Achieving stability in algorithmic stablecoins

Abstract

Stablecoins are designed to bridge traditional fiat currencies with the cryptocurrencies markets market. Stablecoins have been identified as an early solution to mitigate the risk from cryptocurrencies during highly-volatile periods. While our paper aims to provide a taxonomy for the different types of stablecoins, our research focuses on algorithmic stablecoins. Currently, most stablecoins have a centralised structure that makes them vulnerable to regulatory orders. On the other hand, algorithmic stablecoins are cryptocurrencies managed by algorithms (smart contracts) to minimise the volatility in relation to a less volatile asset such as the US dollar or other relatively stable assets. Unfortunately, most algorithmic stablecoins have failed to maintain their pegged value despite the innovation acceleration. This paper aims to identify the differences between fiat-pegged stablecoins and algorithmic stablecoins, create a framework to understand the different types of algorithmic stablecoins, identify the risk of existing solutions, and answer if algorithmic stablecoins could maintain their pegged value. Our focus will be on two attributes critical in the engineering of algorithmic stablecoins: seigniorage and reflexivity.