Stablecoins … not so Stable?

The utility of stablecoins can hardly be disputed … a cryptocurrency with a ‘fixed’ USD conversion rate eliminates more than half of the disappointing aspects to using cryptocurrencies. But, with the recent news of TerraUSD (UST) losing its one-to-one price-pegging to the USD overnight, perhaps we all must take a deeper look into how exactly this ‘stabilization’ works.

Stabilization is achieved by 1 of 3 possible methods: USD-collateralization (by reserving an amount of USD equal to the number of whole stablecoins minted), cryptocurrency-collateralization (by reserving a value of non-stable cryptocurrency tokens, such as Ether and/or Bitcoin, much greater than the value of the stablecoins minted), algorithmic-supply-control (the supply of the stablecoin is manipulated to maintain an ideal set of ratios, similarly to the methods used by the Federal Reserve System in managing the supply of USD).  

So, in which types of stablecoins are worth believing?

USD-collateralization via a one-to-one ratio is always the safest bet. For an example with a fictitious coin, US Whatever (USW), if the issuers of the USW deposit a dollar in a reserve account every time a new 1USW is minted into the circulated supply, then the holders of USW have nothing to worry about.  

Cryptocurrency-collateralization via an uneven ratio is also a safe bet, granted the ratio is favoring the reserve cryptocurrency by a large enough factor. For example, MakerDAO’s DAI is stabilized by reserving a quantity of Ether worth 1.5x the quantity of supplied DAI, with each 1DAI being worth 1USD. While not as safe as using USD reserves, it is frequently more feasible for foundations issuing stablecoins, and serves well granted Ethereum’s Ether token maintains a minimum price within 33% of its price at the time of staking and more Ether is staked to cover price dips below this threshold.

What about algorithmic-supply-control, used by TerraUSD (UST)? Opinion … steer clear of stablecoins implementing algorithmic-supply-control as its primary mechanism of USD price-pegging, unless one understands the stablecoin’s supply-control algorithm and stays aware of the incremental adjustments implemented by the stablecoin’s issuing foundation. An excessive supply erroneously caused by the algorithm or by unforeseeable market fluctuations is only fixable via the injection of collateral, to which some foundations may not have access … hence destabilizing the USD price-peg.