Unbacked Stablecoin’s Collapse Lost $48B; Crypto Says ‘Let’s Launch Two More’

Crypto doesn’t learn.

In May, terraUSD, a so-called “algorithmic” stablecoin broke its dollar peg, causing a run. Within the space of a week, investors were out $48 billion.

The problem was that instead of the one-to-one reserve of dollars and highly liquid investments like short-term treasuries used by competitors including Circle’s USDC and Tether’s USDT, the Terra/LUNA stablecoin ecosystem relied on an algorithm-based arbitrage mechanism to support its dollar peg. Once that failed, it failed hard.

Now, just two months later, a pair of projects want to launch stablecoins that are not currency-backed, claiming to have fixed the problem that killed terraUSD and its partner token, LUNA, which was used to maintain the peg.

So straight from crypto’s “Are you kidding me?” department, we have Aave, a leading decentralized finance (DeFi) lending platform, proposing the GHO stablecoin and memecoin Shiba Inu developers proposing the SHI stablecoin.

Who’s Letting the Dogs Out?

That worry about unstable stablecoins is something developers of Shiba Inu’s stablecoins have addressed, without spelling out any details about how they’ll do that.

“Needless to say Shi is a concern after watching other stable tokens collapse and billions in dollars get wiped off the market completely,” wrote Shiba Inu’s lead developer, who goes by Shytoshi Kusama. “So as for Shi, we’ve seen independent development from a group of developers in our decentralized network. They’ve submitted a version of Shi that seems to avoid the issues found in other moonshots.”

There were no real details of how that would work, other than that a new token TREAT, that would help “provide balance to Shi.”

Which sure sounds algorithmic.

The name TREAT refers to Shiba Inu’s roots as a Dogecoin memecoin competitor that fixes some of Doge’s design flaws. Both have as their logo a Shiba Inu dog.

So yes, the memecoin division of crypto is now proposing a stablecoin — a type of cryptocurrency whose stability relies on users’ confidence that they can redeem their stablecoins on demand.

Ghostly Stability

Aave is primarily a collateralized DeFi lending/borrowing platform that provides investors who provide cryptocurrencies to be loaned out a high interest rate.

Borrowers put up collateral worth up to 125% to 150%, which is automatically liquidated if the volatile crypto markets cause the collateral’s value to drop too low. Aave is one of the largest, with more than $6.5 billion locked in by lenders.

The investor lenders are known as “ghosts” after the Aave token’s logo — that is where the proposed GHO stablecoin comes from.

The way Aave protocol developer, Aave Companies, intends to overcome the problems that killed Terra/LUNA is by replacing the backing reserve supporting USDC and USDT with an over-collateralization mechanism. Stablecoins would be minted by anyone who can put up the collateral. When the sum borrowed is returned, with interest, the collateral is returned.

GHO is not an algorithmic stablecoin and will not have the shortcomings of Terra/LUNA, the company told Decrypt.

The problem is, liquidation is something that happens on a fairly regular basis to borrowers on both DeFI crypto lending platforms and their centralized competitors — several of which just entered bankruptcy or were rescued by acquisition.

See more: $45B Stablecoin Rout Confirms Worst Fears about Crypto’s Need for Reserves

The other problem is liquidity. Stablecoins’ stability ultimately rests on users’ confidence that they can redeem their crypto collateral on demand. This means that if the collateral tokens drop too far too fast, there could be trouble.

Regulators Concerned

This is why most of the regulators alarmed by the Terra/LUNA collapse have proposed mandating that all stablecoins be backed with a one-to-one reserve of dollars, euros or another fiat currency.

Three days after Terra/LUNA’s collapse began, U.S. Treasury Secretary Janet Yellen told the House Financial Services Committee that while even at that scale there wasn’t yet “a real threat to financial stability,” stablecoins are “growing very rapidly and they present the same kind of risks that we have known for centuries in connection with bank runs.”

See also: Yellen: Terra’s Fall Shows Stablecoin Dangers

The EU’s recently completed Markets in Crypto Assets (MiCA) regulatory protocol requires stablecoins to have a one-to-one backing reserve of euros.

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