Algorithmic stabilization is the key to efficient crypto-funding

Following the collapse of Terraform Labs’ cryptocurrency, Terra (LUNA), and its stablecoin, Terra (UST), the notion of “algorithmic stabilization” has fallen to a low point in popularity, both in the cryptocurrency world and among mainstream observers.

However, this emotional response is strongly at odds with reality. In fact, algorithmic stabilization of digital assets is a very valuable and important class of mechanisms whose appropriate deployment will be critical if the cryptosphere is to achieve its long-term goal of improving the mainstream financial system.

Blockchains, and other similar data structures for secure decentralized data networks, are not just about money. However, due to the historical roots of blockchain technology in Bitcoin (BTC), the topic of blockchain-based digital money is woven deep into the ecosystem. Since its inception, a core ambition of the blockchain space has been to create cryptocurrencies that can serve as payment media and stores of value, independent of the “fiat currencies” created, defended and manipulated by national governments.

Related: Developers could have prevented the cryptos 2022 hack if they took basic security measures

So far, however, the crypto world has failed miserably in fulfilling its original ambition of producing tokens that are superior to fiat currency for payment or for store of value.

In fact, this ambition is eminently achievable – but to achieve it in a feasible way requires creative use of algorithmic stabilization, the same type of mechanism that LUNA and other Ponzi-like schemes have abused and thus given an unjustified bad reputation.

Almost all crypto-tokens out there today disqualify themselves as broadly useful tools of payment or store of value for several reasons – they are too slow and expensive to transact, and their exchange values ​​are too volatile.

The “slow and expensive” problem is gradually being solved by improvements in underlying technology.

The volatility problem is not caused directly by technological deficiencies, but rather by market dynamics. Crypto markets are not that big compared to the size of global financial systems, and they are heavily traded by speculators, which causes exchange rates to fluctuate wildly up and down.

The best solutions the crypto world has found to this volatility problem so far are “stablecoins”, which are cryptocurrencies with values ​​tied to fiat currencies such as the US dollar or the euro. But there are fundamentally better solutions to be found that avoid reliance on fiat and provide other benefits by using algorithmic stabilization in sensible (and non-corrupt) ways.

Problems with stablecoins

Stablecoins such as Tether (USDT), BinanceUSD (BUSD) and USD Coin (USDC) have values ​​pegged to the USD, meaning they can be used as a store of value almost as reliably as a regular bank account. For people who are already doing business in the crypto world, it is useful to have wealth stored in a stable form in one’s crypto wallet, so that one can easily move it back and forth between the stable form and various other crypto products.

The largest and most popular stablecoins are “fully backed”, which means, for example, that each dollar-equivalent unit of USDC is equivalent to one US dollar stored in the treasury of the organization that backs the USDC. So if everyone holding a unit of USDC requested to exchange it for one USD at the same time, the organization would be able to quickly fulfill all requests.

Some stablecoins are fractionally backed, meaning that if, say, $100 million in stablecoins have been issued, there may only be $70 million in the corresponding treasury backing it up. In that case, if 70% of stablecoin holders redeemed their tokens, things would be fine. But if 80% redeemed their tokens, that would be a problem. For FRAX and other similar stablecoins, algorithmic stabilization methods are used to “maintain the pin.” That is, to ensure that the exchange value of the stablecoin remains very close to that of the USD peg.

Terra’s UST was an example of a stablecoin whose backing reserve consisted largely of tokens created by the folks behind LUNA as governance tokens for their platform, rather than USD or even cryptocurrencies like BTC or Ether (ETH) defined independently of LUNA. As LUNA began to destabilize, the perceived value of their governance token decreased, which meant that the cash value of their reserves decreased, causing further destabilization, etc.

While LUNA used algorithmic stabilization, the core problem with the setup wasn’t this – it was the presence of vicious circularities in their tokenomics, such as the use of their own governance token as a backing reserve. Like most other flexible financial mechanisms, algorithmic stabilization can be manipulated.

All major governments are explicitly targeting stablecoins in their current regulatory exercises, aiming to come up with strict rules for the issuance and characteristics of any crypto token that tries to match the value of fiat currency.

The answer to all these problems is relatively simple: Leverage the flexibility of blockchain-based smart-contract infrastructure to create new financial instruments that achieve useful forms of stability without being tied to fiat.

Freeing algorithmic stabilization

“Stability” does not itself mean correlation with fiat currency value. What it should mean for a token to be stable is that year after year, it should cost about the same amount of tokens to buy the same amount of stuff – carrots, chickens, fencing material, rare earths, accounting services, whatever.

This leads to what my colleagues in the Cogito project are doing, with new tokens that they call “tracercoins”, which are essentially stablecoins, but of a different type, pegged approximately to other quantities than fiat currencies. For example, the Cogito G coin is pegged to a synthetic index that measures progress to improve the environment (e.g. global temperature).

Tracercoins can be programmed to trace transactions in the manner required by law in the jurisdictions in which they are used. But they are not trying to mimic the currency of a particular country, so they are not likely to be regulated as strictly as fiat-pinned stablecoins.

Related: Programming languages ​​hinder mainstream DeFi

Because the pegs for these tokens are synthetic, it is less of a traumatic market psychology problem if the tokens vary slightly from their pegs from time to time.

What we have here are stores of value that are potentially better even than the US dollar and other traditional financial assets in terms of maintaining fundamental value as the world evolves…and are much less volatile than BTC and other standard crypto assets. because of the stabilization built into their tokenomics.

Along with modern blockchain efficiency optimizations, we also have a viable payment mechanism that is not tied to the currency of any country.

Crypto has the potential to fulfill its ambitious long-term ambitions, including creating financial tokens that act as better stores of value and payment mechanisms than fiat currencies.

To realize this potential, the community needs to set aside the fear inflicted by the various scams, scams, and poorly designed systems that have plagued the crypto world, and aggressively deploy the best tools at hand—like fractional reserve-based algorithmic stabilization—in service of creative design aimed at it greater good.

Ben Goertzel is the CEO and founder of SingularityNET. He previously served as director of research at the Machine Intelligence Research Institute, as chief scientist and chairman of the AI ​​software company Novamente LLC, and as chairman of the OpenCog Foundation. He graduated from Temple University with a doctorate in mathematics.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

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