Algorithmic stablecoins promise a reduction in volatility – ShapeShift

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Promising innovations at DeFi have resulted in a new breed of stablecoins that have the potential to reduce volatility and encourage greater decentralization, according to a new research report from ShapeShift.

In its latest New frontiers ShapeShift research study examines the recent growth of “algorithmic stablecoins,” which are cryptocurrencies that automatically adjust the supply of an asset and other key parameters to reduce volatility. Author Kent Barton, Head of Research and Development at ShapeShift, focuses his analysis on three assets: RAI, FRAX and FEI.

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Barton sums up the potential value proposition of algorithmic stablecoins as follows:

“The rationale here is that if a stablecoin protocol has the ability to automatically manage supply by minting and burning assets in response to market conditions, it can ensure that the asset stays close to its peg. This can lead to a lower dependency on governance and lower collateral requirements. “

The author explains that algo-based stablecoins are different from their fiat-backed and crypto-backed counterparts, but also noted that algorithmic and crypto-backed variants are not necessarily mutually exclusive. These stablecoins “are collateralized to some extent, but also have internal protocol mechanisms to manage supply and reduce volatility,” he said.

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RAI, FRAX, and FEI have all received varying degrees of support from the crypto community, although FEI is the largest of the three in terms of market capitalization at around $ 350 million. By comparison, FRAX has a total market value of $ 245 million, while RAI is valued at around $ 28 million, according to Coingecko data.

RAI follows a “redemption price” protocol that targets sales in the secondary market and allows it to maintain stability over time against the underlying ETH-based asset. Barton says RAI is a more appropriate option for traders than long-term investors.

FRAX is collateralized by USDC, although its overall coverage is always less than what FRAX offers. That makes it undercollateralised and the stability mechanism is aided by the use of USDC as opposed to ETH.

FEI differs significantly from these projects in that it uses a retention curve that FEI sells for ETH. Assets that penetrate the system are locked in a so-called Protocol Controlled Value, which is used to maintain the bond through liquidity management on the exchanges.

Related: The Genesis of the Fei Protocol locks $ 1 billion in ETH, but LPs could suffer losses

Barton concludes by stating that algorithmic stablecoins are still in their early stages, which means their success is nowhere near guaranteed. Still, this emerging asset class is unique because of its regulatory profile, its potentially positive impact on DeFi, and its ability to facilitate niche use cases.