As mentioned before, all decentralized stablecoins are born with a magic spell: You are not Bitcoin but counterfeits, so where does your credit come from? Credit is the cornerstone for a stablecoin to maintain stability. For decentralized stablecoins with specific pegs, the collapse of credit manifests itself as the risk of de-pegging, which is the internal and interactive result of the stablecoin project, so it is called systemic risk. Correspondingly, black swan events such as external incidents or sudden bad news (like scandals of the project team or wars) are called non-systematic risk.

• Systematic risk of de-pegging

The systematic risk of De-pegging refers to the risk that the price of the decentralized stablecoin is out of the pegging range. This risk not only affects the price of the stablecoin, but also affects the security of collateral.

A typical example is DAI in its early stage: before the crash on March 12th 2020, DAI used to peg one dollar by minting DAI with an ETH collateral ratio of 75%. That is, deposit ETH with a value of $100 and mint DAI with a value of $75.

On March 12th 2020, ETH plummeted by about 50% in one day. DAI triggered collateral liquidation, and a large amount of deposited ETH was auctioned. The real-time price of DAI instead soared by 10%. For a stablecoin that should be 1:1 with the US dollar, this is a serious de-pegging.

From the case, it can be seen that the risk of De-pegging not only affects the price of stablecoin, but also affects the security of collateral. After March 12th 2020, DAI modified its own mode, and the collateral began to move closer to USDC, which helped DAI achieve a high degree of price stability, but also caused potential centralized censorship risk.

" I think people often miss the opaque nature of the risk with liquidation markets. The amount of capital available to execute liquidations necessarily exists outside of the system of accounting, so it's very difficult to price. "

Brandon, Co-founder of AmpleForth

• Different logic to deal with De-pegging risks

Risks will never disappear, but they can be mitigated, split and transferred.    

Through the author's observation and research, the whole decentralized stablecoin track mainly responds to systematic risk through the following three logics:  

1. Risk mitigation

The core logic to mitigate the risk of De-pegging is actually very simple. "If the dough is too sticky, add more flour. If the dough is too dry, add more water." If we regard a decentralized stablecoin pegged to the US dollar as the dough, then water is the collateral, and flour is the stablecoin. The goal is to keep the dough neither too dry nor too sticky.

When the dough is too dry (de-pegging, the price of the stablecoin plunges below the pegging range), we need to add water (increase collateral, or even burn some stablecoins). When the dough is too sticky (de-pegging, the price of stablecoin rises above the pegging range), we need to add flour (reduce the collateral, or increase the stablecoins in the market).

Take the stablecoin UST that collapsed before as an example. UST is pegged to the US dollar at a 1:1 ratio. If the price of UST rises above $1, then LUNA holders can sell their LUNA back to the blockchain (for profit). The algorithm converts LUNA into UST. With more UST added to the system, the price of UST falls back to $1. On the contrary, if the price of UST falls, UST holders can convert their UST into LUNA coins so as to reduce the supply and increase the value of UST.

The logic to risk mitigation is the most direct one, but its effect is the worst. Why? Because the risk will not disappear, mitigation measures can only temporarily curb the risk, but cannot eradicate the risk. So, the situation will be like: the price plunges below the pegging range (caused by situations like the collateral is liquidated; the liquidity pool is hacked, and suffers heavy fund losses; the shorting force is too strong, etc.) ------ the project party invests additional collateral to maintain the credit ------ the maintenance of price fails ------ the project party runs out of funds ------ the project fails.

Besides, what’s more horrible is snowball effect. The risk of suppressing a $30 million MC stablecoin is different from the risk of suppressing a $3 billion MC stablecoin, because the bailout funds needed in these two types are on completely different level.

Most stablecoin projects such as DAI, UST, FEI, LUSD have encountered similar problems. UST and FEI failed, while DAI and LUSD survived.

2. Risk splitting

Risk splitting is a new trend popular this year, and its core logic is "the Federal Reserve and commercial banks". The stablecoin protocol can be regarded as the Federal Reserve, and the part involving different collateral can be regarded as the major commercial banks. The Federal Reserve determines the product logic and basic interest rate (the core minting rate). Major commercial banks comply with the decisions of the Federal Reserve. Meanwhile, they can increase or decrease the minting rate or reward proportion according to different circumstances.

On the one hand, major commercial banks can make free adjustments according to different situations without changing the basic framework. On the other hand, even if one commercial bank has bad debts or goes bankrupt, it will not affect other commercial banks and the Federal Reserve, which realizes risk splitting.

For example, the AMO module of stablecoin FRAX is an independent contract that allows the formulation of arbitrary monetary policies without changing the price of FRAX. This means that AMO controllers can perform open market operations through algorithms, but they cannot arbitrarily mint FRAX and break its peg. In other words, FRAX of different modules will adjust the monetary system by increasing or decreasing liquidity, so as to solve local problems without changing the overall collateral ratio.

AMOs of FRAX and facilitators of GHO all follow this logic. That is, the project party recognizes that the risk cannot be eradicated. On the basis of risk mitigation measures, they add risk splitting measures, so as to increase safety and cope with extreme market conditions through a hybrid of these two measures.

To sum up, we can see that both risk mitigation and risk splitting cannot really change the risk of de-pegging, but can only temporarily minimize losses. 

3. Risk transfer

The core of elastic finance is to transfer risks and release market risks through the rise and fall of token supply. It is also the core advantage of elastic finance to convert price volatility to elastic volatility of stablecoin supply, and to convert the hidden risk of price fluctuations previously suppressed to visible risk of supply, so as to achieve a stable state in price.

 " In time, people will learn that visible risk is preferable to hidden risk. "

Fiddlekins, Member of PRL team & the AMPL community

Take AMPL as an example. AMPL transfers price volatility to supply volatility. When its price is higher than the upper limit of the target price, AMPL inflates. When its price is lower than the lower limit of the target price, AMPL deflates. The rise and fall of supply will affect the balance of each account holding AMPL, so as to ensure that the holding proportion of all AMPL holders remains unchanged forever.

In other words, if you hold 1% of the total supply of AMPL, your holding proportion will never change regardless of inflation and deflation, which truly achieves the effect of "Unit of Account" and successfully transfers price volatility to supply volatility. For more information, please refer to previous articles.

SPOT is an inflation-resistant Store-of-Value, which has the following advantages in dealing with systematic risk of de-pegging:

• The epoch-making risk stratification concept: AMPL separates the low-risk part and forms A-Tranche through risk stratification, and uses it to mint SPOT. As long as the price of AMPL does not fall below, say, $0.2, the value of SPOT keeps stable. If the price of AMPL falls below US $0.2, the community can vote to reduce the price threshold of A-Tranche again to flexibly cope with risks.

• No liquidation risk: SPOT is a kind of perpetual note, which is essentially a mixed debt. As long as the debt is not due, the collateral will not be liquidated when the price plunges.

AMPL is decentralized, and its coin and transfer mechanism cannot be modified even if the community votes, which help SPOT solve the risk of censorship. SPOT solves the systematic risk of De-pegging and meets the demand of censorship resistance. As a decentralized inflation-resistant store-of-value, the core of SPOT is to promote users to use SPOT as value storage or value collateral of other stablecoins, so as to contend for the share of USDC in DEFI.

"SPOT is an inflation-resistant store-of-value. We succeed if a critical mass of people understand the importance of this. That is to say, we succeed when a critical mass of people recognize that this is the first substantial "value-add" function created by blockchain technology in totality period. "

Evan Kuo, founder of AMPL

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