How Does the Future of Decentralised Algorithmic Stablecoins Look?

The recent news related to Binance’s native stablecoin BUSD is a topic of multiple discussions in the crypto community. In this article, the experts at Grapherex will explain what happened to BUSD and what the potential consequences are. We’ll discuss the types of stablecoins that are currently used alongside their features and prospects.

Ban on Minting Binance USD

Let’s begin with an overview. Binance is a major cryptocurrency exchange platform that offers a wide range of trading options. The company had an agreement with the blockchain infrastructure platform Paxos Trust Company, which allowed Paxos to mint Binance USD stablecoins.

On February 13, the New York Department of Financial Services imposed restrictions on the Paxos Trust Company, which now must stop minting any new BUSD tokens. The existing BUSD tokens will be fully backed and available for redemption until at least February 2024, but there will be no new ones. The decision was caused by the SEC announcement that BUSD violates securities laws.

As the US dollar is the most popular asset globally, dollar-pegged stables also dominate the market. Binance CEO Changpeng Zhao comments that tighter US regulation could force many other crypto businesses to shift from dollar-pegged stablecoins to non-dollar alternatives pegged to EUR or JPY.

Algorithmic Stablecoins: Features and Risks

With this in mind, let’s move on to the second part of this news. Changpeng Zhao suggested that the role of algorithmic stablecoins in everyday life will increase, even though they involve inherently more risk than fiat-backed tokens.

Fiat-backed stablecoins: these are tokens that are pegged to the value of a fiat currency, for example, the US dollar. They are backed by reserves of the fiat currency held by a centralised entity (a financial institution or a crypto exchange).

Algorithmic stablecoins: these are tokens that use algorithms to maintain a stable value. They don’t rely on reserves but use complex economic models to regulate the supply and demand balance. Algorithmic stables use a dual token system: a stablecoin and a volatile asset. To mint a certain value of a stablecoin, an equal amount of the native token or volatile token is burned. Such tokens are not traditionally collateralised, which makes them riskier than fiat stables.

Some experts believe that fiat-backed stablecoins are reliable assets that will remain superior on the crypto market, while others think that they will be a great alternative to algorithmic stablecoins. After the regulatory action against BUSD, Binance turned to some alternative stablecoins, including several decentralised ones, to meet its liquidity needs. From February 16 to 24, Binance minted 180 million TrueUSD (TUSD) coins.

There is one more thing: Some believe that fiat stablecoins are too deeply rooted in crypto exchanges, which means that algorithmic stablecoins have a harder time competing with fiat stablecoins in terms of global market adoption.

Decentralised Stablecoins: The Hard Past

Decentralised stablecoins were first popularised in the DeFi sector. MakerDAO created DAI tokens, enhancing the decentralised finance ecosystem. DAI maintained its peg through smart contracts regulated by a decentralised autonomous organisation. Despite the MakerDAO’s strong culture and commitment to its values, such as decentralisation and transparency, DAI was gripped by the recent banking crisis, which led to it being depegged, along with the circle-issued USDC.

The implementation of decentralised stablecoins has had a difficult history. One of the major mishaps was the collapse of the Terra ecosystem and its algorithmic stablecoin TerraUSD (UST). Terraform Labs co-founder Do Kwon suggested that the collapse was caused by one entity dumping over $450 million of UST onto the market. Unfortunately, the instability of the algorithmic stablecoin Terra has spoiled the reputation of decentralised stablecoins.

Decentralised Stablecoins: Forecast for the Future

While centralised stablecoins face regulatory scrutiny, the future of decentralised stablecoins is uncertain. According to Hassan Sheikh, the co-founder of the decentralised incubator platform DAO Maker, a shift to decentralised stablecoins is not what people expect.

Firstly, crypto exchanges prefer to control their stables for value capture. Controlled “decentralised” stablecoins are monitored by exchanges, while truly decentralised options are not yet (and perhaps won’t ever be) sufficiently adopted. Moreover, the market caps of existing decentralised stablecoins are small, meaning that they won’t influence networks.

Secondly, decentralised stablecoins and exchange pools are dependent on centralised ones like USDC. Tokens like DAI and FRAX have a large amount of USDC as collateral. During the recent depeg, MakerDAO, the issuer of DAI, proposed an emergency solution to manage 3.1B USDC exposure and minimise harm to the network.

The shift to a decentralised stablecoin is unlikely in the near future as a dominant stablecoin has yet to emerge. Exchanges are mainly supporting these stablecoins for volume profits. There are few trading pairs like BTC/DAI that have low trading activity, and major liquidity partners are not interested in shifting to decentralised alternatives in the foreseeable future, according to Sheikh.

Summary

So, do decentralised stablecoins actually have a future? There are two key concepts to keep in mind:

1. As managing decentralised stablecoins is complicated, exchanges prefer to stick to centralised controlled alternatives, which are mainly dollar-pegged. This causes issues with compliance with tight regulations but seems reliable and simple. Additionally, decentralised algorithmic stables have low market caps and trading volumes. They do not deliver significant benefits to exchanges and users and do not invoke trust and, consequently, interest.
2. If a cryptocurrency exchange like Binance tries to solve problems connected with fiat-pegged stablecoins, creating algorithmic stables will be a reasonable idea, even though they are not as safe or popular. This is why TrueUSD appeared. If it works, people’s willingness to go for new exchange-issued stablecoins will shift the market. There is a possibility of future adoption.