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May 12, 2022

Ember University: What are Stablecoins?

What is a stablecoin? 

A stablecoin is a type of cryptocurrency that has been designed to maintain a fixed value over time, meaning it should not be subject to crypto market volatility. This is achieved by pegging the stablecoin to a currency, such as the US dollar. 

What are some examples of asset-backed stablecoins? 

USD Coin (USDC), MakerDAO Stablecoin (DAI), Binance USD (BUSD)

What are stablecoins used for? 

A stablecoin is a good way to diversify your portfolio so that you can have some dry powder when there is a market opportunity to buy an asset you’ve been eyeing. Think of having some cash on hand in order to purchase assets when they hit a certain price.  Many people like to generate yield on their stablecoins, similar to Ember’s Yield portfolio. 

It is important to note that there are different types of stablecoins. A large majority of stablecoins are collateralized by hard assets like those mentioned above. Others are not, and instead are decentralized, trustless, and do not need huge collateral. It protects its peg by automatically regulating the supply. For example, when the stablecoin price goes above the peg, the protocol issues more tokens, and when the price goes too low, it buys them off.

What is an algorithmic stablecoin? 

Unlike a stablecoin, which is pegged by a hard asset, algorithmic stablecoins utilize algorithms to maintain its peg. Most popular algorithmic stablecoins are pegged to $1 USD.

What are some examples of algorithmic stablecoins? 

TerraUSD (UST), Magic Internet Money (MIM)

What is TerraUSD (UST)?  

There are some risks associated with algorithmic stablecoins, however. Since algorithmic stablecoins are not pegged to a hard asset and rely on various technical factors, these algorithmic stablecoins can lose their peg, which we’ve witnessed with one of the biggest algorithmic stablecoins: TerraUSD (UST). 

To maintain UST’s price stability, Terra mints and burns tokens while also incentivizing arbitrage. Arbitrageurs would buy and sell Terra’s volatile cryptocurrency, LUNA, in an aim to maintain its peg to the U.S dollar. 

Before buying UST, you need to mint it. When doing so, you'll pay for LUNA. The protocol then takes those LUNA and burns them. This decreases LUNA’s supply, making its price go up a bit. The inverse is true here as well. In order for you to mint LUNA, you will first need to convert some UST. Then when UST gets burned and the price of UST goes up. This provides an arbitrage opportunity that maintains the price of UST in check in theory. 

Why is Terra on the news? 

On May 11th, 2022 UST plummeted to as low as $0.30. It has since then recovered some of its losses, but it failed to regain its peg to the US dollar. The Luna Foundation Guard even deployed billions of dollars of worth of Bitcoin to keep UST pegged to the dollar. Even with such efforts, UST did not reestablish its peg. 

In turn, the price of LUNA also nose dived, losing 95% of its value. There is no question that the market has lost its confidence in the mint and burn mechanism that was supposed to keep UST prices stable. 

What does this mean for Ember Fund? 

Luckily, Ember Fund has not included UST in any of our portfolios due to some inherent risks we saw with the asset. 

We constructed our Yield portfolio to maximize stability and shield our investors from crypto market volatility. Our algorithm trades between various asset-backed stablecoins pegged to the dollar and seeks the highest yield among them. Currently the Yield portfolio is generating a 2.8% yield, which is 270x what your bank savings account is offering. 

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