What's Next For Algorithmic Stablecoins After UST Crash?
Being an algorithmic stablecoin, this raises a question about the credibility of other algorithmic stablecoins. How can the other algorithmic stablecoins have any hope of surviving if the third-largest stablecoin can lose all its value in just a few days?
Algorithmic stablecoins
Cryptocurrencies are known for their high degree of volatility and the ease with which their prices can fluctuate. Stablecoins fill this void by providing some stability in the widespread volatility. Stablecoins are digital assets designed to maintain a constant value compared to an underlying asset or currency, often 1 USD.
We can categorize stablecoins into two primary groups.
The first category consists of stablecoins like Tether and USDC that maintain their value through the use of reserves denominated in fiat currency.
The second type of stablecoins is algorithmic or decentralized stablecoins like UST, backed by the cryptocurrency Luna.
These stablecoins use non-fiat-based assets like cryptocurrencies to maintain their value. In this stablecoin protocol, you will need to burn luna to generate UST. More people look to purchase UST, leading to a greater burn of luna. Consequently, this would increase the price of the remaining supply of luna. Since Terra's introduction, this protocol has been functioning perfectly, other than the recent incident.
What does this mean for algorithmic stablecoins?
Do Kwon, CEO of Terralabs, the developer of the terra blockchain, UST, and Luna, believes he has a solution. He recently proposed a hardfork of the Terra blockchain, which entails generating a new copy of the network with major improvements. The new blockchain will be built without the algorithmic stablecoin and will include a billion Luna tokens, which would be distributed to present Luna and UST holders and used to support the creation of new Terra apps.
In the crash, they lost tremendous amounts of money, exposing the vulnerability of several cryptocurrencies and algorithmic stablecoins. Although Terra may rebound with the proposed solution, many investors are already questioning the legitimacy of other stablecoins. They still have a long way to go before gaining people's trust.
The crash may have taught other algorithmic stablecoin projects one or two things. Other projects are currently taking precautionary measures to avoid finding themselves in the same position as Terra. One illustration of this would be the Tron DAO Reserve increasing its reserves by acquiring millions in TRX, Bitcoin, and Tether to protect USDD, its stablecoin.
Is regulation the solution?
There have been many calls previously for regulation in the cryptocurrency sector. After the UST-LUNA crash, regulators have good reason to worry about the resilience of stablecoins. Janet Yellen, the secretary of the US Treasury, recently talked about the crash and asked Congress to approve federal regulation of stablecoins by the end of this year.
This situation demonstrates that even stablecoins that intend to be "stable" cannot guarantee a stable value due to their sheer volatility and the current lack of clear-cut regulation in the cryptocurrency market.