Algorithmic Market Operations (AMOs) automatically control the supply of algorithmic stablecoins while improving scalability, decentralization, and transparency.
Our understanding of traditional stablecoines is relatively simple. The most common types are fully collateralized stablecoins, which are backed by either fiat, crypto or on-chain tokens that can be redeemed or swapped. An example of a collateralized stablecoin is Tether (USDT), which is the most used stablecoin with a market value of more than $60 billion as of July 2021.
Unlike Tether — which manually mints or burns to increase or decrease its supply — algorithmic stablecoins automatically rely on algorithmic market operation modules (AMOs) to control supply. These are beneficial to the system as they enable scalability, in addition to enhancing decentralization and transparency.
By providing an AMO solution, a stablecoin is more likely to achieve the growth and size required for adoption. AMOs also remove the need for a centralized team to make in-house decisions, as that task will then lie primarily with smart contracts. In turn, this reduces the risk of human error and manipulation.
Every AMO has four properties:
1. Decollateralization: decreasing the collateral ratio;
2. Market operations: this part of the strategy doesn’t change the collateral ratio;
3. Recollateralization: increasing the collateral ratio;
4. FXS1559: the precise amount of FXS that can be burned and still leave profits above the targeted collateral ratio.
In order to keep the stablecoin “stable,” if its price ever gets above its stable peg, the collateral ratio is lowered, the supply expands as it normally does and the AMO controllers continue to run.
On the other hand, if the collateral ratio becomes so low that the stablecoin loses its peg, the AMO will be able to utilize the predefined recollateralization operation to increase the collateral ratio up again.
Because AMOs can be described as a “mechanism-in-a-box,” it's possible for anyone to build an AMO, as long as they follow the specifications.
Using complex algorithms in their smart contracts or algorithmic operated market controllers (AMOs), these types of stablecoins can increase or decrease their token’s circulating supply. This makes the stablecoin capital efficient as it issues additional coins when the price rises and burns them off if its value drops. It also removes the need for collateral backing. Examples of algorithmic stablecoins include Basis Cash and Empty Set Dollar.
Sam Kazemian is the founder of FRAX, a fractional algorithmic stablecoin that is partially backed by collateral and stabilized algorithmically, and the only fractional stablecoin that has maintained its peg since its conception. FRAX is open-source and permissionless, bringing a truly trustless, scalable and stable asset to the future of decentralized finance.
Kazemian brings a wealth of experience as a leading blockchain entrepreneur and crypto enthusiast, as the co-founder of the blockchain based knowledge base, Everipedia. Kazemian’s crypto journey started at UCLA in 2013 where he began mining crypto in his college dorm room and today is a frequent guest lecturer at UCLA covering crypto, computer science and entrepreneurship.
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