Do algorithmic stablecoins have a future as centralized coins come under scrutiny?

Binance’s native stablecoin – Binance USD (BUSD) – was the third largest stablecoin pegged to the US dollar, minted by the blockchain infrastructure platform, the Paxos Trust Company, through a technology transfer deal between the two companies.

However, on February 13, the New York Department of Financial Services ordered Paxos to stop minting new BUSD tokens.

The move came just days after the U.S. Securities and Exchange Commission issued a notice from Wells alleging that BUSD violates securities laws.

Binance CEO Changpeng Zhao even predicted that regulatory action would force several other crypto companies to move away from dollar-pegged stablecoins in the near future and look for alternative tokens pegged to the euro or Japanese yen.

Zhao’s comments came during a Twitter AMA (ask me anything) session in which he said that while gold is a good backup option, most people’s assets are in fiat currencies. He admitted that the dominance of the US dollar in international markets makes it a go-to fiat currency, which is one of the main reasons behind the popularity of dollar-pegged stablecoins. However, regulatory action against such assets may give way to other stablecoins.

Zhao also spoke about the role of algorithmic stablecoins, many of which are largely decentralized, saying that these types of stablecoins may play a more prominent role in the crypto ecosystem in the future, but are inherently riskier than fiat-backed tokens.

Algorithmic stablecoins are traditionally not covered; instead, they use mathematical algorithms that are often linked to a tokenomics model rather than backed by a real-world asset such as the US dollar.

Most algorithmic stablecoin projects use a dual token system: a stablecoin and a volatile asset that maintains the stablecoin’s peg by maintaining the supply and demand system that keeps the value of the stablecoin unchanged. To mint a specific value of the stablecoin, an equal amount of the native token or the volatile token is burned.

Following the regulatory action against BUSD, Binance turned to several alternative stablecoins, including a few decentralized ones, to meet its stablecoin-focused liquidity needs. From February 16 to 24, Binance minted 180 million TrueUSD (TUSD) stablecoins.

Binance has beaten TrueUSD after BUSD’s ban. Source: Twitter

Decentralized stablecoins have a tainted past

Decentralized stablecoins first gained popularity in the decentralized finance (DeFi) ecosystem with the creation of Dai (DAI) by MakerDAO. DAI maintains its linkage through a smart contract system controlled by a Decentralized Autonomous Organization (DAO). While DAI has remained true to its decentralized values, it got caught up in the recent banking contagion that led to its depeg along with Circle-issued USD Coin (USDC).

While algorithmic stablecoins remain faithful to the decentralized values ​​of the crypto ecosystem, their real-life implementation has had a troubled history, especially with the collapse of the Terra ecosystem and its algorithmic stablecoin TerraUSD (UST), now called TerraClassicUSD (USTC). .

Terra’s algorithmic stablecoin was once seen as the best example of how a decentralized stablecoin could reach the mainstream. However, after the depeg and the subsequent collapse of the ecosystem, it has cast doubt on the future of such stablecoins.

Decentralized stablecoins suffered a severe setback from the Terra saga and the reputation of such stablecoins was further tarnished by the actions of Terraform Labs co-founder Do Kwon. Kwon evaded law enforcement while insisting the debacle wasn’t his fault despite on-chain proof suggesting the depeg was caused by an entity dumping more than $450 million worth of UST onto the open market. Kwon himself would have exercised control over that entity. He was recently arrested by the Montenegrin authorities.

What does the future of a decentralized stablecoin look like now that centralized stablecoins are under regulatory scrutiny and confidence in algorithmic stablecoins has been destroyed? Is there a future at all?

Hassan Sheikh, the co-founder of the decentralized incubator platform DAO Maker, told Cointelegraph that a shift to decentralized stablecoins would not be in the form people should expect. Centralized exchanges are highly vertically integrated, creating chains, wallets, staking solutions, mining operations, and more.

“A decentralized stablecoin that will be adopted by exchanges is not yet on the market. It won’t be DAI or anything like that. The market caps are not significant enough to have the necessary network effect,” said Sheikh, adding, “Exchanges would likely fork off protocols like Maker and push for the traction of their controlled ‘decentralized’ stablecoin to capture that value. The decentralized stablecoin on exchanges wouldn’t really be decentralized and most likely doesn’t exist yet as the big ones are likely to pursue their own coin.

Speaking of BUSD’s regulatory issues, Sheikh said it was just the first test of people’s willingness to move to a new exchange-issued stablecoin. If proven, the market will shift. It’s reasonable to expect a Binance version of DAI, he added.

Sheikh also highlighted the main issues with decentralized stablecoins currently on the market. He said most of these stablecoins are so deeply rooted in USDC that they are barely decentralized.

Many decentralized exchange pools and decentralized stablecoins, such as DAI and Frax (FRAX), have significant collateral exposure to USDC. This is why DAI issuer MakerDAO has filed an emergency proposal to address the risks of its $3.1 billion USDC collateral exposure during the recent depeg.

If anything, the aura of their marketing as decentralized has now been faded by USDC’s recent troubles, which have quickly eroded its link with DAI. The move to a decentralized stablecoin is too far off as the future dominant stablecoin does not yet exist. Exchanges support these purely for volume gains. The few BTC/DAI and similar pairs out there are so weak in activity that the foreseeable future shows no sign of a shift to decentralized stables with major liquidity partners,” Sheikh said.

Crypto exchanges are integrated with fiat-backed stablecoins

Fiat-backed stablecoins have become a lifeline in today’s crypto world. In the early days of crypto exchanges, these stablecoins acted as an onboarding tool for many traders, and over the past decade have also become a major liquidity provider.

“Fiat-backed stablecoins are so entrenched in exchanges that a massive shift is highly unlikely to occur, despite regulatory scrutiny.” Shiekh told Cointelgraph.

Abdul Rafay Gadit, the co-founder of crypto trading platform Zignaly, told Cointelegraph that despite the recent USDC depeg, crypto trading platforms still favor US dollar-pegged stablecoins.

“I personally believe that [Tether] USDT is currently the best stablecoin, carefully pegged 1:1 and also more or less removed from unfair regulation. USDC was out of luck due to its ties to the SVB [Silicon Valley Bank]; otherwise they run a great business,” he said.

He told Cointelegraph that centralized stablecoins are lifelines for the crypto ecosystem, and they will continue to be a dominant force despite regulatory pressure.

Gadit said exchanges may move away from the US, but fiat-backed stablecoin will continue to reign:

“BUSD action seems like victimization to me; I find it inappropriate and completely unfair. Going forward, stable issuers will try to stay away from the US, just as USDT issuer Tether operates out of Hong Kong.”

Tether (USDT) continues to dominate the stablecoin market despite continued regulatory oversight of many other US dollar-pegged stablecoins. Industry experts believe that while decentralized stablecoins look promising, their real-world implementations are questionable. Thus, centralized stablecoins are likely to continue to dominate the crypto market.

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