Algorithmic stabilization is the key to effective crypto-finance

After the collapse of Terraform Labs’ cryptocurrency, Terra (LUNA), and its stablecoin, Terra (UST), the notion of “algorithmic stabilization” fell to a low point in popularity, both globally cryptocurrency and among mainstream watchers.

This emotional response, however, is strongly at odds with reality. In fact, algorithmic stabilization of digital assets is a very valuable and important class of mechanism whose proper deployment will be essential if the crypto sphere is to achieve its long-term goal of improving the traditional financial system.

Blockchains and similar data structures for secure decentralized computing networks are not just about money. Due to the historical roots of blockchain technology in Bitcoin (BTC), however, the topic of blockchain-based digital currency is deeply embedded in the ecosystem. Since its inception, a fundamental aspiration of the blockchain space has been the creation of cryptocurrencies that can serve as means of payment and stores of value, independent of “fiat currencies” created, championed and manipulated by national governments.

Related: Developers could have prevented 2022 crypto hacks if they had taken basic security measures

So far, however, the crypto world has failed quite miserably in realizing its original aspiration to produce tokens superior to fiat currency for payment or for storing value.

In fact, this aspiration is eminently achievable – but to achieve it in a manageable way requires creative use of algorithmic stabilization, the same kind of mechanism that LUNA and other Ponzi-esque schemes have abused and thus given bad credit. reputation unfairly.

Almost all crypto tokens available today disqualify themselves as broadly useful tools for payment or storing value for multiple reasons – they are too slow and expensive to transact, and their exchange values ​​are too volatile.

The “slow and expensive” problem is gradually being solved by improvements in the underlying technology.

The problem of volatility is not caused directly by technological shortcomings but rather by market dynamics. Crypto markets are not that huge compared to the size of the global financial systems, and they are heavily traded by speculators, causing exchange rates to swing wildly up and down.

The best solutions the crypto world has found to this volatility problem so far are “stablecoins,” which are cryptocurrencies with values ​​pinned to fiat currencies like the US dollar or the euro. But there are fundamentally better solutions to be found that avoid reliance on fiat and provide other benefits by using algorithmic stabilization in a sensible (and uncorrupted) way.

Problems with stablecoins

Stablecoins like Tether (USDT), BinanceUSD (BUSD), and USD Coin (USDC) have near-USD values, meaning they can be used as a store of value almost as reliably as a regular bank account. For people who are already doing business in the crypto world, it is useful to store wealth in a stable form in one’s crypto wallet, so that one can easily move it between the stable form and various other crypto commodities. .

The largest and most popular stablecoins are “fully collateralized”, which means, for example, that each USDC dollar equivalent unit corresponds to one US dollar stored in the treasury of the organization supporting the stablecoin. ‘USDC. Thus, if all holders of a unit of USDC requested to exchange it for USD at the same time, the organization would be able to respond quickly to all requests.

Some stablecoins are partially backed, which means that if, for example, $100 million in stablecoins were issued, there might only be $70 million in the corresponding treasury. In this case, if 70% of stablecoin holders redeemed their tokens, everything would be fine. But if 80% redeemed their tokens, that would become a problem. For FRAX and other similar stablecoins, algorithmic stabilization methods are used to “hold the peg”. In other words, to ensure that the exchange value of the stablecoin remains very close to that of the peg to the USD.

Terra’s UST was an example of a stablecoin whose backing pool consisted largely of tokens created by the people behind LUNA as governance tokens for their platform, rather than USD or even cryptocurrencies. as BTC or Ether (ETH) defined independently of LUNA. When LUNA started to destabilize, the perceived value of their governance token went down, which meant the cash value of their reserves went down, which caused further destabilization, etc.

Although LUNA used algorithmic stabilization, the main problem with their setup was not that – it was the presence of vicious circularities in their tokenomics, such as using their own governance token as a backing pool. Like most other flexible financial mechanisms, algorithmic stabilization can be manipulated.

Every major government explicitly targets stablecoins in their current regulatory exercises, aiming to come up with strict regulations on the issuance and properties of any crypto token that seeks to match the value of fiat currency.

The answer to all of these problems is relatively simple: use the flexibility of blockchain-based smart contract infrastructure to create new financial instruments that provide useful forms of stability without pegging to fiat.

Liberating algorithmic stabilization

“Stability” does not inherently mean a correlation with the value of fiat currency. What this should mean for a token to be stable is that year over year it should cost roughly the same number of tokens to buy the same amount of stuff – carrots, chickens, hardware closing, rare earths, accounting services, whatever.

This leads to what my colleagues at the Cogito project are doing, with new tokens they call “tracercoins”, which are actually stablecoins but of a different type, roughly pinned to quantities other than fiat currencies. For example, the Cogito G-coin is pinned to a synthetic index that measures progress in improving the environment (e.g. global temperature).

Tracercoins can be programmed to track transactions as required by law in the jurisdictions where they are used. But they’re not trying to imitate any particular country’s currency, so they probably won’t be regulated as strictly as fiat-pinned stablecoins.

Related: Programming languages ​​prevent mainstream DeFi

Since the pegs of these tokens are synthetic, it is less of a traumatic issue of market psychology if the tokens vary a little from their pegs from time to time.

So what we have here are stores of value that are potentially better even than the US dollar and other traditional financial assets, in terms of maintaining fundamental value as the world evolves…and are much less volatile than BTC and other standard crypto assets. due to the stabilization built into their tokenomics.

Coupled with modern blockchain efficiency optimizations, we also have a viable payment mechanism that is not tied to any country’s currency.

Crypto has the potential to realize its long-held ambitious aspirations, including the creation of financial tokens that serve as better stores of value and payment mechanisms than fiat currencies.

To realize this potential, the community must set aside fears about the various frauds, scams, and poorly-architected systems that have plagued the crypto world, and aggressively deploy the best tools at hand – such as stabilization. algorithmic based on fractional reserve – in the service of creative designs aiming for the greater good.

Ben Goertzel is the CEO and Founder of SingularityNET. He previously served as director of research at the Machine Intelligence Research Institute, chief scientist and president of AI software company Novamente LLC, and president of the OpenCog Foundation. He graduated from Temple University with a doctorate in mathematics.

This article is for general informational purposes and is not intended to be and should not be considered legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

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