OKEx Research: Understanding Algorithmic Stablecoins – The Battle Between Algorithms and Human Nature

2021.01.21

OKEx Research: Understanding Algorithmic Stablecoins – The Battle Between Algorithms and Human Nature

Current algorithmic stablecoins generally lack a market capable of generating wealth. Therefore, for algorithmic stablecoins to succeed in the future, it is essential to establish a "debt market" or "wealth-creation market" for them.

2021.01.21 - 04:14:55

算法稳定币AMPLBAC

Navigating Web3 tides with focused insights

The most remarkable aspect of the cryptocurrency space lies in its relentless innovation, and algorithmic stablecoins—rising to prominence at the beginning of the year—are undoubtedly the most ambitious and imaginative monetary experiment to date: attempting to abandon traditional human intervention by relying solely on algorithms to achieve monetary stability. One could say that the development of algorithmic stablecoins is a battle between algorithm and human nature. Algorithms pursue absolute rationality, implementing pre-defined rules through code whose logic remains unaffected by external environments. Human nature, however, often exhibits greed and fear under the influence of "animal spirits," leading to market booms and busts. This creates a fundamental paradox prevalent among current algorithmic stablecoins: in their early stages, to expand market size, they must exploit human greed to increase the supply of stablecoins—but this comes at the cost of price instability. Once the stablecoin reaches sufficient scale and achieves greater price stability, people leave due to diminishing profits, causing the market size to contract. From the first-generation algorithmic stablecoin AMPL launched last summer, to today's trending second-generation projects like Basis Cash and ESD, we continue to observe algorithmic stablecoins struggling within this "market scale–price stability" paradox. **First-Generation Algorithmic Stablecoins – Single-Token System (AMPL)** Although algorithmic stablecoins first appeared as early as 2018, it wasn't until the emergence of AMPL in the summer of 2020 that they truly captured widespread attention. From an algorithmic standpoint, AMPL has nothing particularly special. Its theoretical foundation is the most basic yet crucial economic model—the supply and demand framework: AMPL has no fixed cap; when the price exceeds $1.06, the circulating supply increases to lower the market price; when the price drops below $0.96, the supply decreases to raise the price, thereby maintaining AMPL’s value near $1. There's a joke that if you teach a parrot to say “supply” and “demand,” it can become an economist. While humorous, it underscores the centrality of supply-demand analysis in economics. Many analysts explain AMPL using two common phrases: - "When stablecoin prices rise, stablecoin supply increases" - "When stablecoin supply increases, stablecoin prices fall" The first statement seems reasonable—indeed, in reality, higher prices incentivize producers to generate more goods. The second also appears valid—excess supply leads to falling prices. Thus, many describe AMPL’s mechanism as follows: **AMPL price ↑ → AMPL supply ↑ → AMPL price ↓**, achieving price stability. However, in practice, AMPL has exhibited extreme volatility. The flaw lies in conflating two distinct concepts: “supply” and “quantity supplied.” In the first sentence, “price rise → supply rise,” the term refers to *quantity supplied*—a point movement along a fixed supply curve, reflecting increased output at higher prices under unchanged conditions. In the second sentence, “supply rise → price drop,” *supply* refers to a shift of the entire supply curve to the right, meaning producers are willing to offer more at every price level. Thus, the correct formulation should be: - Stablecoin price ↑ → stablecoin quantity supplied ↑ (movement up along the curve) - Stablecoin supply ↑ (curve shifts right) → stablecoin price ↓ Once we distinguish between these two concepts, it becomes clear that the so-called “supply elasticity” of first-gen stablecoins is a misnomer. AMPL remains a currency with perfectly inelastic supply (a vertical curve), merely adjusting supply based on price. Its actual operational logic is: - AMPL demand ↑ (curve shifts right) → price ↑ → AMPL supply ↑ (algorithm-driven curve shift) → price ↓ - AMPL demand ↓ (curve shifts left) → price ↓ → AMPL supply ↓ (algorithm-driven curve shift) → price ↑ For speculators, this presents a perfect opportunity to manipulate the market via algorithmic mechanics: **early on, when circulation is low, injecting capital can cheaply inflate the price (shifting the demand curve), triggering algorithmic expansion. Newly minted tokens are distributed to holders, who then sell for substantial profit once prices peak.