How Stable Are Stablecoins And What Factors Affect Volatility?

Seigniorage models backed by endogenous collateral, like Terra, by design benefit early investors of the governance token. Under the guise of preventing bank runs, the protocol choaks the redemption function by introducing swap spreads (as redemptions exceed a specified threshold, users get less than $1 of LUNA for every 1 UST). However, this mechanism only slows down the pace of bank runs, it doesn’t prevent them. As one can see from above, AMPL’s market cap has been anything but stable.

According to Joseph Edwards, head of finance strategy at crypto company Solrise, stablecoins have grown in popularity worldwide as a method to circumvent capital regulations since 2018. He argues that the stablecoin Tether is especially popular in China and South America. Resource-backed stablecoins have come under fire in recent years for failing to be transparent about their assets and whether these stablecoins have the funds to securely hold all digital currency currently in circulation. Algorithmic stablecoins are fascinating monetary experiments, and their success is anything but assured.

In terms of collateral, MakerDAO has been introducing centralized assets like USDT and USDC since March 2020 and doubts about whether DAI is sufficiently decentralized are growing. Some of the biggest cryptocurrency markets, including China, Japan, and the United States, cannot use DGX due to legal issues. DGX’s capabilities as a gold-pegged stablecoin limit its potential as one of the top stablecoins in the fintech sector. DAI is a stablecoin cryptocurrency offered by MakerDAO, a decentralized independent organization.

Simplicity A stablecoin protocol should be easy enough for the average user to understand, including how stability is maintained. Scalability As long as there’s enough demand for the stablecoin to push the price above $1, new supply can be created. ESD is an unbacked algo stablecoin which uses the 2-token seigniorage model. The key difference from Basis Cash is that ESD has a bond token but not a share token. Instead, by staking ESD , a holder of ESD is entitled to a share for future expansions in supply. Stability RAI has maintained a stable value around $3 since inception.

Draft of this essay two weeks before the UST crash, I wrote that I find this argument untenable even though algorithmic stablecoins are structurally no different from fiat currencies. Fiat currencies work because of a collective belief in the absence of intrinsic value. Another positive side effect of the model is that excess demand for cUSD is most likely to occur when overall market sentiment is bearish. In such a scenario, cUSD is exchanged by the protocol for other crypto assets when downside risk of acquiring volatile assets is significantly reduced.

This also ties back in with how the stable currency is tied to the various underlying asset. Also of note is the Fei Protocol, which set a new fundraising record in DeFi. In the week of its launch, it had a market cap of $ 2.4 billion, which fell to $ 500 million in three months. Fei’s anchor adjustment mechanism, which is based on PCV and Ethereum’s buyback mechanism, ensures stability. The Fei Protocol was intended to solve the problem of inefficiencies and difficulties in scaling overcollateralised stablecoins, but community pressure forced ongoing overhauls of the mechanism after its inception.

Simply because of a collective belief that it must be worth something because others believe it is worth something. After all, the Total Addressable Market of global, digital cash is that of all the money in the world. TerraUSD began de-pegging in May when Terra’s essential decentralised finance technology, Anchor, started allowing high-volume transactions. Furthermore, due to these occurrences, the TerraUSD pool on Ethereum’s Curve Protocol and the primary junction for stablecoin pricing on DeFi saw large transactions. When UST supply is insufficient and the market is extreme, the cost of UST boosts above $1.

Stablecoins offer a variety of risks to the existing financial system, including credit and liquidity problems. If not created and controlled appropriately, these could jeopardize financial stability, hamper monetary policy, and eventually impair actual economic activity. This is accomplished by exacerbating existing banking sector vulnerabilities and enhancing shock transmission across borders. These effects could be amplified if stablecoins become generally recognized and used as a means of payment for public use globally. If the token price falls below the price of the fiat currency it follows, an algorithmic stablecoin mechanism will cut the token supply.

