Built to Fail: The Inherent Fragility of Algorithmic Stablecoins

11 Wake Forest L. Rev. Online 131 (October 2021)

15 Pages Posted: 18 Nov 2021

See all articles by Ryan Clements

Ryan Clements

University of Calgary Faculty of Law

Date Written: October 28, 2021

Abstract

Algorithmic stablecoins are inherently fragile. These uncollateralized digital assets, which attempt to peg the price of a reference asset using financial engineering, algorithms, and market incentives, are not stable at all but exist in a state of perpetual vulnerability. Iterations to date have struggled to maintain a stable peg, and some have failed catastrophically. This Article argues that algorithmic stablecoins are fundamentally flawed because they rely on three factors which history has shown to be impossible to control. First, they require a support level of demand for operational stability. Second, they rely on independent actors with market incentives to perform price-stabilizing arbitrage. Finally, they require reliable price information at all times. None of these factors are certain, and all of them have proven to be historically tenuous in the context of financial crises or periods of extreme volatility. Regulatory guidelines are needed for all stablecoin forms, including issuer registration requirements, a defined taxonomy clarifying forms, prudential, collateral custody, and transparency safeguards, and risk disclosure and containment measures. A strong regulatory framework, with risk disclosure and containment safeguards, is particularly needed for algorithmic stablecoins, which currently serve only speculative DeFi trading applications and have very little, if any, societal or financial inclusionary value.

Keywords: Crypto, Stablecoins, Algorithmic Stablecoin, Systemic Risk, Arbitrage, Efficient Markets, DeFi, Decentralized Finance

JEL Classification: E42, E40, G20, K22, O16, O30, O31, O51

Suggested Citation

Clements, Ryan, Built to Fail: The Inherent Fragility of Algorithmic Stablecoins (October 28, 2021). 11 Wake Forest L. Rev. Online 131 (October 2021), Available at SSRN: https://ssrn.com/abstract=3952045 or http://dx.doi.org/10.2139/ssrn.3952045

Ryan Clements (Contact Author)

University of Calgary Faculty of Law ( email )

Murray Fraser Hall
2500 University Dr. N.W.
Calgary, Alberta T2N 1N4
Canada
4036191173 (Phone)

HOME PAGE: http://https://law.ucalgary.ca/profiles/clements

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