** Yet as AMPL’s circulation grows, manipulating prices becomes increasingly costly. Speculative capital begins selling off and exiting, reducing demand (leftward shift of the demand curve), which causes prices to fall. As prices decline, the algorithm reduces supply (rightward shift of the supply curve), further driving down prices and prompting more exits—an accelerating "death spiral" until demand stabilizes. The chart below illustrates this phenomenon: in June, speculative inflows drove up AMPL’s price, triggering continuous issuance. By July, the price had surged nearly to $4, making further pumping prohibitively expensive. Speculators exited, dumping AMPL and crashing its price below $1, followed by a sharp contraction in supply. **As the pioneer of algorithmic stablecoins, AMPL’s design flaws have led to rampant speculation and extreme price instability.** From this perspective, AMPL cannot be considered a successful project—in the battle between algorithm and human nature, the algorithm became entirely subservient, serving as a tool for speculators to extract value. Nevertheless, its pioneering role remains noteworthy. **Second-Generation Algorithmic Stablecoins – Multi-Token Systems (Basis Cash)** Compared to the single-token design of first-gen models, second-gen algorithmic stablecoins like Basis Cash and ESD introduce additional components to enhance system stability. Take Basis Cash: its ecosystem revolves around three tokens—BAC (Basis Cash), BAB (Basis Bond), and BAS (Basis Share)—marketed as analogues to dollars, bonds, and stocks. The stabilization mechanism works as follows: - When BAC trades below $1, users can purchase BAB at a discount (BAB price = BAC price²), reducing BAC supply and pushing its price upward. - When BAC trades above $1, BAB holders can redeem BAC. If additional BAC needs to be issued after bond redemptions, the excess is distributed as dividends to BAS holders—increasing supply to bring the price down. In terms of token distribution, Basis Cash established three liquidity pools: - **Stablecoin Pool**: Initially, users deposited DAI (MCD), yCRV, USDT, sUSD, or USDC into designated contracts to receive new BAC as yield. This pool is now closed. - **Basis Share Pool 1**: Users provide liquidity to the Uniswap V2 DAI-BAC pool, stake LP tokens in Pool 1, and earn BAS rewards. A total of 750,000 BAS is allocated here. - **Basis Share Pool 2**: Users provide liquidity to the Uniswap V2 DAI-BAS pool, stake LP tokens in Pool 2, and earn BAS. A total of 250,000 BAS is allocated here. Overall, Basis Cash mimics central bank open market operations: selling bonds (withdrawing liquidity) when markets are flush, buying bonds (injecting liquidity) when tight—hence its branding as a “decentralized Federal Reserve.” However, in practice, BAC has shown severe price volatility and failed to maintain stability. Currently, BAC trades below $0.6—a 40% discount—with no sign of recovery. Why has the so-called “decentralized Fed” failed to stabilize prices? Because Basis Cash only replicates the superficial mechanisms of modern central banking, not its essence—particularly in the design of Basis Bonds and monetary tools. **What Exactly Is Basis Bond (BAB)?** Officially labeled a “bond,” BAB is not a true bond. Unlike real bonds, which promise repayment with interest regardless of asset price movements, BAB functions as a perpetual up-and-in call option. Only when BAC’s price rises above $1 does the system allow redemption. Profit equals the current BAC price minus the square of the BAC price at purchase. For example, buying one BAB at $0.81 when BAC is $0.9 allows redemption for one BAC when the price hits $1.5, yielding a $0.69 profit. But if BAC never reaches $1, the BAB becomes worthless—effectively “junk paper.” This exotic option structure undermines the effectiveness of Basis Cash’s “open market operations.” Investors buy BAB not based on guaranteed returns, but on speculation that BAC will return above $1—that is, betting on future market confidence rather than intrinsic value. It’s akin to a crypto analyst urging leveraged BTC buys during a crash, arguing: “If everyone buys, supply shrinks, price rises, and profits follow.” How many would actually take that bet? The market has already answered. **Is Basis Cash a Legitimate “Decentralized Federal Reserve”?