Stability Mechanisms

When this happens, it is mathematically impossible to further reduce the supply of stablecoins. On the other hand, stablecoins with an inbuilt redemption arbitrage loop have a significantly easier time mainting peg since the existence of an exploitable profit opportunity is incentive enough to garner required demand. Ethereum and Bitcoin, which introduced crypto assets, caused profound levels of price volatility.

  • “Fractional Reserve Stablecoin Tether Only 74% Backed by Fiat Currency, Say Lawyers.” 30 Apr. 2019, lawyers.
  • There are also concerns that the secured currency currently poses systemic structural risks.
  • If it trades at $0.99, you have some automatic process in which you print more Sharecoins and use them to buy Dollarcoins until it is back to $1.
  • The repercussions of this circumstance are the same as those of a traditional bank run.
  • The issuer of a stablecoin can use the proceeds of the fiat currency to invest in the reserves or in other assets.
  • This type of stablecoins presupposes commodities, like precious metals (gold, silver, etc.) or raw materials (oil, gas, etc.), as collaterals.
  • In terms of collateral, MakerDAO has been introducing centralized assets like USDT and USDC since March 2020 and doubts about whether DAI is sufficiently decentralized are growing.

For example, if higher yields are available elsewhere, users may still borrow at higher stability fees, negating the expected decrease in supply. The protocol derives a periodically changing Target Price for the stablecoin through an algorithm taking into account various factors. Differences between the Market Price and Target Price are arbitraged, causing a price convergence. The Gold Standard restricted a country’s Central Bank from issuing currency in excess of the value of its gold reserves. The Bretton Woods Conference in 1944 adopted the US Dollar as the international reserve currency and the Gold Standard was used within each of the adopting nations as an exchange rate pegging mechanism between Central Banks.


All such experiments till date, without exception, have been victims of the death spiral. Sogur started off as a stablecoin pegged to and backed by a basket of assets, mirroring the IMF’s SDR . The plan was to start with a peg to instill trust in the system and reduce the collateralization over time as a function of increasing demand, indicating trust and growing intrinsic value independent of reserves. When demand grew, the pricing algorithm would reduce the reserve ratio and vice versa.

Stability and stablecoins

This mandate is particularly difficult for many algorithmic stablecoins to fulfill because of their inherent reflexivity. Algorithmic supply changes are intended to be counter-cyclical; expanding the supply ought to reduce price, and vice versa. However, relative price stability may not be the case for all stablecoins owing to variations in the ways in which they are pegged, the nature of reserve assets , and their governance structure. Supply and demand are at the core of algorithmic stablecoins’ prices. If the price of such stablecoins falls below the price of fiat currency, the algorithmic system which uses automated supply techniques will reduce the token supply.

Dai Case Study

Digix Gold, or DGX, is the perfect stablecoin with the backing of gold that is based on commodities. Each DGX is pegged to an ounce of gold in Digix Distributed Autonomous Organization. True USD, which was added recently to the stablecoin list, is another promising addition.

Stability and stablecoins

The price movement of USDT comes mainly from the credit approval of the issuer, the custodian and the dollars of the stablecoin holders. This paper investigates the volatility processes of stablecoins and their potential stochastic interdependencies with Bitcoin volatility. We employ a novel approach to choose the optimal combination for the power law exponent and the minimum value for the volatilities bending the power law. Our results indicate that Bitcoin volatility is well-behaved in a statistical sense with a finite theoretical variance.

It offers crypto investors a transparent and efficient alternative to the USD fiat currency. In addition to Google, UC Berkeley, Palantir, and Stanford, members of the True USD team are involved in the effort. Besides lack of transparency, Tether has also been criticized for discrepancies in its collateralized reserves. The Tether project originally claimed that it would provide 100% support for USDT through its cash reserves, where it would hold a dollar for every USDT issued. With coupon-based burn or mint, there have been several cases where the price of a stablecoin never returned to its peg, and the coupon holders were left with nothing. Fiat currency is subject to inflation – the USD, for example, has lost more than 96% of its purchasing power since the creation of the FED in 1913.

