UST, an algorithmic stablecoin, made headlines when it lost its peg, which was completely correlated with its underlying token, LUNA.
In retrospect, it’s clear the incentives paid by UST overwhelmed the utility that existed for the LUNA token by itself. This was unique to UST and is not representative of the structure of most algorithmic stablecoins, but there are some important lessons to be learned.
For every token in circulation, there should be one dollar in reserve.
Will maintain its peg so long as the market believes its reserves are sufficient and redemption requests will be honored by a centralized entity in a timely manner.
Market self-corrects to the peg because redemptions strictly reduce supply and reserves are in liquid, low-risk assets.
Introduced as a means to govern a decentralized stablecoin, there is significant variability in their structure, each with its own peg-maintaining mechanism.
Generally not backed 1:1 by cash equivalents; their value is maintained by a programmatically defined mint and redemption relationship between it and associated assets.
Sharing characteristics of fiat-backed and algorithmic, these stablecoins are backed by uncorrelated cryptoassets (often overcollateralized to further ensure value stability).
Have an algorithmic component as their peg is governed via a decentralized smart contract.
Stablecoins generally don’t pay interest collected from the reserves to coin holders – the issuers keep it for themselves.
Interest payments could raise a question as to whether a stablecoin is a security, significantly reducing its utility for payments and banking. However, the lack of interest payments is a major disadvantage for the unbanked population and worth considering as an opportunity to improve financial equity and inclusion.
One way of solving this would be for the SEC to specify that stablecoins that meet the five criteria above – whether they pay interest or not – are not securities.