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This aspect of the crypto space has been fraught with turmoil and negative headlines in recent years; but investors should take note that new framework should ensure history doesn’t repeat itself
By Siddarth Patil, Cofounder of Comdex
Increasing market volatility in cryptocurrency has made many retail investors run in the opposite direction from the space. However, the bear market brings with it much in the way of needed innovations both on the regulatory and technological fronts. Many of these improvements directly address some of the most highly documented failures in the industry last year, like the collapse of the stablecoin Terra—at its peak, the 3rd most popular of its kind—and its sister token, Luna.
Stablecoins are very important in the cryptocurrency industry, especially for trading and investing. They enable cryptocurrency trading without the need to convert them back into fiat currency, which can be time-consuming and costly.
When they function properly, Stablecoins accomplish many things, chief among them, they hedge against cryptocurrency market volatility. They also function as a means of payment, and are becoming more widely accepted by merchants and other businesses. Stablecoins can also provide a more efficient and cost-effective way to send money across borders because they are designed to maintain a stable value, particularly in areas where traditional banking services are limited.
Stablecoins have historically been seen by many as a trust exercise in collateralization. And, without independent audits and a scrutinous regulatory framework, one cannot dismiss the thought of the underlying assets not being appropriately preserved.
In 2023, stablecoins with new proper design framework and solid governance will change the game for not only investor peace of mind, safety, and security, but will ultimately help bring about mass adoption and scale to crypto, once it becomes clear that the wild west aspects of early stablecoins flaws have been solved for.
The problem with algorithmic, and case for over-collateralization: Many layers of defense are needed to maintain a peg
Algorithmic stablecoins are pegged to a value and not by an asset, and follow rebase or seigniorage algorithms or a combination of two. The efficiency of an “algo” stablecoin depends largely on its adoption and demand. Algo stablecoins are exposed to risks of depegging in a volatile market and depegging beyond a certain threshold level can cause a greater harm in the value of stablecoin. It is important to note that virtually all examples of algo stablecoins have ultimately failed, historically.
Similar risks are negligible in collateral backed stablecoins as they come with different layers of defense mechanism to ensure users funds are safe.
Long-term pegging is managed by monetary policies while the short term is managed by an arbitrage based mechanism; collateral assets deposited to mint the stablecoin are always higher, typically 150%, this is called overcollateralization. If the price of the collateral asset falls below the minimum, it causes liquidation through auctions to recover the debt.
This setup ensures that multiple interchain assets allow for deeper liquidity and minimize dependency on a single asset. With the speed, low cost and efficiency in transactions that come with ecosystems such as Cosmos, giving power to DeFi will enable users to earn sustainable yields and leverage opportunities in lending and liquidity provision.
A basic checklist for investors of the hallmarks of an effective stablecoin+token design would account for:
Overcollateralization with multiple assets
Value of collateral is always more than the debt issued in the form of the stablecoin.
Surplus
Minted stablecoins exists as a debt & accrue a variable interest rate disbursed to the surplus module, which serves as a primary monetary tool to control stablecoin issuance.
This module has a floor & a ceiling. When the surplus module hits the ceiling, all the extra interest accumulated in the module is used to buy back the governance token and burn it from the supply, thereby increasing the value of the governance token. When surplus hits the floor and the peg is still broken, the system moves to the following line of defense.
Proper token design
A token should not be used as collateral to mint; rather it should serve as a line of defense to maintain the stablecoin peg through recapitalization in case of high market volatility and in scenarios when liquidations fail to recover debt and maintain peg.
Emergency Shutdown
This design aspect is essential if needed to shut down the protocol and stop all further transactions while ensuring all stablecoin holders and vault users receive net value of assets they are entitled to.
Reserve
The stablecoin reserve should consist of locked stablecoins which are used to mint.
Investors should be aware that despite so much bad news last year, and the current economic headwinds, teams are building and deploying great products and solutions based on the above principles right now in an effort to show the world what is possible with the correct approach. Design, governance, and regulatory improvements to the stablecoin will be a large part of what fulfills the promise of blockchain technology- not just for investors, but the unbanked masses of the world.
About Siddarth Patil
Comdex Co-founder and COO. Before co-founding Comdex, Siddarth’s professional endeavors centered on finance, with working experience in wealth management and investment banking. He began building Comdex in 2018 as a blockchain-based solution to digitize the commodity supply chain industry. Along with the Comdex team, Siddarth launched Comdex chain in 2021 as a DeFi infrastructure layer to power a multi-chain ecosystem.
About Comdex
A DeFi infrastructure layer for the Cosmos ecosystem. A layer-1 infrastructure for seamless deployment of DeFi applications in the Cosmos ecosystem, powering DeFi in the multi-chain future.
The Comdex chain is built to enable bridging of capital to assets across the DeFi and CeFi ecosystems. A truly decentralized ecosystem of solutions enables limitless access to global liquidity in finance.
Comdex aims to deliver a robust infrastructure layer that supports seamless creation and deployment of DeFi applications in the Cosmos ecosystem. The Comdex chain enhances investor’s access to a broad range of assets that help investors diversify and generate yield on their investments.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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