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Cross-collateralized stablecoins generate stablecoins worth USD 1 by depositing collateral worth more than USD 1. Therefore, collateral can be other volatile tokens such as ETH, protocol tokens, and liquidity provider tokens . Such stablecoins are in the same chain as the collateral and the main risk arises from fluctuations in the value of the collateral, so the liquidation mechanism of these protocols is particularly important. Touchpoints with the traditional financial system that might result in systemic risk. Crypto-backed stablecoins, on the other hand, paint a very different picture than those pegged to crypto assets. There is a complete list of stablecoins available today, including crypto-backed stablecoins.

Stability and stablecoins

This means, as traditional money, they are also subject to inflation and that’s why they are not that stable as you could expect. Two of the above prices fluctuated by more slightly more than 1% and most of the time fluctuations are less than 1% over or under $1.00. The basic economics of supply and demand explain some variations, but depending on the type of stablecoins, there can be many factors in play.

Stablecoins To Watch In 2022

Terra refers to an open-source blockchain protocol for stablecoins and apps and is one of two main cryptocurrency tokens under this protocol. To serve as a medium of exchange, a currency that’s not legal tender must remain relatively stable, assuring those who accept it that it will retain purchasing power in the short term. Among traditional fiat currencies, daily moves of even 1% in forex trading are relatively rare. With inspiration from Tether’s protocol, True USD has evolved into a more stable cryptocurrency.

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It is possible to categorize stablecoins based on their supporting assets, primarily. The different types of stablecoins can be used to understand the stability of stablecoin prices. Below are some of the common stablecoins you are likely to encounter.

UXD is the algorithmic stablecoin supported entirely by the delta stable position on the Solana blockchain. So, even though stablecoins are backed by items that may lose value in the online market or become unavailable in unfavourable market conditions, they are still highly susceptible to the end of investors. Furthermore, a move on the stablecoin could put a strain on the traditional financial system, causing it to spill over into the payment ecosystem, according to a report. Stablecoins, on the other hand, have recently received a lot more attention.

We now apply this knowledge to evaluate some of the noteworthy attempts at building stablecoins. In this section we will look at the various methods/tools available to protocols to influence price and maintain a stablecoin’s peg. Although they may appear different from one another, the underlying mechanics are the same. At a high level, stablecoins can be classified on the basis of peg, collateral and the core mechanism employed.

Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. what is a stablecoin and how it works He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. James Rathmell works on policy and regulatory strategy for a16z crypto and its portfolio. Stablecoins are uniquely positioned to be the cornerstone of a better, more inclusive financial system.

From both first-principles reasoning and empirical data, we can conclude that the multi-token, “Seigniorage Shares”-inspired model has significantly more built-in stability than its single-token rebasing alternative. Indeed, Ferdinando Ametrano has recently updated his “first simplistic implementation” of Hayek Money from 2014, and he now favors a multi-token, seigniorage-based model in light of the problems outlined above. Consultation on recommendations to address the challenges of “global stablecoin” arrangements. High-level recommendations that promote coordinated and effective regulation, supervision and oversight of global stablecoin arrangements. Besides, such stablecoins offer much liquidity as they can be converted fast and presuppose low transaction costs. The three types of stablecoins have their own advantages and disadvantages.

Previously, she spent a decade as a federal prosecutor focusing on fraud, cyber, and corporate crime alongside agencies including the SEC, FBI, and Treasury. Blockchain Council is an authoritative group of subject experts and enthusiasts who evangelize blockchain research and development, use cases and products and knowledge for a better world. Blockchain Council creates an environment and raises awareness among businesses, enterprises, developers, and society by educating them in the Blockchain space.

Tether , one of the most important stablecoin cryptocurrencies, is pegged to and backed by the U.S. dollar. Their primary distinction is the strategy of keeping the stablecoin’s value stable by controlling its supply through an algorithm, essentially a computer program running a preset formula. Such reserves are maintained by independent custodians and are regularly audited. Tether and TrueUSD are popular stablecoins backed by U.S. dollar reserves and denominated at parity to the dollar.