Introduction: The Dual-Token Model and Its Evolution
The collapse of TerraUSD (UST) and the resilience of other DeFi stablecoins like DAI, FRAX, and FEI highlight the enduring relevance of Robert Sams' 2014 paper, A Note on Cryptocurrency Stabilisation: Seigniorage Shares. Sams proposed a dual-token model to reconcile the conflicting demands of "transactional utility" and "speculative investment" in cryptocurrencies.
The Core Conflict: Transaction vs. Speculation
- Transactional Demand: Users seek price stability for reliable medium-of-exchange functionality.
- Speculative Demand: Investors hoard assets anticipating future value appreciation, exacerbating volatility.
Sams' solution segregates these functions into two tokens:
- Stablecoin: Pegged to a stable asset (e.g., USD) for transactions.
- Seigniorage Token: Absorbs volatility and captures protocol value, appealing to speculators.
👉 Explore how dual-token systems work
Why Transparency Backfired for Terra UST
1. Triple Transparency Pitfalls
UST’s design introduced three vulnerabilities:
- UST’s circulating supply was publicly visible.
- LUNA’s price and supply acted as a real-time signal for UST’s health.
- LUNA as sole collateral meant its decline directly undermined UST’s stability.
2. The Death Spiral Explained
When UST depegged:
- Users burned UST to mint LUNA, increasing LUNA’s supply.
- LUNA’s price plummeted, triggering panic selling.
- The feedback loop accelerated UST’s collapse.
Key Insight: Algorithmic stablecoins relying on endogenous collateral (like LUNA) are inherently fragile.
Case Studies: What Worked and What Didn’t
Success: MakerDAO’s DAI
- Exogenous Collateral: Backed by USDC, ETH, and other assets outside the Maker ecosystem.
- Risk Isolation: MKR token price fluctuations don’t directly impact DAI’s peg.
Failure: Terra UST
- Endogenous Reliance: LUNA was the primary backing, creating a co-dependency.
- Poor Liquidity Defense: LFG’s $3B BTC reserve was insufficient for $18B UST.
- Concentrated Use Case: 61% of UST was parked in Anchor Protocol, lacking diversification.
👉 Learn about stablecoin liquidity strategies
Three Pillars for Future DeFi Stablecoins
1. High-Quality, Exogenous Reserves
- Priority: Assets uncorrelated with crypto markets (e.g., fiat-backed stablecoins, treasury bonds).
- Examples: DAI’s USDC, FEI’s USDC reserves.
2. Robust Liquidity Infrastructure
- Curve Pools: Critical for stablecoin swaps.
- Protocol-Owned Liquidity: DAOs should allocate funds akin to central bank forex reserves.
3. Organic Demand Drivers
- Diverse Use Cases: Payments, trading pairs, DeFi collateral.
- Example: USDT’s dominance in trading pairs ensures survival during crises.
FAQ: Addressing Key Concerns
Q1: Can algorithmic stablecoins recover post-UST?
Yes, but with stricter safeguards: exogenous collateral, liquidity buffers, and demand diversification.
Q2: Why didn’t USDT collapse during UST’s crash?
USDT’s liquidity depth and perceived backing (despite opacity) maintained trust.
Q3: What’s the ideal reserve ratio?
At least 100% for fiat-backed; algorithmic models need higher buffers (e.g., 150%+).
Conclusion: Stability Over Efficiency
UST’s collapse underscores that liquidity and trust outweigh reserve efficiency. Future projects must:
- Avoid endogenous collateral traps.
- Build liquidity defenses akin to traditional finance.
- Foster organic demand beyond speculative yield.
The path forward lies in balancing innovation with the timeless principles of monetary stability.
**Keywords**: DeFi stablecoins, algorithmic stablecoins, Terra UST, dual-token model, liquidity, exogenous collateral, DAI, seigniorage shares.
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