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Algorithmic stablecoins are provably impossible without continuous funding

263 points by brandoncarl 4y ago

manytree 4y ago
A lot of finacial theory jargon here but not a very clear explanation. Definitely not a “proof” in the logical sense. Likely the Vitalik post linked in this article will have some insight.
- manytree 4y ago
  Vitalik says: > While there are plenty of automated stablecoin designs that are fundamentally flawed and doomed to collapse eventually, and plenty more that can survive theoretically but are highly risky, there are also many stablecoins that are highly robust in theory, and have survived extreme tests of crypto market conditions in practice. Hence, what we need is not stablecoin boosterism or stablecoin doomerism, but rather a return to principles-based thinking.
  - SkyMarshal 4y ago
    I don't know if there are many that are robust in theory and in practice. MakerDAI is the only one I can think of that might fall into that category.
    - fjkdlsjflkds 4y ago
      Any stablecoin that follows the same logic as DAI (i.e. overcollateralized debt-based stablecoins) could also apply (at least in theory). This includes (but is not limited to) sUSD, MIM, LUSD, MAI, agEUR...
      - cuteboy19 4y ago
        The "collateral" is a bunch of useless tokens that can flash crash in an instant. It is the same thing as the luna/Terra system but with minting $2 worth of luna for $1 worth of UST. Any depeg event will only be faster as compared to luna
        coding_lobster 4y ago
        It is not the same because in the case of the coins above a flash crash results in liquidation of the collateral to support the peg. In the case of Luna there was no such mechanism as it relies on people doing the arbitrage required to maintain the peg.
        cuteboy19 4y ago
        Liquidating luna is the same thing as minting luna. The trigger is the same (price below peg) and the effect is the same (more luna in circulation)
        fjkdlsjflkds 4y ago
        The difference is that you can always redeem UST for LUNA, which directly results in minting additional LUNA (the total amount of LUNA in circulation increases when UST is destroyed), while the same does not happen for debt-based stablecoins. In the case of DAI and other debt-based stablecoins, there is no minting of additional collateral when liquidations occur or when debt is repaid (the total amount of the underlying collateral in circulation does not increase when DAI is destroyed). This is the main difference between so-called "algorithmic stablecoins" (e.g. UST, FRAX, USDN), which rely on internal collateral (whose supply can be arbitrarily expanded/contracted by the controlling entity) and "overcollateralized debt-based stablecoins", which usually rely on external collateral (whose supply cannot be arbitrarily expanded/contracted). Treating these two different things as if they are the same is not particularly insightful.
devit 4y ago
Algorithmic stablecoins are impossible simply because all crypto not tied to outside assets can suddenly go to 0 value, and then any stablecoin is going to be worthless unless they are claims to outside assets (which requires trust in the issuer honoring them).
jqpabc123 4y ago
Analysis aside, common sense suggests that it is very difficult if not impossible to manufacture long term stability in any system based mostly on speculation with limited hard assets to back it up.
- bloodyplonker22 4y ago
  indeed, but it's funny how we use the word phrase "'common' sense", isn't it?
- SkyMarshal 4y ago
  More generally, I think we can state, it is difficult if not impossible to manufacture long term stability in any inherently unstable system, which all financial markets and human economies are. Better to acknowledge and accept that reality, understand the nature of the inherent volatility, and work to become robust and resilient against it. Scalable, self-similar, clustering, and long memory are some of the characteristics of the fractal-style randomness of financial markets. Thus, build in safety factors, multiple redundancies, hedges, etc. with those characteristics in mind.
  - jqpabc123 4y ago
    Stability; or the lack thereof, is relative --- with currency made from electrons and hardly any ties to real world economic conditions being a relatively extreme example.
- MuffinFlavored 4y ago
  yet people still buy and hold into crypto daily, no?
mcs5280 4y ago
Not a crypto fan but I'm beginning to see that our entire economy is proving impossible without continuous manipulation by the fed
- meitham 4y ago
  That’s by design and is called the “Invisible Hands”.
- AndrewStephens 4y ago
  Well duh, that is the whole point of the fed - tweaking the dials to smooth out the peaks and troughs. Sometimes that doesn’t work, or works only after the fact, but the last 70 years or so has been fairly smooth sailing compared to what came before.
  - throwawaymaths 4y ago
    The worst is when it works to smoothen out the peaks but the cost is silently screwing over poor people. So everyone at the top can pat themselves on the back, and people in the middle start blaming capitalism.
    - imtringued 4y ago
      The people in the middle never blame capitalism because they want to join the upper ranks and screw poor people over.
    - eatonphil 4y ago
      It's hard to believe the poor were really better off before the 1920s than they are today.
    - pas 4y ago
      how does that screw over poor people?
  - deleted 4y ago
    [deleted]
samsquire 4y ago
Let me share my theory that the economy is impossible or paradoxical and that the American dream is impossible and that everything is built on by faith. To buy a loaf of bread, the price needs to pay for the wheat, ovens, energy and the employee costs. This relationship is recursion. The staff of the bread company need to afford bread of their own and shelter and energy and transportation. Everyone is thereby supporting themselves and everyone else with what they purchase. This guarantees poverty as not everyone can scale their earnings to provide for themselves and everyone else as the prices all come from the same money supply. Inflation is baked in. This is why central banks don't want wage growth. If you understand recursion and recursive relationships then you understand that poverty is baked into the system. (Edit: due to not everyone producing more than they cost) Think what this means for people at the bottom and give to the poor.
