Robert Lauko Profile picture
Jun 1 18 tweets 4 min read
In a recent blog article @VitalikButerin put out two thought experiments to evaluate automated #stablecoins.
vitalik.ca/general/2022/0…

1/18
I’d like to address the second one: what happens if you try to peg the stablecoin to an index that goes up 20% per year?

Vitalik claims that it will turn out as either of two ways:

2/18
1. It charges some negative interest rate on holders that equilibrates to basically cancel out the USD-denominated growth rate built into the index.
2. It turns into a Ponzi, giving stablecoin holders amazing returns for some time until it suddenly collapses with a bang.

3/18
I’m not sure I follow the second point since I doubt that anybody would want to borrow an indexed stablecoin that results in a rapidly growing debt. So there would be no stablecoin to begin with that could turn into a Ponzi and blow up. Ex nihilo nihil fit.

4/18
But even outside of this hypothetical example, Vitalik goes on by saying, a stablecoin must somehow be able to respond to situations where even at a zero interest rate, demand for holding exceeds demand for borrowing.

5/18
Otherwise the price rises above the peg, and the stablecoin becomes vulnerable to price movements in both directions that are quite unpredictable.

This is an interesting point...

6/18
@LiquityProtocol’s $LUSD is a living example of an overcollateralized zero-interest stablecoin that has gone through multiple stress scenarios while keeping its peg pretty well given the circumstances.

7/18
Thanks to its minimum collateral ratio of 110%, Liquity creates a hard price ceiling at $1.10, confining price movements to a relatively narrow band when holding demand exceeds borrowing demand.

8/18
And in theory, this range could be further reduced if the underlying chain and price oracle would allow for faster liquidations and thus a lower liquidation ratio.

9/18
Of course, $LUSD hasn’t always held its peg perfectly. I elaborated on a temporary peg break in January, and how Liquity mitigates it without relying on centralized collateral assets or redefining the notion of stability (like @reflexerfinance)


10/18
Besides enabling instant liquidations without immediate price impact, Liquity’s Stability Pool acts as a liquidity buffer from which $LUSD can be freely withdrawn (and sold) at any time.

11/18
And the higher the price of $LUSD rises, the bigger the incentive to remove your deposit given the higher price risks in case of liquidations.

12/18
Stablecoins overcollateralized by volatile assets like $ETH are subject to scalability limitations due to a fundamental decorrelation between borrowing and holding demand.
Apart from simply being decorrelated, the two sides of the market seem to behave pretty differently:

13/18
...a sufficiently established stablecoin market should move slower than the corresponding borrowing market which always remains highly dependent on the (leveraged) Ether price and the general market sentiment.

14/18
Imposing an explicit or implicit negative interest rate shifts the burden caused by the borrwing volatility to stablecoin holders, who oftentimes aren't responsible for the peg deviation.
And it penalizes all current holders alike, including those who bought at peg.

15/18
On the other hand, an overpriced stablecoin is only detrimental to existing borrowers who want to repay, while new borrowers may even benefit from the peg break, assuming that they can repay once it stabilizes again (e.g. when more people seek leverage on Ether).

16/18
Overall, a temporary peg deviation thus incentivizes the “right” anti-cyclical borrowing behavior (e.g. borrow when the price is high), while “punishing” those who are contributing to the situation by repaying their debts.

17/18
This is the lesser evil both from an efficiency and fairness perspective: those who caused the unwanted situation should shoulder its consequences.
Charging negative interest on the stablecoin holders to mitigate pro-cyclical borrowing holds the wrong users responsible.

18/18

• • •

Missing some Tweet in this thread? You can try to force a refresh
 

Keep Current with Robert Lauko

Robert Lauko Profile picture

Stay in touch and get notified when new unrolls are available from this author!

Read all threads

This Thread may be Removed Anytime!

PDF

Twitter may remove this content at anytime! Save it as PDF for later use!

Try unrolling a thread yourself!

how to unroll video
  1. Follow @ThreadReaderApp to mention us!

  2. From a Twitter thread mention us with a keyword "unroll"
@threadreaderapp unroll

Practice here first or read more on our help page!

More from @robert_lauko

Sep 13, 2020
@AndreCronjeTech @iamDCinvestor StableCredit USD is an intriguing borrowing, trading and stablecoin system with the following neat properties:
- Stablecoin has an intrinsic use as a transfer currency
- No interests
- No governance
- No liquidations
- Simple and elegant system
Though, let’s take a closer look and see how the system works and why it cannot guarantee a fully backed stablecoin supply.

Suppose that equal values of tokens A, B, C are already in the system, i.e. each token contributes with 33.3% to the total value of all collateral.
All tokens are held in Uniswap V2 pools with an equivalent value of StableCredit USD (= SC) as the other side of the respective trading pair.

A new borrower comes along and deposits x token A to the system.
Read 22 tweets

Did Thread Reader help you today?

Support us! We are indie developers!


This site is made by just two indie developers on a laptop doing marketing, support and development! Read more about the story.

Become a Premium Member ($3/month or $30/year) and get exclusive features!

Become Premium

Don't want to be a Premium member but still want to support us?

Make a small donation by buying us coffee ($5) or help with server cost ($10)

Donate via Paypal

Or Donate anonymously using crypto!

Ethereum

0xfe58350B80634f60Fa6Dc149a72b4DFbc17D341E copy

Bitcoin

3ATGMxNzCUFzxpMCHL5sWSt4DVtS8UqXpi copy

Thank you for your support!

Follow Us on Twitter!

:(