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Dynamic Set Dollar faces “massive test” as stablecoin falls as low as $.27

An algorithmic stablecoin experiment is playing out over Christmas weekend — and real money’s on the line.

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.