The Stability of Algorithmic Stablecoins

Here is how an algorithmic stablecoin works. You invent two tokens, call them Dollarcoin and Sharecoin. You list them on the crypto exchanges. Sharecoin trades for whatever price is determined by supply and demand. It might be $0.01 per Sharecoin, or $1, or $100, who knows. But Dollarcoin is supposed to trade at $1. If it trades at $0.99, you have some automatic process in which you print more Sharecoins and use them to buy Dollarcoins until it is back to $1. If it trades at $1.01, you have some automatic process in which you print some more Dollarcoins and use them to buy Sharecoins until it is back to $1. The result is that Dollarcoin is firmly pegged to the dollar. The process is sometimes compared to algorithmic central banking, where the central bank maintains the value of the currency (Dollarcoin) by adjusting its supply.

On first principles this is insane. It relies on Sharecoin always being worth something. If Sharecoin trades at $0.01, you can print 10 million of them and buy 100,000 Dollarcoins and push the price up. But if Sharecoin trades at $0.00, you can print infinity quadrillion of them and you’re still not gonna be able to push up the price of Dollarcoin. If Sharecoin is worthless, it cannot be used to support the price of Dollarcoin. And because you just made it up, there is no particular reason for Sharecoin to be worth anything, so there is no particular reason for Dollarcoin to be worth a dollar. If I made up Sharecoin and Dollarcoin on my computer and said to you “I will give you the number 10 billion in this Excel spreadsheet if you give me 1 million U.S. dollars,” you would say no, and if I raised my offer to 400 quadrillion you would not change your mind.