- MuffinFlavored 4y ago
  why do some people make it to the top then? why do some people make $40k/yr, some make $80k, some make $120k, some make $200k, some make $400k, some make $4m, some make $40m, some make $100m
  - samsquire 4y ago
    For someone to earn high value numbers someone else has to be doing the grunt work, the work that allows that value to be unlocked. These people are desperate and have no capital. Money is a time machine and if you have none of it you are forced into grunt labour. You don't get 100 million working as a pizza delivery driver or delivering parcels but the owner sure does.
  - truckerbill 4y ago
    The answer is usually luck
- readthenotes1 4y ago
  I think that is the author's point, that a closed system makes it impossible. You need the wealth from outside sources to fund the debt to fund the spending. Also, at some point, there is some production that is not just shuffling existing assets around.
jmyeet 4y ago
This doesn't go far enough. The only thing that maintains the value of any asset (or currency) is the collective belief in that asset or currency. Put another way: there is an inescapable component of trust in every asset. Crypto in any form doesn't solve the trust problem other than a very narrow slice because as soon as you interact with anything outside of the blockchain, you're adding trust. Even on the blockchain, all the math in the world doesn't avoid the trust problem (eg it's been estimated that over half the Ethereum are owned by less than 10 entities). Even backing a currency with gold (or any other asset) doesn't solve this problem. Additionally, it's not even correct. In years long gone the US government just maintained a peg between the US dollar and the gold price. Any reserves (which were never 100% anyway) are irrelevant to this. You don't need them. You just need sufficient capital to maintain the peg. Even if you had 100% reserves you still have to trust the government to honor redemptions and not to change the peg. If you have sufficiently deep pockets, you end up not even having to spend much money because no one challenges your peg. So what actually makes the US dollar work as a currency is that it is backed by the long dick of the US government. This is a combination of economic, military and even cultural might. So going back to algorithmic stablecoins, it doesn't matter how much you have in reserve. It doesn't even matter if there's new money entering the system (as this article claims) to maintain the peg. If people lose faith in the "stable" coin, it's finished.
- pid-1 4y ago
  > The only thing that maintains the value of any asset (or currency) is the collective belief in that asset or currency. Put another way: there is an inescapable component of trust in every asset Most non currency assets are cash flow generating financial instruments. If analysts don't believe a company is worth a dime, it can show them wrong by being profitable and paying dividends. Edit: I think my point is - even if no one else believes in a stock or bond, you can still profit by "being right". The same is not true for currencies.
  - xphos 4y ago
    Have to agree an asset is not a currency, in some case one can consider labor an assets and by extension an asset that can produce value. Labor might be unique in that regard but property seems to be similar you can derive value from nothing by putting property to use and since you can always change what the property produces. However, without any property, you physically cannot produce anything.
mNovak 4y ago
> To be in balance, the Stablecoin must provide real utility to the Outside World that transcends the Stablecoin/Insurer construct. Specifically: > 1. There must be a transaction tax for real utility provided by the Stablecoin. Don't all major reserve-based algorithmic stablecoins charge some kind of minting/redemption fee, to reward the risk taken on by reserve holders? And that makes this whole argument somewhat moot, since it's not a purely closed construct like they're describing. Though perhaps this line of reasoning (equivocating to other financial constructs) could lead to fee pricing equations required for some notion of stability.
- charcircuit 4y ago
  Luna stakers were paid in transaction fees in the network which consisted Luna and the stable coins on terra such as UST
- HelloNurse 4y ago
  Minting consists of spending money (hardware, energy, human work...) to obtain some cryptocurrency units, basically the same as buying them from someone and an influx of actual money into the crypto scheme (which might or might not compensate the risk takers as delineated in the article).
bradwood 4y ago
The problem here is the abuse of the word "stable". It's being conflated with the word "pegged". Pegging something to something else that is unstable doesn't make it stable. For as long as monetary policy in fiat continues to ease, you'll have more dollars around, inflating the money supply. The pegged item will need to match this in the long run to maintain the peg. Which won't be possible without further minting of the so-called stablecoin. The real solution, which I admit is a long time away, is to just stop using fiat and their "stablecoin" proxies altogether and just use another currency altogether.
- subroutine 4y ago
  What is a viable alternative to fiat? Both commodity money (e.g. gold shillings) and representative money (e.g. backed by precious metal reserves) have already failed.
  - bradwood 4y ago
    Bitcoin duck ;)
seanhunter 4y ago
I'm not sure I know enough to have a credible opinion about his underlying thesis, but it seems to me this article is wrong in lots of specific details: 1. "Stablecoin insurers" (in the author's terminology) are not short puts on the stablecoin, because noone has a specific right to force them to buy the stablecoin. Their position (as I understand it) is much more akin to some sort of swap where they pay/receive the difference between the stablecoin and the volcoin 2. Since it's a swap, then their position has 1 delta, so they don't "delta hedge". They need to make good losses on the stablecoin (and collect profits in good times) 3. There is no expiry so they are not long theta. They are collecting carry on the swap
