UST, a stablecoin that’s supposed to maintain a price peg with the US dollar 1:1, spiraled out of control to reach as low as USD 0.10 this month. Following the momentous rise of UST in just a few months, only a few predicted its monumental crash, especially with the dominance stablecoins were gaining in the market.
Stablecoins have become a dominant force in the crypto markets as they enable investors to hold funds in dollars without leaving the cryptoasset markets. Decentralized finance (DeFi) is one of the major beneficiaries of stablecoins as they power most of the borrowing, lending, and liquidity provision in many DeFi protocols.
In the wake of the collapse of UST, another stablecoin backed by a prominent crypto entrepreneur, which is aiming to play the algorithmic card better than UST, has hit the market.
Read on to learn about Justin Sun’s new stablecoin, USDD, and how it looks eerily similar to the recently collapsed UST.
What are algorithmic stablecoins?
Before we go all-in on this new stablecoin, let’s get a foundation by diving in on the concept of algorithmic stablecoins.
Stablecoins are generally defined as “digital currencies that maintain a price peg with other assets by holding them as collateral.” But we already know that this definition doesn’t always apply as there are different types of stablecoins. Let’s take a quick look at each one.
Fiat-collateralized stablecoins are backed by fiat currency held in reserves by a central entity. They often come under criticism by crypto enthusiasts for their centralization and lack of transparency as their reserves are off-chain.
Commodity-collateralized stablecoins are backed by physical assets like oil, precious metals, real estate, etc. through a central entity. They face the same criticism as fiat collateralized stablecoins.
Crypto-collateralized stablecoins are backed by holding other cryptoassets as collateral through a smart contract. While they fit the decentralization model and allow for transparency, they aren’t capital efficient as they need to be over collateralized to maintain stability.
Algorithmic stablecoins aim to solve the challenges seen by other stablecoins by removing the need for any form of collateral or dependency on a central issuer. They maintain a price peg with other assets through a process that requires a crypto token burn and mint mechanism.
The process generally, requires two tokens – one to act as the stablecoin and another to help in maintaining its stability – to retain the price peg by regulating demand and supply between both tokens. Some protocols choose a bit of both worlds by employing an algorithmic mechanism and still holding cryptoassets in a reserve.
A closer look at algorithmic stablecoins, however, shows the possibility of a death spiral when their price peg breaks – as revealed with UST and its sister token, LUNA by Terra.
But even so, algorithmically-backed stablecoins are not looking to leave the crypto market anytime soon. In the middle of events leading to the UST de-peg, controversial crypto entrepreneur and founder of Tron (TRX) blockchain, Justin Sun, together with the Tron DAO (decentralized autonomous organization, launched a new algorithmic stablecoin called USDD.
What is USDD?
USDD is a new algorithmic stablecoin that aims to maintain a price closely pegged with the US dollar through an algorithm that incentivizes arbitrage traders to trade between TRX, Tron’s native token, and USDD.
The mint/burn process involves burning USD 1 worth of TRX for USDD 1 when the price of USDD increases above the peg. Hence, reducing the supply of TRX and increasing the supply of USDD. When the price of USDD falls, USDD 1 will be burned for USD 1 worth of TRX tokens, reducing the supply of USDD and increasing that of TRX in the process.
According to Justin Sun, USDD was born from a vision of making stablecoins in the crypto industry just as “decentralized as bitcoin.”
USDD is managed by Tron DAO, which is helping to administer an interest rate as high as 30% (more than UST) when you stake USDD. Tron DAO will also help in maintaining the stability of USDD in times of market crash that may cause the algorithm to fail by accumulating USD 10 billion in bitcoin, TRX, and other stablecoins in a reserve.
Data from Coinmarketcap.com shows that USDD already has a market capitalization of USD 542.9 million (at 12:45 UTC on Tuesday, May 24). While that is nowhere near the market capitalization of top stablecoins like USDT (USD 73.2 billion), USDC (USD 53.3 billion), BUSD (USD 18.4 billion), DAI (USD 6.6 billion), or UST before its crash, it suggests that the market seemingly has more trust in Justin Sun’s ability to maintain the peg than they did in Terra’s Do Kwon.
What happened with UST?
On May 9, 2022, UST lost its peg to the US dollar for the first time in a long while, trading below 92 cents. In a bid to defend the peg, the Luna Foundation Guard (LFG) started selling its BTC reserve to buy UST.
However, the strategy employed by the LFG turned out counterintuitive as UST eventually crashed to USD 0.1 losing almost all of its value within days. The effect of the crash also drastically affected UST’s sister token, LUNA, plummeting its value from above USD 84 to essentially zero (USD 0.0001).
There’s a theory about UST’s crash being a coordinated attack where an attacker had borrowed funds to attack UST’s peg and then made a killing on a short position on BTC as they knew that the LFG would sell its BTC reserves in an attempt to maintain UST’s peg. While this has not been confirmed, the general consensus in the community is that this is what must have happened.
UST and LUNA lost about USD 60 billion of combined market capitalization from the crash.
USDD vs. UST: similarities & differences
USDD and UST are both algorithmic stablecoins that aren’t backed by collateral. Considering the recent crash of UST, investors are becoming skeptical of stablecoins, especially those in the algorithmic category.
USDD has come under fire as its algorithm and framework look the same as that of UST – mint USDD by burning TRX and mint TRX by burning USDD.
USDD is also backed by the Tron DAO, which plans to manage a reserve of USD 10 billion in different cryptoassets to support its peg. This is similar to the LFG which planned to hold USD 10 billion in bitcoin and AVAX to support the peg of UST.
While the fundamentals of USDD appear just the same as UST, Justin Sun argued in a recent zoom session that USDD’s operational difference makes it quite different from UST.
He argued that UST grew too quickly in a short time and used over-leverage, citing the large market capitalization of UST and its relatively small reserve before the crash. He also pointed to the high yields of Anchor Protocol and the lack of proper consideration of market variables as technical areas in which UST failed.
According to Justin Sun, USDD plans to focus on healthy growth by keeping its market capitalization lower than that of TRX, the Tron DAO reserve, and the entire crypto market capitalization. He stated that the reserve will comprise mainly of bitcoin and TRX and other top stablecoins like USDT, USDC, BUSD, DAI, and TUSD. The stablecoins can be deployed immediately in case USDD falls below its peg, hence buying time to gradually liquidate other assets.
Unlike Anchor Protocol which had a constant interest rate of 20% without any withdrawal limits, Justin Sun said USDD aims to put structures in place that influence interest rate and withdrawal limit.
Is Justin Sun’s USDD bound to go the same way as UST?
Considering the similarity of USDD’s fundamentals and that of UST, it would make sense to assume that USDD will eventually suffer the same fate as UST. Moreover, no algorithmic stablecoin has succeeded so far because of the apparent attack vectors they possess.
At the same time, it’s important to acknowledge that Justin Sun and Tron’s pockets are a lot deeper than Do Kwon and the LFG’s, which means that their ability to maintain the dollar peg is likely to be higher.
However, now that there is a very public playbook of how to attack a stablecoin such as this one, the chance of more market participants attempting to do so has also increased.
While a functioning, stable algorithmic stablecoin would be an excellent addition to the growing DeFi market, the recent attempts at creating one suggest that there is still more work to be done before one can truly succeed.