Stablecoin projects need to work better together to fuel each other's liquidity and the ecosystem as a whole, according to Sam Kazemian, founder of Frax Finance.
Speaking to Cointelegraph, Kazemian explained that there will never be true competition between stablecoins as long as the liquidity of the stablecoins grows in proportion to each other through shared liquidity pools and collateral systems.
Kazemian's stablecoin FRAX is a fractional-algorithmic stablecoin where part of the supply is secured by collateral and another part is algorithmically secured.
Kazemian explained that growth in the stablecoin ecosystem is not a "zero-sum game" as each token is increasingly intertwined and dependent on the development of the other. .
Among other things, FRAX uses Circle’s USD Coin ( USDC ) as collateral. DAI is a decentralized stablecoin managed by Maker Protocol, also uses USDC as collateral for more than half of the tokens in circulation . As FRAX and DAI continue to expand their market capacity, they will likely need more USDC as collateral.
Kazemian explained that if one project decides to drop another, it could have a negative impact on the ecosystem.
"It's a hate to say, but if Maker divests its USDC it would be bad for Circle because it's a return on investment for them."
USDC is the key
The current top 3 stablecoins by market cap are Tether ( USDT ), USDC and Binance USD (BUSD). DAI and FRAX are both decentralized stablecoins, ranking 4th and 5th, respectively.
USDC has seen the most growth among the big three stablecoins over the past year. Market capitalization more than doubled last July to $55 billion. According to CoinGecko , the coin is thus getting closer and closer to USDT.
Kazemian believes USDC is likely to be the most valuable stablecoin to collaborate within the ecosystem due to its industry acceptance and arguably greater transparency regarding its reserves .
He called the USDC a "low-risk, low-innovation project" and acknowledged it serves as a base for further innovation in other stablecoins. He also said:
"We and DAI are the innovation layer above USDC, like the decentralized bank above a traditional bank."
Algo stablecoins don't work
Although the FRAX stablecoin is partially algorithmically stabilized, Kazemian says purely algorithmic stablecoins "just don't work."
Algorithmic stablecoins like Terra USD (UST), which crashed dramatically in May, maintain their pairing through complicated algorithms. The offer is adjusted to market conditions and is not secured with traditional securities.
"Collateral is necessary for an on-chain decentralized stablecoin. It doesn't need to be over-collateralized like Maker, but it does need exogenous collateral."
The death spiral in the ecosystem of Terra became evident when UST, now renamed USTC, lost its pairing.
The protocol then minted new LUNA tokens to ensure there were enough tokens for the stablecoin. This rapid imprint caused the price of LUNA, which is now called LUNC, to plummet. This has triggered a complete retail sell-off of tokens, ending any hope of re-pairing.
In the weeks leading up to the UST decoupling, Terraform Labs founder Do Kwon stated his project needed to fractionally collateralize the stablecoin with various types of collateral, most notably BTC .
"In the end, even Terra realized that their model wouldn't work," Kazemian continued. "Therefore they bought up other tokens."
By the end of May, Terra had sold nearly all of its $3.5 billion worth of BTC .
Terra has also brought down other projects in its collapse, including Deus Finance's algo stablecoin DEI , which also has still not regained its peg to the US dollar at press time.
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