Ghosts of Algorithmic Stablecoins Past

Terra Labs’ algorithmic stablecoin UST kickstarted a summer of scandals last year by imploding in spectacular fashion. Along with its sister token Luna, the stablecoin survives in its classic avatar as USTC.

In the aftermath of their implosion, both USTC and LUNC – Luna’s classic version – suffered massive devaluation and were abandoned by traders to crypto purgatory. Their current valuations reflect this status. Luna is currently changing hands at 0.00018 while USTC is trading at 0.03.

One would have thought that a price crash and subsequent criticism would be enough to dissuade further experimentation. But (misguided) hope springs anew in crypto.  

USTC Rises Again

A fresh effort is underway to revive USTC and inch it back towards the $1 peg. Backed by the world’s biggest crypto exchange Binance, it is a modified version of the earlier mechanism that underpinned Terra’s stablecoin’s workings.

The new system will still rely on burn and issue of USTC tokens to peg the stablecoin based on market conditions and demand. However, it will make use of a soft peg – equal to the coin’s prevailing market price – and an exchange modifier range (ERM) that will establish a limit for its price movements upwards.

Incentives like high interest rates and increased liquidity will be offered to traders to gradual push USTC towards the $1 peg.

Problems With New Proposal

Soft pegs are not a new concept. Many currencies like the Hong Kong dollar maintain soft pegs with the US dollar to prevent runs and maintain a constant rate. But they have a liquid ecosystem populated with traders and market makers.

The “soft peg” outlined for Terra’s new iteration is nothing short of market manipulation – an attempt to reward insiders, read investors and validators, with gains while shortchanging traders.

Demand from centralized exchanges, like Binance, will help set the market price. That is a red flag since many such exchanges are known to deal in wash trading and market manipulation.  

To create incentives for staking USTC and avoid major selloffs, the system proposes withholding of commissions by validators to fund bonds that distribute “rewards” to them. Around fifty percent of USTC’s total supply is staked. No prizes for guessing who benefits the most from this system.       

A Fundamental Misunderstanding

The system also betrays a fundamental misunderstanding of currencies. To recap, a currency is a store of value, medium of exchange, and unit of account. USTC is none of these. Even Tether, a stablecoin that attracts controversy, has some utility in its function as a rail between different coins.

In its current form, USTC is worthless and its main utility rests on speculation. Duncan Day, who is behind the proposal, identified non-fungible tokens and high frequency trading (HFTs) as possible use cases for the token. The former is an unproven concept that has already undergone a bubble and crypto’s dwindling credibility is hardly likely to attract traders to USTC.

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