- julianbuse 4y ago
  I believe (with my limited knowledge) that in this scenario the insurer is algorithmic, so in a sense they are "forced" to buy the stablecoin. Maybe that addressed the first point?
karsinkk 4y ago
A related article : https://voxeu.org/article/algorithmic-stablecoins-and-devaluation-risk https://voxeu.org/article/algorithmic-stablecoins-and-devalu...
gigatexal 4y ago
So a pyramid scheme. The coins need more and more suckers to sustain it and fails when that supply dries up.
- notch656a 4y ago
  USD has the same issue. The dollars continually get "used up" and need reprinted. Transferring electronic money burns energy and labor, and costs labor at the treasury and fed to mantain. If stablecoins are a pyramid scheme, the USD is too. Virtually every currency is negative-sum, destroying value every time they are spent.
  - qeternity 4y ago
    > USD has the same issue. The dollars continually get "used up" and need reprinted. … > Virtually every currency is negative-sum, destroying value every time they are spent. What?! This is not even remotely close to accurate.
dasz 4y ago
This puts into light how the usd works. And how inflationary money printing is. Every dollar printed might as well be seen as debt or burden. That's an interesting aside. More relevant to stablecoins: If the stablecoins need constant funding then what is their real value? Why should someone hold them? Why spend them? Why owe them? Constant funding itself isn't bad as such but how much and how often are what decide value. This is not to say they are useful or useless. But it certainly seems like the market hasn't got a firm answer either. The greater market is at least certainly ambivalent about them. Contrast what would happen if any of these stablecoins were used for purchasing crude oil or wheat or some other international commodity. In that case we'd see very different views on their value.
Animats 4y ago
Well, of course. An algorithmic stablecoin with a backing system can survive some stress. What they can't survive is a net outflow, because they can't reprice downwards. The era of "line goes up" is now over, and we see net outflows in many financial sectors. A lot of faith-based financial instruments are going to tank.
nathias 4y ago
The article uses fuzzy terms that conflates some essential points, and then uses this confusion to demand regulation. All about this is bad. Yes pegging has some essential limitations, but capital flow is a condition for most financial sytems. > Investments that are provably problematic should be appropriately regulated and efforts should be made to protect consumers against them. Not at all. Regulate yourself and don't buy things that exceed your risk threshold, or if you are a child incapable of that, tell your parents to regulate you.
thisisit 4y ago
I find it interesting that the CHF peg example is always missing articles like these. The Swiss Central Bank had decided to defend the peg the CHF at 1.2. This wasn't broken until the Central Bank decided to drop it in 2015. I guess unless it became a big trade it doesn't really matter.
charcircuit 4y ago
>In the event that the funding comes from new entrants into the Stablecoin/Insurer ecosystem, the system is definitionally a Ponzi Scheme and is unstable. No, that is not the definition of a Ponzi scheme. A Ponzi needs funding from outside money to continue to operate, but not everything that needs outside funding to operate is a Ponzi scheme. As an example let's create a gambling system. Any deposits made into the house account gives you a proportional share of the profits of the system. If the house gets lucky investors can make money. If they are unlucky the house account can run out of money and require outside money to work again. This gambling system isn't a Ponzi scheme at no point are you paid out with new investor's money. If you are lucky you are paid out with gambler's money and if you unlucky your investment goes to 0. Edit: Even with a positive house edge the house can get unlucky and go bankrupt.
- notahacker 4y ago
  The gambling system has a house edge. It's a system which exists for the house to take money (in aggregate) off gamblers. The profits are real, and nobody pretends there aren't losers. Most casinos operate on this basis without requiring constant injections of further capital. The stablecoin on the other hand claims that stakers are being rewarded for risking their capital without holders of the stable coin being fleeced at their expense. The only way to do this is by the number of people coming into the system expanding, and unlike the gambling system, the proposition of the stablecoin is these new participants don't lose money either. It has the classic Ponzi dynamic of being a zero sum game masquerading as a positive sum game through growth. I guess a stablecoin could theoretically operate on the basis that "stakers" were supposed to enjoy average negative returns for the sheer joy of gambling like people on craps tables. That would be much more like your proposal, and would be far too truthful in its white paper to be called a Ponzi, though it might have trouble attracting gamblers compared with the glitz and glamour of the casino and all the crypto ways to gamble money that don't openly admit paying negative returns.
  - charcircuit 4y ago
