With all the hoopla around NFTs, let’s not forget last year’s crypto darling, “Stablecoins”.
This technology continues to evolve in different ways.
One of the more utopian visions in Nakamotoland is the idea of “algorithmic money”, an abstract token that is maintained at a specified “value” by software. In the case of a “stablecoin”, the idea would be for the algorithm to automatically trade assets to maintain the desired peg. For example, a token pegged to the US dollar would be supported by a basket of assets worth $1, which would be adjusted as the dollar fluctuated against those assets.
If you could make this work, then you would have a very stable asset, useful at least for digital traders. (E.g., algorithmic trading could estimate the value of trades easily and reliably.)
But this is harder than it sounds. In fact, no one has ever done it.
This spring Brady Dale discusses the travails of yet another try, the “Fei” stablecoin [1].
This project is designed to maintain a 1:1 peg to the US dollar, which is done by algorithms that basically buys and sells Ethereum and other (digital) assets. The concept is to manage the supply of ‘Fei’ to encourage buying or selling to maintain the target peg. I.e., if Fei is trading less than $1 (which is always is), the algorithms work to contract the supply of Fei, with the aim of increasing its exchange rate up to $1.
How’s this working out?
Anyone who has even the slightest familiarity with engineering will recognize this as a dynamic control system, which are always tricky to get right. In fact, this kind of feed back system is often unstable and chaotic.
So, no surprise, Fei has had a “Rocky Start”. For one thing, (at the time of the article) it had never actually reached the $1 peg. So all the speculators who bought Fei at $1 (apparently $1B worth!) are holding a loss. With nothing else really to do with Fei, they want to sell, sell, sell.
The algorithms intended to maintain the peg have proved ineffective. Indeed, one mechanism which “rebalances” the exchange rate (by reducing the supply of Fei) has actually made things worse. Each time the exchange rate is pushed up toward $1, there is a spike in selling, forcing it down.
The other mechanisms work less directly, attempting to incentivize buying or selling to move toward the peg. These theoretical market forces have not come through, probably due to the fact that markets are more complicated than the algorithm’s model.
I’ll also note that these indirect effects have at least a little latency, which likely contributes to the instability. And, of course, no one is really using Fei for anything other than speculation yet, so it has only a limited and fickle pool of users.
The managers of Fei are beginning to tinker with the algorithms. I’m not optimistic that fiddling with the knobs and switches will really make things more stable.
We’ll have to see.
Three final points.
First, Fei is competing with MakerDAO and other similar projects. It’s major innovation is that instead of selling debt (as MakerDAO does) it is directly trading. I.e., you just plain buy Fei, you don’t borrow them.
Second, I have to say that I don’t really understand the business model of this project. At bottom, they are selling these tokens to users, accumulating a pool of assets. How is this sustained? Perhaps there are fees for buying in. Or perhaps they count on raking off profits when the Fei is worth more than $1.
The latter has yet to happen, so they haven’t made any profit that way. Charging fees to buy tokens seems counterproductive to me—it makes the tokens worth less than the face value, which defeats the whole purpose. (I.e., if it costs me $1.01 to ‘buy’ a dollar bill, the bill is worth 99 cents. This is called ‘debasing’ the currency.)
Finally, I’ll note the irony that this entire project is, in a sense, heretical. The whole point of Nakamotoan cryptocurrency is to replace fiat currency, not to rely on it. Worse, the hated and “debased” USD seems to be more stable than the algorithm intended to track it.
- Brady Dale (2021) $1B Fei Stablecoin’s Rocky Start Is a Wake-Up Call for DeFi Investors. Coindesk, https://www.coindesk.com/1b-fei-stablecoins-rocky-start-is-a-wake-up-call-for-defi-investors
Cryptocurrency Thursday
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