The curious implications of algorithmic stablecoins, Dec. 2–9

This is the latest issue of Finance Redefined, Cointelegraph’s DeFi-centric newsletter delivered to subscribers every Wednesday.

A relatively quiet week in DeFi finally has given me some breathing room to talk about a subject I’ve been postponing since almost the beginning of this newsletter, namely: What’s up with DeFi’s weird obsession with algorithmic stablecoins?

There are so many of them, and so many new projects get an unreasonable amount of attention. The latest is Basis Cash, which turned the heads of quite a few farmers this week.

BAC chart by CoinGecko. It’s supposed to trade at $1.

This week also saw the full launch of Neutrino’s NSBT governance token, which is used to backstop the reserves of the project’s stablecoins. Neutrino is not fully algorithmic, since it ultimately derives its value from its collateral of WAVES tokens. Dai is also not an algorithmic stablecoin for analogous reasons.

Algorithmic stablecoins, as defined by MakerDAO itself, use supply manipulation or market buying and selling to track a particular unit price — usually $1.

Perhaps the longest-running algorithmic token is Ampleforth, though in the Summer of DeFi we also witnessed the creation of similar projects like Yam and Based. The basic principle of these coins is that smart contracts expand and contract the supply at predefined intervals. If oracles detect that the coin is trading for more than $1 or so, the supply expands. If it’s worth less, supply contracts.

The mechanism is called a rebase, and it is extremely powerful. Usually it’s an adjustment of 10% of the deviation from $1, every day. So if the price is $3, the supply changes by 20%, compounded every single day. That usually works pretty well to eventually bring it to $1.

For the Ampleforth and Yam family, supply changes affect every single wallet holding the coins. If you had 1,000 tokens one day, you may have 1,100 the next, without taking any action yourself. Basis is slightly different, as it limits the rebases to those who want to take the associated risks and rewards.

Now, Ampleforth never referred to itself as a stablecoin, preferring the categorization of “non-correlated asset.” But it does target the 2019 “value” of USD and it is popularly called a stablecoin. The other projects are not so shy of that moniker.

Here’s the kicker: These assets are not stable, at all.