Why Over-Collateral Puts the Stability Back Into Stablecoins

Reports of the death of stablecoins are premature, as Mark Twain may have said if he were alive today. The collapse of terra luna showed that what worked well in theory was in practice an accident waiting to happen.

One of the victims of the collapse has been the whole notion of stablecoins themselves. Many pundits have taken to calling them un-stablecoins or versions on that theme. But that misses the point. Terra luna was never really a true stablecoin because the value of the collateral determined the value of the coin. For a true stablecoin to exist as a reliable store of value and a useful means of exchange, the link between the price of the coin and the value of the collateral must, like Caesar’s wife, be above suspicion and beyond even questioning.

One way to achieve this is by a mechanism of guaranteed over-collateralization. An example of an over-collateralized stablecoin is decentralized USD, or USDD, issued by the Tron DAO Reserve. USDD is over-collateralized by multiple mainstream digital assets, including Tron’s native token TRX, BTC and USDT. The total value of USDD's collateral is much higher than that of USDD in circulation. The guaranteed minimum collateralization ratio is 130% of the value of the coin, although its current collateral is worth over 200% of the value of the coin. That far exceeds the 120% required for DAI.

Furthermore, responsive monetary policy mechanisms allow the ratio to dynamically adjust to maintain stability despite fluctuating reserve asset values and market conditions. Additionally, all collateral assets are stored in public on-chain accounts and listed on the Tron DAO Reserve’s website for full transparency.

The responsive monetary policy mechanisms that ensure USDD’s price stability follow the laws of supply and demand for a pegged currency. Once the system detects a deviation in the USDD price from its peg, it takes countermeasures to normalize the price. When USDD price level is above its target, the mechanism contracts the money supply to get a higher relative price level, and when the USDD price level is below the target, it reduces the USDD supply to bring the price level back to normal.

Another aspect of price stability is having a way to reduce the potential for volatility. In the USDD protocol, Tron has agreed with its institutional users to be “super representatives.” These are akin to underwriters in the primary markets, primary dealers in the U.S. government bond market or market makers in the secondary markets. They are incentivized intermediaries whose job is to ensure the fair and efficient functioning of the market by going on either side of a trade.

Tron’s super representatives absorb the volatility of the USDD price, bearing the costs in the short term. When the USDD price falls below the target, users will burn their USDD to mint TRX, which brings the USDD price back to the target level. The minting of TRX will temporarily dilute the TRX mining power of the super representatives.

In the medium to long term, however, super representatives are compensated with fee rewards incurred from token swaps by the USDD protocol. Taken together, super representatives bear the costs of USDD price volatility in the short term but will be compensated in the long term. In this way, they are incentivized to absorb volatility, reducing its potential and adding another layer of stability to USDD.

One last aspect of USDD’s stability credentials comes from the demand side. Put simply, the more utility a stablecoin has, the more its value is assured. The wider the demand for the coin as a means of exchange, or the currency of choice in a decentralized system, the more its utility will stabilize its value. A decentralized currency protocol with a stable price expands the use cases for cryptocurrencies in general. Making it truly accessible has far-reaching implications for both the blockchain sector and the real economy.

This is why in May, while the rest of the stablecoin market was in turmoil, USDD was growing rapidly. Launched on May 5, USDD had entered CoinMarketCap’s top 100 by May 21. As of June 1, USDD had reached a new milestone with over $667 million in circulating supply, burning over 8 billion TRX along the way. That shows how stability can return to the wider stablecoin market.