- Algorithmic stablecoins are pegged to an algorithm fed into the network.
- TerraUSD is a popular example to study the risk associated with an algorithmic stablecoin.
Considerable to other stablecoins which are pegged to the fiat currency or other cryptocurrency, commodities or other precious metals, algorithmic stablecoins are the riskiest stablecoin as they are not pegged to the US dollar, which has a stable value, or to some commodity or metal, its value depends on the algorithm fed in the network, maintains its value by supply and demand.
After terraUSD collapse, this question is all around, whether algorithmic stablecoins are safe or not. This becomes a valid question as all the coins at some point in time have connections with each other. So if there is any collapse or crash in the market price of any coin it affects the performance of other coins too.
The potential risk attached to an Algorithmic Stablecoin
Influenced by market risk –
It aces the risk of increase and decrease as the market fluctuates up and down. As the price of the digital asset increases the value price, then more tokens are generated on the network. If the price falls below the value price, then the algorithm burns the tokens. This reduction in the supply is compensated by offering bonds to buyers – who get paid when the price rises above the valued price.
Oracle smart contract –
Oracle is a technology that connects real-world data to the protocol. Oracle takes the price from the exchange, compares the price, and adjusts the system to maintain the balance. It is important for Oracle to acquire accurate data to the current price. It is difficult for developers and managers to maintain the accuracy of the oracle.
Peg separation –
It is also known as peg break. This situation occurs when a chain breaks from its parent. It causes fluctuation in the price and destabilizes the algorithmic stablecoin, this can eventually destroy the project.
TerraUSD crash –
- People held cryptocurrency because of the Anchor protocol, which was a saving account offering 20% of interest and the main reason many people posted their UST with Anchor protocol.
- In March, there was news that Anchor protocol will replace 20% with variable one, which created havoc in the market. People started taking out their funds from the network.
- In this panic situation, people started to convert their UST tokens with other tokens via different crypto exchanges.
- TerraUSD (UST) was also burnt against LUNA, which caused LUNA’s price to skyrocket.
- This mass dumping caused an imbalance in the UST-LUNA mechanism, which at last resulted in a loss in the value of both coins.
- It was reported that Terra ecosystem, Luna Foundation Guard(LFG), attempted to maintain the peg of $3B by the reserve fund but proved unsuccessful.
Among all the stablecoins, the algorithmic stablecoin is the riskiest stable coin as it is not pegged to any fiat currency or any precious metals. But Algorithmic stablecoins hold all the properties of a stablecoin and other than TerraUSD there are other popular Algorithmic stablecoin that are used by users.
Like DefiDollar(DUSD, Empty Set Dollar(ESD), Frax(FRAX), and Ampleforth(AMPL) which are still used by traders for trading.