    >Most casinos operate on this basis without requiring constant injections of further capital. They mitigate the risk by settings caps to maximum bets. You can't just bet a bit more than half of a casino's assets in double or nothing with them. They don't want to be taking a 50% chance of losing everything. Even if there was a 2% edge that's still a 48% chance of it happening. They would rather work with smaller amounts where the chance of someone winning a ton of times in a row to eventually win everything is practically 0%. >The stablecoin on the other hand claims that stakers are being rewarded for risking their capital without holders of the stable coin being fleeced at their expense. They may be rewarded but they aren't being guaranteed that the value of what they hold will always go up. Again a Ponzi scheme is a very specific thing. People make an investement and returns on that investment come from new investors. In this kind of stablecoin system there is no part that where that specific thing happens. >were supposed to enjoy average negative returns for the sheer joy of gambling like people on craps tables This is usually how algostables work. People bet on growth of the project and once growth has peaked negative returns will be coming. By trying to avoid this period of negative returns a depeg happens.
EGreg 4y ago
The only way I think a stablecoin can work without trust is to be backed by another coin which is deflationary and always in demand. Such as a gas coin that has no block rewards but burns some percent of the mining fees on every transaction. As long as the network is used for transactions, people will voluntarily pay gas fees and deflate the coin (unlike Safemoon which burns it on transfer, paying to secure transactions is a service and the miners can just raise their fees if they want to make more). Then theoretically as long as there is demand for this coin, it will go up in price and therefore can back any sidechain coin that will grow slower in price (or better yet, gradually drop in price relatively to it like the dollar). That’s what we are planning to do with Intercoin: https://community.intercoin.org/t/intercoin-application-virtual-currency/ https://community.intercoin.org/t/intercoin-application-virt...
foxes 4y ago
You cannot prove things in the real world by running a computer program. Traditional financial systems have trust, belief, demand all factored in. They are constantly prodded and tweaked by powerful entities, with cultural, legal and military might to keep things running. However it turns out these are all features, and in the speed run to invent finance 2.0, deluded tech bros forgot that reality exists, or they were complicit in implementing a pyramid scheme.
axus 4y ago
Is this true of any currency pegged to an exchange rate, such as yuan, ruble, and riyal?
- rsynnott 4y ago
  I mean, it’s true that the peg may in some instances be difficult (or undesirable) to maintain, and may be dropped (the yuan isn’t strictly pegged to the dollar anymore, say). But at that point the currency will generally still be a useful currency. The only value of a stablecoin is that it’s pegged to something; once the peg is lost it becomes largely useless.
MrGuts 4y ago
The lesson I learned: One who invests in stablecoins is soon to be "pegged".
ramijames 4y ago
Ya? So is the US dollar.
formerkrogemp 4y ago
Cryptocurrencies are built on a deck of lies and scams. You equivocate about 'fiat' or real dollars being 'the same.' They're not. If you support this drivel, you'll only perpetuate and prolong the pain.
mt_ 4y ago
What else needs continuous funding? Pyramid schemes.
- BlueTemplar 4y ago
  I guess it's kind of the point of TFA "not proving enough", everything is a "Pyramid scheme" : can't escape the law of thermodynamics !
someguydave 4y ago
Seems like this is actually a proof against fractional reserve banking in favor of full-reserve banking.
abakker 4y ago
LOL. “Transaction tax” and “devaluing their asset to pay insurers”. Both things that are handled by Base rate inflation. The missing part of this analysis is that it is very hard to peg a deflating asset. The other problem is that from a monetary policy POV, you can’t defend it in a deflationary system without capital inflow because the whole system is denominated in a different currency which is inflating.
mvolfik 4y ago
Sorry for hijacking this thread, but can somebody explain like I'm five, what's the point of algorithmic stablecoins? My understanding of the term 'stablecoin' means that it is a crypto 'proxy' to some fiat currency, typically US dollar, just to avoid the actual conversion between crypto and fiat (because of taxes etc). So why isn't there just a DumbCoin(tm) that simply is 1-to-1 backed by the dollars? You give me a dollar, I mint you a coin. Somebody sends the coin back, I return them the dollar.
- sanderjd 4y ago
  This is pretty much what USDC is.
- xwdv 4y ago
  Because you can make a lot of money keeping a fraction of the dollars you get in cash and keeping the rest invested in treasuries. Eventually you will get tired of the work and costs involved in maintaining your dumbass coin in perpetuity for no benefit.
- logifail 4y ago
  > So why isn't there just a DumbCoin(tm) that simply is 1-to-1 backed by the dollars? Q: Where would you actually keep the dollars?
- tylergetsay 4y ago
  It costs (a lot) of money to move dollars between people; how would I aquire DumbCoin without physically traveling to you and buying it?
- retube 4y ago
  There is - this is exactly what Tether is. It's the largest, most liquid of the stable coins with someone like $80bn of coins in circulation [1]. Binance and Coinbase also have their own as well which are also pretty big. As far as algorithmic stable coins are concerned, I have no idea what the point is. Largely experimental as far as i can tell (but pretty much guaranteed to fail given how they work) 1. In fact so big now that cash managers and corporate treasurers keep an eye on Tether as they have a material impact on the bills and CP markets.
deleted 4y ago
[deleted]
TedShiller 4y ago
Next: all crypto and NFTs are probably worthless
ospohngellert 4y ago
I'm looking for a reliable source on why LUNA crashed, and am unsure where to find one. Anyone know of a good article or video explainer? Thanks.
TrapLord_Rhodo 4y ago
This is the problem with "analysis" on stablecoins. He dreams up a 'potential stablecoin', inherently designs it with flaws and says all algorithmic stablecoins will fail without contiinuous funding. The sky is the limit with Algorithmic stablecoins and you can't throw the baby out with the bath water. All this is simply not true in every case. Imagine a stablecoin over-collateralized with interest bearing crypto (basket of POS coins) and certified tokenized REITS, synthetic S&P, commodity futures, etc.
Cypher 4y ago
Surely, you mean liquidity?

