Are Crypto-Collateralized Stablecoins Ticking Bombs?

[PRIBO247]

Crypto-collateralized stablecoins lock crypto-assets
such as ETH as collateral — with a significantly
higher value — to back their stable tokens. This
way, whenever the backing crypto-asset loses
value to lower levels than the value of stable
tokens, the peg is broken and the system collapses
as a consequence. Accordingly, many people
believe stablecoins of the kind are like ticking
bombs and can be detonated at any moment.
However, a brief review of market prices during
the last year reveals that the most prominent
crypto-collateralized stablecoin DAI has firmly
maintained its peg even at times when Ether — the
crypto-asset backing it — lost value to one-tenth
comparing to its peak price. So, the argument
presented in paragraph one seems to be far from
true.

Are we missing something?

In fact, it is true that crypto-collateralized
stablecoins are at risk of breaking their peg, but,
the risk is far less than what is generally believed.

But why?

Smart contracts issuing crypto-collateralized
stablecoins can be viewed as banks issuing loans.
As mentioned before, they require collateral with a
value that is significantly higher than the loan they
are providing So if the collateral value decreases
to lower levels than the value of the loans, the
system collapses.

But, that’s not the whole story.

Smart contracts do not remain idle to allow the
collateral depreciate value to lower than or even
equal to the value of the loans. Once the collateral
loses value to less than 1.5 times the value of
loans, the smart contract actively puts the
collateral in an auction that only accepts native
stablecoins.

For example, Ether is worth $200, John locks 1
Ether in order to receive $100 worth of
stablecoins. Now, suppose Ether price falls to $180,
$160 and so on. As soon as price reaches $150, the
smart contract puts all collateral Ethers in an
auction in order to forcibly settle John’s loan.
Buyers will probably come along who are willing
to buy John’s Ethers at a little bit cheaper price by
providing $100 worth of stablecoins. Subsequently,
John’s loan is settled. More than two third of his
Ether will be paid for settling his loan and the
remaining is paid back to him. So, John’s loan is
settled before his collateral value gets too close to
his stablecoins.

So, where exactly is the risk? Can the system
collapse at all?

The answer is yes.

The system can collapse if and only if the price fall
the collateral is so fast and furious that nobody is
willing to buy $100 worth of stablecoins in order
to receive $150 worth of Ether and benefit by 50%
because they are afraid that in the short period of
time that they are buying the stablecoins and
settling the loans, Ether falls below $100.
It is worth mentioning that most of those who
participate these auctions are bots for whom even
a 1% gain per auction is more than enough. These
bots are able to finish all the steps above in a
significantly short time. Therefore, a system
collapse for a crypto-collateralized stablecoin is as
probable as Ether losing one-third of value in a
few minutes.

In conclusion, the risk is real but unlikely, and,
you don’t see people living on the street because
there is a real but unlikely risk of an earthquake,
do you?

Source: https://hackernoon.com/