Today, the stablecoins industry has begun to grow in popularity and adoption. This is due to the fact that investors feel their investments are more safe in the sphere because of its less volatility. Worth noting that stablecoins exist in four different categories. They include fiat-oriented stablecoins, crypto-oriented stablecoins, algorithmic stablecoins, and commodity-oriented stablecoins. The value of stablecoins are usually designed to be equivalent with the prevailing value of fiat currencies pegged with it.
Similarly, the circulation level of these stablecoins are usually proportional to the fiat pegged with them. This simply means any issuer with a reserve of $2 million in fiat, for instance, will grossly distribute two million dollars worth of the tokens. Generally, stablecoins can be utilized for numerous uses. It’s remarkably popular as a store of value against market crises because of its stability. Also, it functions as a means of payment and exchange. It’s also an asset because it’s valuable and highly recognized. As noted earlier, stablecoins exist in four categories but this piece will focus only on algorithmic stablecoins alone.
What are Algorithmic Stablecoins?
An Algorithmic stablecoin uses an underneath algorithm with the capacity to issue more coins when the price soars and repurchase them when it plummets. The algorithmic stablecoins are reliant on both stablecoins and crypto. As designed, the assets achieve stability through their inherent smart contracts. It is worth mentioning that smart contracts or algorithms define the relationship between the assets. This thus enhances the stability of the assets and drastically reduces the volatility of a particular cryptoasset.
Certainly, there are different categories of algorithmic stablecoins. They include DAI, MAI, FRAX, TerraUSD and a host of others. Each of these assets employs a different algorithm to sustain its value. At the moment, TerraUSD remains the most popular algorithmic stablecoins around. Meanwhile, algorithmic stablecoins need a certain degree of demand for its ecosystem to run efficiently. This thus means a particular algorithmic stablecoin may lose its value if its demand declines to a certain level.
Why are Algorithmic stablecoins losing relevance?
The collapse of UST exposed the vulnerability of algorithmic stablecoins, thus leading to their decline. Users became skeptical about them due to their lack of a reserve pool that helps maintain their pegs. More so, their reliance on financial engineering and market incentives to maintain their pegs is no longer fashionable in the present-day crypto market.
The financial structure of algorithmic stablecoins emphasizes demand and supply. The higher the demand for the underlying asset of an algorithm stablecoin, the stronger their position in maintaining their respective peg. However, the collapse of UST during a period when the price of crypto assets plummeted, exposed another shortcoming of algorithmic stablecoins.
With that, investors realized how damaging a drop in the demand for the underlying asset can affect algorithmic stablecoins. Coming to realize that situations like that can sometimes be out of their control, investors opted for a more safer and secure option; fiat-backed stablecoins.
Accordingly, this is due to the increasing demand for transparency and a feasible working system. Lately, the collapse of various projects in the crypto space has left investors demanding more transparency. To some extent, algorithm stablecoins lack enough transparency that can convince investors to adopt them.
Additionally, the market dominance and stability of fiat-backed stablecoins like USDT and USDC also pushed algorithmic stablecoins outside the limelight of the crypto space. The collapse of UST shifted investors’ attention to the aforementioned stablecoins, aiding them to grow more. Since the demise of UST, no algorithmic stablecoin has been able to challenge the market dominance of USDT and USDC. Therefore, complicating the present condition of algorithm stablecoins.
Conclusion
UST played a prominent role in the advancement of the algorithmic stablecoins market. However, its collapse also sponsored a sharp decline in the attention they receive. For many, the algorithmic structure of these assets under review makes them no different from regular crypto assets.
The rise to fame of stablecoins was birthed due to the protection they offer against the volatile nature of crypto. This is possible due to underlying assets backing them. Consequently, the collapse of UST exposed algorithm stablecoins and their shortcomings in being a hedge against the volatile nature of the crypto market.