263 points by brandoncarl 4y ago

A lot of finacial theory jargon here but not a very clear explanation. Definitely not a “proof” in the logical sense. Likely the Vitalik post linked in this article will have some insight.

manytree 4y ago
Vitalik says: > While there are plenty of automated stablecoin designs that are fundamentally flawed and doomed to collapse eventually, and plenty more that can survive theoretically but are highly risky, there are also many stablecoins that are highly robust in theory, and have survived extreme tests of crypto market conditions in practice. Hence, what we need is not stablecoin boosterism or stablecoin doomerism, but rather a return to principles-based thinking.
- SkyMarshal 4y ago
  I don't know if there are many that are robust in theory and in practice. MakerDAI is the only one I can think of that might fall into that category.
  - fjkdlsjflkds 4y ago
    Any stablecoin that follows the same logic as DAI (i.e. overcollateralized debt-based stablecoins) could also apply (at least in theory). This includes (but is not limited to) sUSD, MIM, LUSD, MAI, agEUR...
    - cuteboy19 4y ago
      The "collateral" is a bunch of useless tokens that can flash crash in an instant. It is the same thing as the luna/Terra system but with minting $2 worth of luna for $1 worth of UST. Any depeg event will only be faster as compared to luna
      - coding_lobster 4y ago
        It is not the same because in the case of the coins above a flash crash results in liquidation of the collateral to support the peg. In the case of Luna there was no such mechanism as it relies on people doing the arbitrage required to maintain the peg.
        cuteboy19 4y ago
        Liquidating luna is the same thing as minting luna. The trigger is the same (price below peg) and the effect is the same (more luna in circulation)
        fjkdlsjflkds 4y ago
        The difference is that you can always redeem UST for LUNA, which directly results in minting additional LUNA (the total amount of LUNA in circulation increases when UST is destroyed), while the same does not happen for debt-based stablecoins. In the case of DAI and other debt-based stablecoins, there is no minting of additional collateral when liquidations occur or when debt is repaid (the total amount of the underlying collateral in circulation does not increase when DAI is destroyed). This is the main difference between so-called "algorithmic stablecoins" (e.g. UST, FRAX, USDN), which rely on internal collateral (whose supply can be arbitrarily expanded/contracted by the controlling entity) and "overcollateralized debt-based stablecoins", which usually rely on external collateral (whose supply cannot be arbitrarily expanded/contracted). Treating these two different things as if they are the same is not particularly insightful.

devit 4y ago

Algorithmic stablecoins are impossible simply because all crypto not tied to outside assets can suddenly go to 0 value, and then any stablecoin is going to be worthless unless they are claims to outside assets (which requires trust in the issuer honoring them).

jqpabc123 4y ago

Analysis aside, common sense suggests that it is very difficult if not impossible to manufacture long term stability in any system based mostly on speculation with limited hard assets to back it up.

bloodyplonker22 4y ago
indeed, but it's funny how we use the word phrase "'common' sense", isn't it?
SkyMarshal 4y ago
More generally, I think we can state, it is difficult if not impossible to manufacture long term stability in any inherently unstable system, which all financial markets and human economies are. Better to acknowledge and accept that reality, understand the nature of the inherent volatility, and work to become robust and resilient against it. Scalable, self-similar, clustering, and long memory are some of the characteristics of the fractal-style randomness of financial markets. Thus, build in safety factors, multiple redundancies, hedges, etc. with those characteristics in mind.
- jqpabc123 4y ago
  Stability; or the lack thereof, is relative --- with currency made from electrons and hardly any ties to real world economic conditions being a relatively extreme example.
MuffinFlavored 4y ago
yet people still buy and hold into crypto daily, no?

mcs5280 4y ago

Not a crypto fan but I'm beginning to see that our entire economy is proving impossible without continuous manipulation by the fed

meitham 4y ago
That’s by design and is called the “Invisible Hands”.
AndrewStephens 4y ago
Well duh, that is the whole point of the fed - tweaking the dials to smooth out the peaks and troughs. Sometimes that doesn’t work, or works only after the fact, but the last 70 years or so has been fairly smooth sailing compared to what came before.
- throwawaymaths 4y ago
  The worst is when it works to smoothen out the peaks but the cost is silently screwing over poor people. So everyone at the top can pat themselves on the back, and people in the middle start blaming capitalism.
  - imtringued 4y ago
    The people in the middle never blame capitalism because they want to join the upper ranks and screw poor people over.
  - eatonphil 4y ago
    It's hard to believe the poor were really better off before the 1920s than they are today.
  - pas 4y ago
    how does that screw over poor people?
- deleted 4y ago
  [deleted]

samsquire 4y ago

Let me share my theory that the economy is impossible or paradoxical and that the American dream is impossible and that everything is built on by faith. To buy a loaf of bread, the price needs to pay for the wheat, ovens, energy and the employee costs. This relationship is recursion. The staff of the bread company need to afford bread of their own and shelter and energy and transportation. Everyone is thereby supporting themselves and everyone else with what they purchase. This guarantees poverty as not everyone can scale their earnings to provide for themselves and everyone else as the prices all come from the same money supply. Inflation is baked in. This is why central banks don't want wage growth. If you understand recursion and recursive relationships then you understand that poverty is baked into the system. (Edit: due to not everyone producing more than they cost) Think what this means for people at the bottom and give to the poor.

