Algorithmic stablecoins are another type of stablecoin, in addition to fiat-backed and crypto-backed stablecoins.
Background
Stablecoins are a crucial component of the crypto industry, especially in DeFi. As of 2023, the stablecoin market has shown significant progress, with a growing demand for stablecoins. This is evident in the chart below, which displays the total supply of stablecoins.
https\://www.theblock.co/data/decentralized-finance/stablecoins/total-stablecoin-supply
The largest growth in stablecoins has been observed in fiat-backed and crypto-backed stablecoins. Additionally, there is another type of stablecoin called Algorithmic Stablecoin, which operates based on an algorithm.
Algorithmic Stablecoin uses an algorithm called Rebase to maintain its stability through an elastic supply mechanism.
When dealing with Algorithmic stablecoins, it's crucial to understand the rebase rules, including:
Rebase time: This varies between projects and may have different names.
Rebase trigger price: The project must have a price range to trigger the rebase condition to increase or decrease the supply. For instance, AMPL has a +-5% price range.
Oracle source: Usually, projects use Uniswap's TWAP as the oracle source for pricing.
Maximum increase/decrease in supply.
I will temporarily divide Algorithmic Stablecoins into three types: the single-token model, the multiple-token model, and the hybrid model.
Algorithmic stablecoins under the 1-token model will work with a simple Rebase mechanism. The token price will be pegged at $1. Every time a Rebase occurs, there will be three possible outcomes:
(1) If the token price increases by more than $1, the total supply will increase.
(2) If the token price drops by more than $1, the total supply will decrease.
(3) If the token price remains around $1, the total supply will remain unchanged.
When the total supply changes, it will directly affect the token holders, represented by the number of tokens that can increase or decrease corresponding to the Rebase result.\ The most prominent project and leader of the Algorithmic Stablecoin trend is Ampleforth (AMPL), followed by Yam Finance (YAM).
The mechanism of operation of the Multiple-Token Model is still the same as that of the Single-Token Model, with the token price still pegged at $1. When a Rebase occurs, there are three possible outcomes:
(1) If the token price is above $1, more tokens will be generated.
(2) If the token price is below $1, debt will be created in the form of a bond.
(3) If the token price remains stable at $1, no more tokens will be generated.
Projects following this model must have up to 3 tokens, including:
Stablecoin.
Shares tokens for Shareholders.
Bond tokens representing the debt of the protocol.
Unlike the Single-Token Model, the Multiple-Token Model does not distribute the generated token equally to all holders. Instead, it will distribute to the participants in the protocol, such as shareholders, liquidity providers, and bond token holders, with different rates depending on the specific protocol.
Projects of this type include Basis Cash (BAC, BAS, BAB) and Dollar Protocol (USDX, SHARE, xBOND).
The working mechanism of the Hybrid Model involves only one stablecoin. When the rebase is positive, the total supply will increase and be distributed to the participants in the protocol. When the rebase is negative, debt is issued as a coupon at a high discount to incentivize stablecoin holders to buy debt.
Examples of this type of model include Empty Set Dollar (ESD) and its fork, Dynamic Set Dollar (DSD).
For a stablecoin to have lasting value, it must exhibit a certain degree of stability to attract widespread use. Algorithmic stablecoins, in particular, must achieve a sufficiently large market capitalization (ranging from 1 to 10 billion USD) to ensure ample liquidity and prevent price fluctuations.
However, to reach such a sizable cap, the rebase loop must remain positive. This raises the crucial question of how to generate enough demand for stablecoins to maintain a price level above $1.
To solve this problem, it is necessary to incentivize the participants in the protocol by creating a reward program for those who provide liquidity through liquidity mining (single-token).
Multiple-token:
Liquidity provider is entitled to % of stablecoins generated after a positive rebase
Speculator: Buy debt as a bond at a high discount.
Shareholders who hold shares tokens will receive more stablecoins following a positive rebase
Hybrid:
Liquidity Provider is entitled to % of stablecoins generated after positive rebase.
Speculators buy debt in the form of coupons at highly discounted prices.
Stakers are entitled to a percentage of the stablecoins generated after a positive rebase.
However, these incentives are not sustainable in the long term and can lead to a 'death spiral' if participants lose interest or the incentives are no longer available.
Although the idea of Algorithmic Stablecoin has been around since 1974 and 2014, it wasn't until 2020 that many experimental and active projects began creating stablecoin products.
Therefore, these stablecoins are still very young, but the experiences of the above-mentioned projects have given us an overview of the paradoxes from which we can find good solutions, bringing us closer to the goal of creating fully decentralized stablecoins.