The G20 is Right: Algorithmic Stablecoins are Inherently Unstable

For once we agree with the G20 central bankers – algorithmic stablecoins are inherently unstable.

No stablecoin currently meets the standards set for the digital asset category by central bankers of the world’s largest economies, and many stablecoins “do not have credible mechanisms to support their promise of price stability," a report issued by the Financial Stability Board concluded today.

The board also cast doubt as to how “stable” stablecoins actually are.

The financial research and policy organization, which is led by senior central bankers and regulators from various large economies, does not make binding rules. But a set of high-level recommendations around crypto assets, and warnings about stablecoins and other digital currencies, will carry weight with policymakers and financial institutions across the globe.

The organization released two reports Tuesday. One centers around high-level recommendations for crypto assets, which the regulatory body plans to finalize next year after a public comment period. The other is an assessment of how broadly stablecoin issuers would meet the “High-Standard” criteria set by the group in 2020.

According to the FSB: None.

Citing limits on redemptions, including the ability to delay or deny them, the FSB found that most users have to sell stablecoins on exchanges in order to liquidate them, and the price could drop below the value of the currency that the coin is pegged to.

The FSB also cast doubt on how most stablecoins would be able to maintain their pricing under market stress, concluding that, “most stablecoins enable arbitrage activities of market participants and to a considerable extent rely on them,” and that it’s unclear how that would hold up under adverse financial conditions, “raising questions about the effectiveness of the stabilization mechanisms in supporting a stable price at all times.”

Algorithmic stablecoins are, in fact, a contradiction in terms, and are wholly flawed because they rely on a “support level of demand” for operational control. They require independent actors making rational, market-driven choices that provide “price-stabilizing arbitrage” and reliable, consistent price information. None of these three factors have been something that can be kept under control or even relied upon consistently in financial markets.

They are also inherently fragile. These uncollateralized digital assets, which attempt to peg the price of a reference asset using financial engineering, algorithms, and market incentives, exist in a state of perpetual vulnerability. Ultimately, the price control problem can’t be eliminated unless you can enforce it at the point of a gun, because you can’t rely on other actors in the market to act in certain ways.

Fully collateralized stablecoins, like Circle’s USDC, take a much more realistic approach by ensuring that there are always sufficient assets to back each and every token. But, even collateralized stablecoins are only as usable as the Layer 1 network they run on.

There are among the many reasons we are building Silvermint from the ground up as a proof-of stake protocol that will deliver smart contracts with censorship resistance. Our combination of better tech, better security, and cheaper infrastructure leads to better outcomes. Our equal-stake weighting model means validators will operate more nodes rather than piling up stake on existing nodes. And, because our network scales with the number of nodes, this will increase both network security and transaction throughput.