MuffinFlavored 4y ago
why do some people make it to the top then? why do some people make $40k/yr, some make $80k, some make $120k, some make $200k, some make $400k, some make $4m, some make $40m, some make $100m
- samsquire 4y ago
  For someone to earn high value numbers someone else has to be doing the grunt work, the work that allows that value to be unlocked. These people are desperate and have no capital. Money is a time machine and if you have none of it you are forced into grunt labour. You don't get 100 million working as a pizza delivery driver or delivering parcels but the owner sure does.
- truckerbill 4y ago
  The answer is usually luck
readthenotes1 4y ago
I think that is the author's point, that a closed system makes it impossible. You need the wealth from outside sources to fund the debt to fund the spending. Also, at some point, there is some production that is not just shuffling existing assets around.

jmyeet 4y ago

This doesn't go far enough. The only thing that maintains the value of any asset (or currency) is the collective belief in that asset or currency. Put another way: there is an inescapable component of trust in every asset. Crypto in any form doesn't solve the trust problem other than a very narrow slice because as soon as you interact with anything outside of the blockchain, you're adding trust. Even on the blockchain, all the math in the world doesn't avoid the trust problem (eg it's been estimated that over half the Ethereum are owned by less than 10 entities). Even backing a currency with gold (or any other asset) doesn't solve this problem. Additionally, it's not even correct. In years long gone the US government just maintained a peg between the US dollar and the gold price. Any reserves (which were never 100% anyway) are irrelevant to this. You don't need them. You just need sufficient capital to maintain the peg. Even if you had 100% reserves you still have to trust the government to honor redemptions and not to change the peg. If you have sufficiently deep pockets, you end up not even having to spend much money because no one challenges your peg. So what actually makes the US dollar work as a currency is that it is backed by the long dick of the US government. This is a combination of economic, military and even cultural might. So going back to algorithmic stablecoins, it doesn't matter how much you have in reserve. It doesn't even matter if there's new money entering the system (as this article claims) to maintain the peg. If people lose faith in the "stable" coin, it's finished.

pid-1 4y ago
> The only thing that maintains the value of any asset (or currency) is the collective belief in that asset or currency. Put another way: there is an inescapable component of trust in every asset Most non currency assets are cash flow generating financial instruments. If analysts don't believe a company is worth a dime, it can show them wrong by being profitable and paying dividends. Edit: I think my point is - even if no one else believes in a stock or bond, you can still profit by "being right". The same is not true for currencies.
- xphos 4y ago
  Have to agree an asset is not a currency, in some case one can consider labor an assets and by extension an asset that can produce value. Labor might be unique in that regard but property seems to be similar you can derive value from nothing by putting property to use and since you can always change what the property produces. However, without any property, you physically cannot produce anything.

mNovak 4y ago

> To be in balance, the Stablecoin must provide real utility to the Outside World that transcends the Stablecoin/Insurer construct. Specifically: > 1. There must be a transaction tax for real utility provided by the Stablecoin. Don't all major reserve-based algorithmic stablecoins charge some kind of minting/redemption fee, to reward the risk taken on by reserve holders? And that makes this whole argument somewhat moot, since it's not a purely closed construct like they're describing. Though perhaps this line of reasoning (equivocating to other financial constructs) could lead to fee pricing equations required for some notion of stability.

charcircuit 4y ago
Luna stakers were paid in transaction fees in the network which consisted Luna and the stable coins on terra such as UST
HelloNurse 4y ago
Minting consists of spending money (hardware, energy, human work...) to obtain some cryptocurrency units, basically the same as buying them from someone and an influx of actual money into the crypto scheme (which might or might not compensate the risk takers as delineated in the article).

bradwood 4y ago

The problem here is the abuse of the word "stable". It's being conflated with the word "pegged". Pegging something to something else that is unstable doesn't make it stable. For as long as monetary policy in fiat continues to ease, you'll have more dollars around, inflating the money supply. The pegged item will need to match this in the long run to maintain the peg. Which won't be possible without further minting of the so-called stablecoin. The real solution, which I admit is a long time away, is to just stop using fiat and their "stablecoin" proxies altogether and just use another currency altogether.

subroutine 4y ago
What is a viable alternative to fiat? Both commodity money (e.g. gold shillings) and representative money (e.g. backed by precious metal reserves) have already failed.
- bradwood 4y ago
  Bitcoin duck ;)

seanhunter 4y ago

I'm not sure I know enough to have a credible opinion about his underlying thesis, but it seems to me this article is wrong in lots of specific details: 1. "Stablecoin insurers" (in the author's terminology) are not short puts on the stablecoin, because noone has a specific right to force them to buy the stablecoin. Their position (as I understand it) is much more akin to some sort of swap where they pay/receive the difference between the stablecoin and the volcoin 2. Since it's a swap, then their position has 1 delta, so they don't "delta hedge". They need to make good losses on the stablecoin (and collect profits in good times) 3. There is no expiry so they are not long theta. They are collecting carry on the swap

julianbuse 4y ago
I believe (with my limited knowledge) that in this scenario the insurer is algorithmic, so in a sense they are "forced" to buy the stablecoin. Maybe that addressed the first point?