** True open market operations require both liquidity injection and withdrawal tools. Central banks use repurchase agreements, spot transactions, and central bank bills to manage liquidity dynamically. While Basis Cash claims to emulate a central bank, it only mimics one tool—issuing bonds (BAB) to absorb liquidity. When liquidity is scarce (BAC > $1), it lacks effective instruments to inject supply beyond directly increasing BAC issuance—essentially reverting to AMPL’s flawed approach. Despite its shortcomings, Basis Cash represents progress over AMPL—especially in curbing excessive issuance. In AMPL’s single-token model, all holders benefit directly from expansion, fueling speculation. In contrast, Basis Cash prioritizes bond redemption before distributing new BAC to BAS holders. Additionally, ongoing FXS emissions dilute speculative incentives, collectively reducing vulnerability to market attacks. **Third-Generation Algorithmic Stablecoins – Partially Collateralized (FRAX)** Currently, FRAX stands as the leading partially collateralized algorithmic stablecoin. Unlike earlier generations, FRAX is minted and redeemed using two assets: the traditional stablecoin USDC and the protocol’s native token FXS. The formula is: F = X × Pₓ + Y × Pᵧ, where R determines collateralization ratio. Here, F is the number of newly minted FRAX, X is the amount of FXS, Pₓ is the dollar price of FXS, Y is the amount of USDC, Pᵧ is the dollar price of USDC, and R is the collateral ratio. The collateral ratio R adjusts algorithmically: initially set at 100%, it changes hourly based on block count. During the first hour, minting one FRAX requires $1 worth of USDC. Thereafter: - If P_FRAX > $1, R decreases by 0.25% - If P_FRAX < $1, R increases by 0.25% To ensure actual collateral matches the target, FRAX employs two mechanisms: **Recollateralization** and **Buybacks**. - **Recollateralization**: When R increases, users add USDC to the system and receive bonus FXS (e.g., deposit $1 USDC, receive $1.2 worth of FXS). - **Buybacks**: When R decreases, users can exchange FXS for equivalent-value USDC—no bonus applied. These mechanisms ensure users can always mint or redeem FRAX at the algorithmic rate, preventing USDC shortfall. Arbitrage then enforces price stability: - If 1 FRAX < $1, arbitrageurs buy FRAX, redeem for USDC + FXS, and sell FXS for profit—buying pressure pushes price up. - If 1 FRAX > $1, arbitrageurs mint FRAX with USDC + FXS, then sell for profit—selling pressure brings price down. Thus, although branded “partially collateralized,” FRAX effectively operates as a fully collateralized stablecoin: users can always redeem 1 FRAX for $1 worth of underlying assets. The algorithm merely adjusts collateral ratios and FXS emission rates—resulting in exceptional price stability. However, FRAX faces a critical issue: FXS holds no intrinsic value. Since arbitrage ensures 1 FRAX always redeems for $1 across USDC and FXS, any price fluctuation risk is fully transferred to FXS holders. A $1 FXS value could mean 100 FXS at $0.01 each—or 1,000 FXS at $0.001. More importantly, while earlier algorithmic stablecoins relied on speculation for growth, FRAX eliminates such attack vectors—leading to slow adoption. As shown in the chart, FRAX issuance has barely surpassed 26 million since launch. To grow rapidly, FRAX must develop its own “debt market” or other wealth-generating ecosystems. **The Future of Algorithmic Stablecoins** In modern economies, money enters circulation through two primary channels: 1. **Purchase of reserve assets** (e.g., gold, foreign exchange) to back currency issuance, establishing unit value and credibility. 2. **Lending or bond purchases** from economic entities—representing claims on *future* wealth, enabling timely money supply aligned with economic growth, thus preserving price stability. Take China: from 2000 to 2014, RMB issuance was driven by foreign exchange holdings, as rising exports led the central bank to accumulate USD assets and issue RMB in return. After 2014, as forex reserves declined, issuance shifted toward domestic credit expansion—money creation backed by debt. Similarly, first-gen stablecoins like USDT and USDC operate on full collateral: each token issued corresponds to $1 in fiat reserves (though some non-compliant issuers may cut corners), ensuring trust and price stability. The root cause of the “market scale–price stability” paradox in current algorithmic stablecoins is clear: their issuance isn’t tied to present or future wealth creation. Instead, they rely on speculation to drive expansion—leading to volatility and unsustainability. A prevailing misconception is that algorithmic stablecoins must sacrifice price stability to grow via speculation. This reflects a shallow understanding of economics. Real monetary expansion stems from real wealth growth. Speculation redistributes existing wealth without creating new value—so when speculators exit, the system collapses. Current algorithmic stablecoins lack a genuine wealth-generating ecosystem. For long-term success, they must build a “debt market” or productive financial layer—such as lending protocols, insurance platforms, or other utility-driven DeFi applications. Only by anchoring issuance and redemption to current and future economic activity can algorithmic stablecoins resolve the core paradox and gain sufficient policy tools to maintain stability.

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AuthorOKEx Research

OKEx Research: Understanding Algorithmic Stablecoins – The Battle Between Algorithms and Human Nature

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