L1 was a stablecoin that UST had planned to use for Ethereum, but it has since been discontinued. The recent success of UST’s launch will likely result in more competition for this type of coin.
After the success of UST, a new race for L1 stablecoins is here. U.S. dollar-backed coins are the most popular and widely accepted stablecoin today, but there is a new competitor that has been gaining traction in recent months: Tether (USDT). The USDT is backed by the US Dollar, so it should be more reliable than other options like BTC or ETH.
The need for efficient money markets is so great that even the 8.5 percent inflation rate isn’t enough to quell it. That’s how much the dollar has lost in buying power since last year. Stablecoins tied to the dollar, on the other hand, consistently have the greatest interest rate rates, allowing them to outperform inflation.
Why is it that tokenized dollars have such a high yield? Although bitcoin traders like volatility since it allows for bigger profits, it is not conducive to a major DeFi infrastructure. Stablecoins combine seriousness with stability, based on the dollar’s role as the world’s reserve currency.
Stablecoins not only offer a constant value for use in payments, but they also eliminate the risk associated with smart contract loans. This is why, in order to get stablecoin loans, DeFi protocols are often collateralized with volatile cryptocurrencies.
International Monetary Fund (IMF) (IMF)
Furthermore, the collateralized volatile assets are often over-collateralized. In this approach, the lender may be certain that if the value falls below a specified liquidation percentage, the smart contract would immediately liquidate the collateral. For example, during Q1 2022, owing to ETH volatility, there was a significant increase in collateral liquidations for the Compound protocol.
But, whereas crypto assets must be over-collateralized in order to mitigate volatility, what about stablecoins? Is their collateralization strong enough to reassure investors?
On the Horizon: A New Generation of Stablecoins
Stablecoins that are also decentralized would seem to be a natural fit for DeFi systems. That hasn’t been the case for the majority of the stablecoin market’s rise in the previous two years, which now stands at $186.8 billion. Tether (USDT) and USD Coin (USDC), the top two off-chain stablecoins, are collateralized in the traditional way, using cash or cash-equivalent reserves.
Since its debut in 2015, Tether has been the top stablecoin in terms of market size and trading volume due to its simplicity. Tether has had rising momentum over years, despite some mystery around its reserves, since USDT remains widely available.
DAI from the MakerDAO platform on Ethereum was the first to escape the centralization pattern. From the original ETH collateral, this algorithmic stablecoin currently has a half-dozen cryptocurrencies as collateral. Unfortunately, since it is an Ethereum ERC-20 token, it is subject to the high transaction costs associated with Ethereum.
While Ethereum remains the DeFi backbone, with a market cap of $95.5 billion, no one can claim that it is ideal for cheap and quick stablecoin transactions. The TerraUSD (UST) stablecoin on the competing Terra blockchain, on the other hand, is proving to be a game-changer. Terra (LUNA) blockchain was created as a worldwide payment system using the Cosmos architecture, providing up to 10,000 tps for a small flat charge.
TerraUSD: A New Era of L1 Stablecoins Has Arrived
Terra enhanced this quicker backbone with an algorithmic UST stablecoin, thereby making it a blockchain similar to Visa’s performance. It was a resounding success. UST’s market value surged by 890 percent in a year, from $1.86 billion in April 2021 to $18.42 billion in April 2022. Not only has UST surpassed Ethereum-based DeFi lending protocols as the third biggest stablecoin, but Terra’s Anchor Protocol for yield farming has also surpassed them.
Terra’s Anchor outpaced the DeFi pioneers in smart contract lending and borrowing, Aave and Compound. Terra’s attraction is obviously based on Anchor’s success, since the protocol accounts for 67 percent of UST demand.
Structure of the TerraUSD (UST) stablecoin. AnchorProtocol.com is the source of this information.
Anchor protocol, in turn, benefits from Terra’s UST stablecoin’s collateralization. UST maintains its peg as an algorithmic stablecoin by dynamically eliminating either LUNA or UST from circulation, a process known as burning.
UST tokens are required to manufacture LUNA tokens, Terra’s native cryptocurrency, in the same way that ETH is required for Ethereum. LUNA tokens are required to produce UST stablecoins, and vice versa. The supply of UST/LUNA is raised or lowered in either direction, maintaining UST’s peg to the dollar.
Traders may earn from arbitrage because of the elasticity of the supply. For example, if UST falls to Because of this elastic supply, traders have an opportunity to profit from arbitrage. For instance, if UST goes down to $0.97, traders can buy them at this lower price and sell UST for LUNA. This reduces the UST supply which makes it more scarce, triggering its price to rise closer to the 1:1 dollar peg..97, traders may purchase them at that price and sell them for LUNA. As a result, the supply of UST is reduced, making it more scarce, and its price to grow closer to the 1:1 dollar peg.
Anchor’s massive APY, which was 19.49 percent at press time, is directly related to this automated pegging.
How does Anchor maintain a yield of up to 20%?
Anchor has had a lot of success in the money markets so far. Investors may earn up to 20% interest on their UST tokens by depositing them. As a result, they become lenders, giving liquidity to the Anchor Protocol’s borrowers.