karsinkk 4y ago

A related article : https://voxeu.org/article/algorithmic-stablecoins-and-devaluation-risk https://voxeu.org/article/algorithmic-stablecoins-and-devalu...

gigatexal 4y ago

So a pyramid scheme. The coins need more and more suckers to sustain it and fails when that supply dries up.

notch656a 4y ago
USD has the same issue. The dollars continually get "used up" and need reprinted. Transferring electronic money burns energy and labor, and costs labor at the treasury and fed to mantain. If stablecoins are a pyramid scheme, the USD is too. Virtually every currency is negative-sum, destroying value every time they are spent.
- qeternity 4y ago
  > USD has the same issue. The dollars continually get "used up" and need reprinted. … > Virtually every currency is negative-sum, destroying value every time they are spent. What?! This is not even remotely close to accurate.

dasz 4y ago

This puts into light how the usd works. And how inflationary money printing is. Every dollar printed might as well be seen as debt or burden. That's an interesting aside. More relevant to stablecoins: If the stablecoins need constant funding then what is their real value? Why should someone hold them? Why spend them? Why owe them? Constant funding itself isn't bad as such but how much and how often are what decide value. This is not to say they are useful or useless. But it certainly seems like the market hasn't got a firm answer either. The greater market is at least certainly ambivalent about them. Contrast what would happen if any of these stablecoins were used for purchasing crude oil or wheat or some other international commodity. In that case we'd see very different views on their value.

Animats 4y ago

Well, of course. An algorithmic stablecoin with a backing system can survive some stress. What they can't survive is a net outflow, because they can't reprice downwards. The era of "line goes up" is now over, and we see net outflows in many financial sectors. A lot of faith-based financial instruments are going to tank.

nathias 4y ago

The article uses fuzzy terms that conflates some essential points, and then uses this confusion to demand regulation. All about this is bad. Yes pegging has some essential limitations, but capital flow is a condition for most financial sytems. > Investments that are provably problematic should be appropriately regulated and efforts should be made to protect consumers against them. Not at all. Regulate yourself and don't buy things that exceed your risk threshold, or if you are a child incapable of that, tell your parents to regulate you.

thisisit 4y ago

I find it interesting that the CHF peg example is always missing articles like these. The Swiss Central Bank had decided to defend the peg the CHF at 1.2. This wasn't broken until the Central Bank decided to drop it in 2015. I guess unless it became a big trade it doesn't really matter.

charcircuit 4y ago

>In the event that the funding comes from new entrants into the Stablecoin/Insurer ecosystem, the system is definitionally a Ponzi Scheme and is unstable. No, that is not the definition of a Ponzi scheme. A Ponzi needs funding from outside money to continue to operate, but not everything that needs outside funding to operate is a Ponzi scheme. As an example let's create a gambling system. Any deposits made into the house account gives you a proportional share of the profits of the system. If the house gets lucky investors can make money. If they are unlucky the house account can run out of money and require outside money to work again. This gambling system isn't a Ponzi scheme at no point are you paid out with new investor's money. If you are lucky you are paid out with gambler's money and if you unlucky your investment goes to 0. Edit: Even with a positive house edge the house can get unlucky and go bankrupt.

notahacker 4y ago
The gambling system has a house edge. It's a system which exists for the house to take money (in aggregate) off gamblers. The profits are real, and nobody pretends there aren't losers. Most casinos operate on this basis without requiring constant injections of further capital. The stablecoin on the other hand claims that stakers are being rewarded for risking their capital without holders of the stable coin being fleeced at their expense. The only way to do this is by the number of people coming into the system expanding, and unlike the gambling system, the proposition of the stablecoin is these new participants don't lose money either. It has the classic Ponzi dynamic of being a zero sum game masquerading as a positive sum game through growth. I guess a stablecoin could theoretically operate on the basis that "stakers" were supposed to enjoy average negative returns for the sheer joy of gambling like people on craps tables. That would be much more like your proposal, and would be far too truthful in its white paper to be called a Ponzi, though it might have trouble attracting gamblers compared with the glitz and glamour of the casino and all the crypto ways to gamble money that don't openly admit paying negative returns.
- charcircuit 4y ago
  >Most casinos operate on this basis without requiring constant injections of further capital. They mitigate the risk by settings caps to maximum bets. You can't just bet a bit more than half of a casino's assets in double or nothing with them. They don't want to be taking a 50% chance of losing everything. Even if there was a 2% edge that's still a 48% chance of it happening. They would rather work with smaller amounts where the chance of someone winning a ton of times in a row to eventually win everything is practically 0%. >The stablecoin on the other hand claims that stakers are being rewarded for risking their capital without holders of the stable coin being fleeced at their expense. They may be rewarded but they aren't being guaranteed that the value of what they hold will always go up. Again a Ponzi scheme is a very specific thing. People make an investement and returns on that investment come from new investors. In this kind of stablecoin system there is no part that where that specific thing happens. >were supposed to enjoy average negative returns for the sheer joy of gambling like people on craps tables This is usually how algostables work. People bet on growth of the project and once growth has peaked negative returns will be coming. By trying to avoid this period of negative returns a depeg happens.

