Terraform Labs failed miserably, but stablecoins can still succeed in the future with fractional reserve-based algorithmic stabilization.
) have values tied close to that of USD, which means they can be used as a store of value almost as reliably as an ordinary bank account. For people already doing business in the crypto world, there is utility in having wealth stored in a stable form within one’s crypto wallet, so one can easily shift it back and forth between the stable form and various other crypto products.
Some stablecoins are fractionally backed, meaning that if, say, $100 million in stablecoins have been issued, there may be only $70 million in the corresponding treasury backing it up. In that case, if 70% of the stablecoin holders redeemed their tokens, things would be fine. But if 80% redeemed their tokens, it would become a problem. For FRAX and other similar stablecoins, algorithmic stabilization methods are used to “maintain the peg.
While LUNA did use algorithmic stabilization, the core problem with their set-up was not this — it was the presence of vicious circularities in their tokenomics, such as the use of their own governance token as a backing reserve. Like most other flexible financial mechanisms, algorithmic stabilization can be manipulated.
The answer to all these issues is a relatively simple one: Utilize the flexibility of blockchain-based smart-contract infrastructure to create new financial instruments that achieve useful forms of stability without pegging to fiat.“Stability” does not intrinsically mean correlation with fiat currency value.
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