Borrowers must, in turn, put up collateral as security for the loan. Anchor is now using bETH and bLUNA as bonded collateral assets. These are, of course, over-collateralized as well. Staking incentives on either bLUNA or bETH are liquidated into UST, which uses a liquid-staking protocol.
“bAsset tokens represent an entitlement to the underlying staked asset position, which distributes staking incentives to its holders.”
-Whitepaper on the Anchor Protocol.
With a LUNA staking return of 12% and a hefty borrowing limit, a double-digit Anchor APY is a certain conclusion. In reality, this mechanism is comparable to rehypothecation, a financial procedure in which the same collateral is used to secure a new loan.
Following in the footsteps of UST, other L1 chains have emerged.
Terra isn’t the only layer-1 blockchain vying for a piece of Ethereum’s DeFi ecosystem. UST’s success inspired two rival networks to develop their own algorithmic stablecoins, much as Axie Infinity sparked an avalanche of blockchain games that culminated in the ApeCoin metaverse currency.
The USDD Stablecoin of TRON
TRON DAO, the Tron network, has announced the launch of its own USDD algorithmic stablecoin. Justin Sun, the Tron creator, describes the new stablecoin as a technological generational transition in his blog post. Tron, like Terra, specialized on stablecoin payments, processing more than $4 trillion in USDT transactions.
USDD is the third generation of stablecoins, since it is completely on-chain and does not rely on any centralized organizations. The new stablecoins are set to launch on May 5th, and will be accessible on Ethereum and BNB Chain as well.
“The decentralized stablecoin USDD will liberate holders from the unjust impositions of central authority and remove all entrance restrictions.” Decentralized stablecoins efficiently defend private property rights, unlike centralized organizations that may freeze or take users’ cash at whim.”
USN Stablecoin by NEAR
NEAR Mechanism, which uses the Nightshade scaling solution and the Doomslug proof-of-stake consensus protocol, is another Ethereum contender. While Ethereum isn’t expected to be sharded until next year, the NEAR blockchain currently has integrated sharded chains and was introduced in 2020. Transactions are not only executed in parallel over many sharded chains in NEAR’s version of the sharding technology, but each shard also creates “chunks” of blocks to be completed.
In the meanwhile, the Doomslug consensus from NEAR eliminates block competition from the consensus. As a consequence, transaction completion may be achieved in seconds, with a total network throughput of 100,000 tps. Transaction costs are also reduced as a result of this. NEAR has developed its own USN stablecoin based on this smart contract formula 1.
USN, like Terra’s UST, has no cash reserves and instead depends on NEAR tokens as collateral, which were first enhanced with USDT. In collaboration with Proximity Labs, Decentral Bank DAO will handle its reserve money. USN will create yield depending on NEAR token staking incentives, much as UST.
According to Decentral Bank, the minimum return should be 11% APY, with the possibility of reaching up to 20% for initial lenders.
Is the 3rd Generation of Stablecoins Really Worth It?
At first glance, algorithmic stablecoins seem to be a logical match for the DeFi ecosystem, serving as the last cog that is entirely on-chain and fed fiat data via oracles. Do algorithmic stablecoins produce additional vulnerability, even though this pushes the decentralization element to its limit?
There is some vulnerability, based on what we’ve observed of how they function with Terra’s UST. This weakness comes from a few of places.
The first is the need for constant demand, which includes the network’s native money. Without it, the degree of support diminishes, which is why Do Kwon, Terra’s co-founder, has taken a new step to boost UST with $10 billion in Bitcoin. However, this, too, is contingent on Bitcoin’s long-term upward trajectory.
“I’m counting on the long-term scenario of Bitcoin rising and reserves being robust enough to absorb UST demand reductions.”
-Do Kwon, CEO of Terraform Labs, on the Unchained podcast.
The second flaw stems from decentralization, which relies on the market to sort things out. As a result, algorithmic stablecoins depend on a positive perspective of the market in both circumstances. It was described by the European Central Bank as “purely based on the assumption of its future market worth.”
Finally, they are fundamentally weak since they depend on a layered incentive system to maintain particular floor levels. When put to the test under market stress, however, some have performed better than others.
One of the most egregious algorithmic stablecoin failures, on the other hand, occurred as one would anticipate. Iron Finance’s IRON stablecoin, on the other hand, did not scale up with market demand. Then there’s the question of whether the added complexity of automated smart contracts, market arbitrage, and reserve token protocols is too high a price to pay for decentralization.
Only time will tell whether this is true. Without a doubt, DeFi offers advantages that our current financial system cannot even imagine. However, we’ll be working out a few issues for quite some time.
Shane Neagle of The Tokenist contributes a guest piece.
Since 2015, Shane has been a vocal advocate of the decentralized finance movement. He’s authored hundreds of papers on the topic of digital securities, which are the combination of conventional financial securities with distributed ledger technology (DLT). He is still enthralled by the expanding influence of technology on business and daily life.
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The “ust stability” is a race that has been started after UST’s success. This race will be for L1 stablecoins and the winner of this race will receive $100,000.
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