While wild price action
on Bitcoin and Ethereum have claimed the attention of most traders over
the Christmas weekend, a select sect of crypto traders are following an
experiment playing out in real-time that may have implications for the
future of stablecoins: the fate of Dynamic Set Dollar. 

Dynamic
Set Dollar and its DSD token is an algorithmic stablecoin project
designed to — eventually — track the United States Dollar on a 1-1 ratio
with DSD. During expansionary cycles, such as one that led DSD as high
as $3 per token last week, users are rewarded with freshly-printed
“rebased” tokens for providing liquidity.

According to Avalanche
blockchain platform founder Emin Gün Sirer, however, developers of
protocols like DSD face a much tricker task during price dumps like the
one DSD is currently experiencing: incentivizing users to adjust the
amount of tokens in circulation. In DSD’s case, holders can burn their
tokens at any time for “coupons” which they can redeem at any point
within 30 days so long as DSD is above $1 per token — hypothetically
enabling them to reap significant profit.

“These mechanisms rely
on whales who will jump in and out of the coin in order to stabilize its
price around the intended target,” said Sirer in an interview with
Cointelegraph. “And they implicitly assume that the whales share the
exact same worldview as the coin's designers: that the stablecoin should
be worth $1. But if the whales do not share this view themselves, […]
the coins can fail and break their intended peg.”

In a Twitter
thread on Saturday, Sirer noted that this disconnect between game
theoretics and developer intentions can lead participants in a protocol
to identifying a Schelling point/price peg, but not the one developers
had in mind:



Traders tread cautiously

These dicey dynamics have led other
observers, such as Ari Paul, the chief investment officer at BlockTower
Capital, to conclude that the project is indistinguishable from a “pump
and dump.” Decentralized finance (DeFi) maven Tyler Reynolds, however,
believes that if DSD pulls through, it could mean that it’s established
itself as “the next big decentralized stablecoin.”



For Sirer, these kinds of uncertainties are to be expected — and traders need to take them into account. 

“Because
the science behind these experiments is not yet well-established, there
is considerable risk and traders need to carry out their own research,”
he said. “Personally, I look for three critical components: uses for
the stable coin beyond just speculation; an incentive mechanism that
offers realistic, modest yields during periods of stability; and a
dedicated, well-capitalized, and competent team behind the coin.”

So
far, the market seems to think Dynamic Set Dollar clears the bar. After
hitting a low of $.27 earlier today, DSD has been climbing steadily and
sits at $.63 at press time. Moreover, intrepid block explorers have
noticed significant on-chain volumes indicating that whales are indeed
buying and burning DSD for coupons:



Oscillating stability

Still, Sirer warms that even if DSD recovers, it could be subject to future gut-punch dumps. 

“Algorithmic
stablecoins all incorporate feedback loops designed to dampen
oscillations around the targeted peg value,” he said. “They seem to do
best when they are trading close to the target peg, and not so well when
they diverge. A coin that veers into dangerous territory and then
recovers might very well be subject to similar oscillations in the
future.”

Aside from price action and traders’ fortunes, however,
Sirer says these experiments are also key to pushing DeFi forward. Sirer
points to MakerDAO, Balancer, DyDx and Uniswap as previous algorithmic
experiments that have become “genuinely useful instruments that provide
critical functionality.”

And in the end, as the science gets better, projects like DSD will eventually achieve long-term viability, he concluded.

“Algorithmic stablecoins are here to stay.”