Vitalik Buterin
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After eight consecutive weeks of red candles, we’re starting to see some signs of a potential recovery.
The price of bitcoin soared 7.8% over the past week. XRP is up 3.1%, cardano 27.4%, dogecoin 3.5%. On the other hand, the price of ethereum and BNB fell a few basis points. Solana SOL is down 6.1%, and luna 48%.
But this glimmer of hope could be just the calm before the storm.
Last Wednesday, Ethereum cofounder Vitalik Buterin said that the collapse of Terra’s UST UST exposed the inherent dangers in overly-complex, automated cryptos. And that there many more stablecoins that are “fundamentally flawed” and “doomed to collapse eventually”.
In his essay, titled, “Two Thought Experiments to Evaluate Automated Stablecoins” Buterin suggested that many crypto assets are built on the expectation of continued, limitless growth, which is both unreasonable and detrimental.
As an example, Buterin proposed a thought experiment related to algorithmic stablecoins. He proposes a hypothetical stablecoin that tracks an index that consistently produces 20% annual returns.
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“Even outside of crazy hypotheticals where you build a stablecoin to track a Ponzi index, the stablecoin must somehow be able to respond to situations where even at a zero interest rate, demand for holding exceeds demand for borrowing,” he wrote. “If you don’t, the price rises above the peg, and the stablecoin becomes vulnerable to price movements in both directions that are quite unpredictable.”
“So what happens if expected future activity drops to near-zero,” he asks. “The market cap of the volcoin [a volatile coin used to counteract changes in a stablecoin’s price] drops until it becomes quite small relative to the stablecoin. At that point, the system becomes extremely fragile: only a small downward shock to demand for the stablecoin could lead to the targeting mechanism printing lots of volcoins, which causes the volcoin to hyperinflate, at which point the stablecoin, too, loses its value.”
In other words, such stablecoins, ironically, can be anything but stable. If they aren’t growing, they’re dying for the most part.
[Ed note: Investing in crypto is highly speculative and the market is largely unregulated. Anyone considering it should be prepared to lose their entire investment.]
Zooming out
Buterin’s essay is a response to the implosion of Terra’s UST stablecoin earlier this month. As I wrote last week, it was the biggest crypto crash to date that wiped out ~$40 billion of capital.
In order to prevent such an event from happening in the future, he strongly recommends that developers and investors “move away from the attitude that it’s okay to achieve safety by relying on endless growth.”
Buterin suggests that investors “evaluate how safe systems are by looking at their steady state, and even the pessimistic state of how they would fare under extreme conditions and ultimately whether or not they can safely wind down.”
He says that while developers should hope for endless growth, counting on it can make stablecoins fragile and that “the steady-state and extreme-case soundness should always be one of the first things that we check for.”
Looking ahead
The demise of Terra makes it clear that, much like Ponzi schemes, many cryptocurrencies and their derivatives are reliant on unsustainable growth— making them extremely fragile in the event of a sudden or sustained downturn.
So, unless investors quickly regain their appetite for risk, we’ll likely see more implosions down the line, which is a good thing. Think of it as a “detox diet” that will cleanse the market of dodgy and unsustainable assets.
As Elon Musk put it, the markets have been “been raining money on fools for too long.”
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