EGreg 4y ago

The only way I think a stablecoin can work without trust is to be backed by another coin which is deflationary and always in demand. Such as a gas coin that has no block rewards but burns some percent of the mining fees on every transaction. As long as the network is used for transactions, people will voluntarily pay gas fees and deflate the coin (unlike Safemoon which burns it on transfer, paying to secure transactions is a service and the miners can just raise their fees if they want to make more). Then theoretically as long as there is demand for this coin, it will go up in price and therefore can back any sidechain coin that will grow slower in price (or better yet, gradually drop in price relatively to it like the dollar). That’s what we are planning to do with Intercoin: https://community.intercoin.org/t/intercoin-application-virtual-currency/ https://community.intercoin.org/t/intercoin-application-virt...

foxes 4y ago

You cannot prove things in the real world by running a computer program. Traditional financial systems have trust, belief, demand all factored in. They are constantly prodded and tweaked by powerful entities, with cultural, legal and military might to keep things running. However it turns out these are all features, and in the speed run to invent finance 2.0, deluded tech bros forgot that reality exists, or they were complicit in implementing a pyramid scheme.

axus 4y ago

Is this true of any currency pegged to an exchange rate, such as yuan, ruble, and riyal?

rsynnott 4y ago
I mean, it’s true that the peg may in some instances be difficult (or undesirable) to maintain, and may be dropped (the yuan isn’t strictly pegged to the dollar anymore, say). But at that point the currency will generally still be a useful currency. The only value of a stablecoin is that it’s pegged to something; once the peg is lost it becomes largely useless.

MrGuts 4y ago

The lesson I learned: One who invests in stablecoins is soon to be "pegged".

ramijames 4y ago

Ya? So is the US dollar.

formerkrogemp 4y ago

Cryptocurrencies are built on a deck of lies and scams. You equivocate about 'fiat' or real dollars being 'the same.' They're not. If you support this drivel, you'll only perpetuate and prolong the pain.

mt_ 4y ago

What else needs continuous funding? Pyramid schemes.

BlueTemplar 4y ago
I guess it's kind of the point of TFA "not proving enough", everything is a "Pyramid scheme" : can't escape the law of thermodynamics !

someguydave 4y ago

Seems like this is actually a proof against fractional reserve banking in favor of full-reserve banking.

abakker 4y ago

LOL. “Transaction tax” and “devaluing their asset to pay insurers”. Both things that are handled by Base rate inflation. The missing part of this analysis is that it is very hard to peg a deflating asset. The other problem is that from a monetary policy POV, you can’t defend it in a deflationary system without capital inflow because the whole system is denominated in a different currency which is inflating.

mvolfik 4y ago

Sorry for hijacking this thread, but can somebody explain like I'm five, what's the point of algorithmic stablecoins? My understanding of the term 'stablecoin' means that it is a crypto 'proxy' to some fiat currency, typically US dollar, just to avoid the actual conversion between crypto and fiat (because of taxes etc). So why isn't there just a DumbCoin(tm) that simply is 1-to-1 backed by the dollars? You give me a dollar, I mint you a coin. Somebody sends the coin back, I return them the dollar.

sanderjd 4y ago
This is pretty much what USDC is.
xwdv 4y ago
Because you can make a lot of money keeping a fraction of the dollars you get in cash and keeping the rest invested in treasuries. Eventually you will get tired of the work and costs involved in maintaining your dumbass coin in perpetuity for no benefit.
logifail 4y ago
> So why isn't there just a DumbCoin(tm) that simply is 1-to-1 backed by the dollars? Q: Where would you actually keep the dollars?
tylergetsay 4y ago
It costs (a lot) of money to move dollars between people; how would I aquire DumbCoin without physically traveling to you and buying it?
retube 4y ago
There is - this is exactly what Tether is. It's the largest, most liquid of the stable coins with someone like $80bn of coins in circulation [1]. Binance and Coinbase also have their own as well which are also pretty big. As far as algorithmic stable coins are concerned, I have no idea what the point is. Largely experimental as far as i can tell (but pretty much guaranteed to fail given how they work) 1. In fact so big now that cash managers and corporate treasurers keep an eye on Tether as they have a material impact on the bills and CP markets.

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TedShiller 4y ago

Next: all crypto and NFTs are probably worthless

ospohngellert 4y ago

I'm looking for a reliable source on why LUNA crashed, and am unsure where to find one. Anyone know of a good article or video explainer? Thanks.

TrapLord_Rhodo 4y ago

This is the problem with "analysis" on stablecoins. He dreams up a 'potential stablecoin', inherently designs it with flaws and says all algorithmic stablecoins will fail without contiinuous funding. The sky is the limit with Algorithmic stablecoins and you can't throw the baby out with the bath water. All this is simply not true in every case. Imagine a stablecoin over-collateralized with interest bearing crypto (basket of POS coins) and certified tokenized REITS, synthetic S&P, commodity futures, etc.

Cypher 4y ago

Surely, you mean liquidity?