized, Tron is not, and it’s built on Tron.

A Few More:

Here are a few more popular algorithmic stablecoins to note.

·         The Frax Protocol is the first fractional-algorithmic stablecoin system that uses Frax shares for governance which have dramatically gone down in value but still trading the green. - https://coinmarketcap.com/currencies/frax/ & https://coinmarketcap.com/currencies/frax-share/

·         Neutrino USDN is an algorithmic crypto-collateralized stablecoins pegged to USD - https://coinmarketcap.com/currencies/neutrino-usd/

·         Ampleforth is an Ethereum based cryptocurrency with a circulating supply that’s automatically adjusted algorithmically via rebases. - https://coinmarketcap.com/currencies/ampleforth/

These are all the different kinds of algorithmic stablecoins to give you a better idea of different protocols trying to address algorithmic stablecoins. However, as you can see by looking on Coinmarketcap, out of the handful of coins that are actually pegged, many have depegged in the past or their connected cryptocurrency has lost so much value that the project has no more confidence in it.

I personally hold HBD though I am still in the process of learning as much as I can about it and will soon be doing another interview with Dan from 3Speak to discuss why HBD is different from other stablecoins. I have dramatically pulled back on how much I rely on any stablecoins until I know more about them, hence all this research.

Do you hold any stablecoins? Do you trust algorithmic stablecoins? Were there just a few bad apples or are all algorithmic stablecoins risky? Let me know what you think about this in the comments below and don’t forget to subscribe!

*Disclaimer: This is not financial advice and is purely for entertainment purposes. What you see, hear, or read is my personal opinion, and any statements made are based on my views and should not be misconstrued as fact. My crypto portfolio may or may not be simulated*

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