Critics say algorithmic stablecoins are ‘disaster waiting to happen’

The recent increase in the popularity of the so-called “algorithmic stablecoins” has caused an uproar within the crypto community, resulting in serious debates around their utility for the crypto market. 

Algorithmic stablecoins are seen as new breeds of cryptocurrencies seeking to replicate the stability of the dollar. They are regarded as the high-strung relatives of traditional stablecoins, which are virtual legal tenders built on the foundation of maintaining a connection with a conventional currency, typically the dollar. However, critics say they are a disaster waiting to happen. They are crypto tokens that utilize price stabilization algorithms to store the value of assets, usually at $1. An increase in the value of assets results in a supply of tokens, while tokens reduce when assets fall in value.  

What Do Supporters and Critics of Algorithmic Stablecoins Say?

Supporters of algorithmic stablecoins claim they are superior to traditional stablecoins since a sole centralized body does not administer them. Instead, they are controlled autonomously with the aid of a blockchain-based network that relies on traders all over the globe to link them to the dollar. 

Such an arrangement makes it more challenging for government regulators to oversee algorithmic stablecoins. This particular feature is seen as a crucial advantage that makes algorithmic stablecoins popular within crypto circles. As a result, U.S-based regulators have in recent months increased their scrutiny of stablecoins, particularly asset-backed coins. 

Critics of algorithmic stablecoins claim that unlike traditional stablecoins, whose value is supported by the dollars’ worth in real assets, algorithmic stablecoins are essentially not supported by any asset. Instead, they depend on algorithms or financial engineering to connect their value to the dollar. Therefore, there is huge uncertainty about their stability, and they exist in a state of constant vulnerability. Most uncollateralized digital assets peg their value to an established asset, typically the dollar. However, algorithmic stablecoins only maintain their value because traders expect the coins to hold value in the future. Algorithmic stablecoins require a given level of demand to stay afloat, and if demand goes beyond a given threshold, the system will fall apart.

Furthermore, they rely on the actions of independent actors within the blockchain who only care about their interests. And in times of crisis, the coins could be prone to unclear and uncertain information, causing herd mentality which could affect the system.

According to Charles Cascarilla, the managing director of Paxos, the lead distributor of the Binance dollars (USD), a common stablecoin that utilizes the asset-backed method, it is more challenging than simply tokenizing it. He further notes that algorithmic stablecoins are signs of a dangerous omen about to take place.

While this has been a common concern to members of the crypto community, some remain upbeat about the potential of algorithmic stablecoins. According to Sam Kazemian, owner of Frax, an algorithmic stablecoin that is partially supported by crypto assets, algorithmic stablecoins are growing increasingly better at maintaining their connection with the dollar and could ultimately overtake their traditional stablecoin peers.