The End of Algo-Stablecoins?

The crash of the Terra USD is a setback for algorithmic stablecoins but there is a solid Bitcoin-based alternative.

The collapse of the UST stablecoin and the related Luna Coin is arguably the most spectacular crypto event of the year so far. The dominant Stable Coin Tether (USDT) also lost its parity to the US dollar for a short time and is considered by many to be the next victim of the crypto bloodbath.

Unlike the Tether, Terra-Luna’s UST is not backed by the equivalent amount of U.S. dollars in bank accounts (whether this is really the case remains to be seen). Its parity to the dollar is to be guaranteed by cryptocoins that are supposed to hedge its value. In the case of the UST, these are the Luna coin on the one hand, as well as a considerable amount of Bitcoin as an “emergency anchor”. Those who provided their Bitcoin as collateral reportedly received interest of more than 18% on it.

Crucial to the stability of so-called algorithmic stablecoins are – as the name suggests – algorithms. They automatically sell so many of the backing coins, or buy them up again, that the stablecoin always keeps close to the price of one U.S. dollar. It is a sophisticated mechanism, but not always as stable as one should expect from a stablecoin.

The DAI’s U-Turn

The first of these so-called algorithmic stablecoins was the DAI by Maker DAO. DAI was originally backed by Ether. However, in March 2020, when all cryptocurrencies heavily crashed in the wake of the Corona crisis, the DAI system collapsed. A state of emergency was declared and the DAI platform was shut down. For a few days, those who had deposited Ether into DAI’s Smart Contract could no longer access their money.

Then Maker DAO made a radical system change. The DAI is no longer backed by Ether only, but by a basket of coins. About half of them are Tether and other dollar-backed stablecoins like Coinbase’s USDC. DAI is therefore no longer a true algorithmic stablecoin, but is indirectly backed by U.S. dollars.

The DAI is backed to nearly 50% by FIAT based coins

Such dependence on government fiat currencies is contrary to the very philosophy of decentralised, government-free money. It was supposed to be abolished by the invention of algo-stablecoins, which do not require dollars or euros in bank accounts at all. After DAI dropped out of the league of algorithmic, fiat-independent stablecoins, many pinned their hopes on UST. So does its collapse mean the end of algorithmic stablecoins?

Not quite, because there are stablecoins whose algorithms have survived the previous crypto crises without damage. First and foremost, there is the Dollar-on-Chain created by Money-on-Chain from Argentina. It is based on Rootstock technology, which makes everything we know from Ethereum possible based on Bitcoin. We have explained how Rootstock works in this article.

The Dollar-on-Chain (DoC), which is entirely backed by Bitcoin, exists since December 2019. The DoC is pegged to the value of the U.S. dollar, but dollars in a bank account are nowhere to be found in the system, not even indirectly as in the case of DAI. The dollar is merely used as a unit of account because we are familiar with it. Humans are creatures of habit, and after the introduction of the euro, many people would still convert all price into currencies they were used to, like the D-mark, franc or peseta.

Dollar-on-Chain and BitPro

In contrast to the UST, the collateral for the Dollar-on-Chain (DoC) is very high, on average the ratio is 1:8. This means: if DoCs in the value of one Bitcoin are issued, eight Bitcoins are deposited in a smart contract to secure that. These Bitcoins are not some dubious “emergency anchor” owned by a company as in case of Terra, they still belong to their original owners who can get them back at any time.

Those who provide their Bitcoins as collateral receive a token called BitPro in return, which generates a passive income for them. This is mainly generated by another much more highly leveraged token in the system, the BTCx. It is aimed at traders who are willing to take a higher risk and pay for it. Most of the revenues from the BTCx is paid out to BitPro holders. This incentive is important, as no one would invest their Bitcoins into the system for free. The high overcollaterlisation of the DoC, which is so important for its stability, is only possible by the profitabilty of the BitPro token.

Since its introduction the BitPro has always appreciated compared to Bitcoin

The BitPro operates with a leverage of about 1.1 to 1.25 on Bitcoin. This means: when the Bitcoin price goes up, the BitPro goes up even more. For example, with a leverage of 1.2, the value of the BitPro would increase by $120 if the bitcoin rises by $100. Of course, this also means that if the bitcoin price falls by $100, the BitPro will fall by $120. The BitPro is therefore a good investment for bullish times, not so much in a „Crypto Winter“, when the price is low. However, since DoC and BitPro were released on the Rootstock Mainnet in December 2019, we have mostly seen a rising Bitcoin price. BitPro owners have since enjoyed a 23.9% gain compared to just hodling their Bitcoins – not bad for a relatively low-risk investment!

Stress Test for Stablecoins

Due to the high collateralization of the dollar-on-chain, a total failure like in the case of Luna is very unlikely. According to Money-on-Chain founder Max Carjuzaa, Bitcoin would have to crash by more than 75% to put the system at risk. The March 2020 crash of all cryptocoins was a good stress test for Money-on-Chain. While DAI suffered its emergency shutdown, the MoC protocol continued to function without any problems. Money-on-Chain also easily survived the big cryptocrash of the last weeks – „Business as usual“, Carjuzaa says.

The amount of Bitcoin locked in the MoC system has risen sharply since the Terra Luna crash

The amount of Bitcoins invested in Money-on-Chain has increased rapidly during the current crisis, from around 1000 Bitcoin at the beginning of May to currently over 1500 Bitcoin. This means: around 4 million issued DoCs are backed by Bitcoins currently worth around 45 million US dollars, so the overcollateralisation is now around 1:11.

45 million US dollars is still a rather low amount compared to other stablecoins, but the dynamics are interesting. Obviously, the Luna crash has made more investors look for alternatives. Dollar-on-Chain and BitPro have been relatively unknown in the crypto world, largely because the founders have put their priority less on marketing than on developing a reliable protocol. I assume that the level of awareness for Money-on-Chain will increase significantly in the near future, because there is currently no better stablecoin than the DoC, and hardly a more solid crypto investment than the BitPro.

The Euro-on-Chain

In the future, Money-on-Chain will issue more stablecoins that function according to the same principle, such as Euro-on-Chain, Yuan-on-chain or Ruble-on-chain. For the mass adoption of decentralized, state-free money, functioning stablecoins are essential. Bitcoin’s volatility may be good for traders and poses no real problem for long-term hodlers. However, merchants need a stable unit of account for their pricing and accounting. In the Euro area, the Euro-on-chain can take over this function.

If we want to make Bitcoin and Euro-on-Chain (EoC) de-facto legal tender, for example in my home country Germany, it is not necessary to force people to accept Bitcoin or EoC, as that would contradict the freedom spirit of Bitcoin. It is perfectly sufficient to abolish the any taxes on these two currencies, and to allow the payment of taxes and fees in them. Both of these legal changes can be made at the national level. Given Germany’s leading role in Europe, it is very likely that other Eurozone states will follow this example. Hyperbitcoinization will then only be a matter of time.

by Aaron Koenig