Author: Jae, PANews
What should “true DeFi” look like? When Ethereum co-founder Vitalik Buterin cast his vote for algorithmic stablecoins, a reflection on risk, governance, and monetary sovereignty was reignited.
A single tweet was enough to shake a narrative worth hundreds of billions of dollars.
On February 9, Vitalik Buterin posted a tweet presenting a compelling viewpoint: algorithmic stablecoins are the “real DeFi.”
This is not a technical tweak to the current stablecoin landscape but an authoritative redefinition of DeFi’s underlying logic.
In a market dominated by centralized stablecoins like USDT and USDC, Vitalik’s statement is like a deep-water bomb, bringing the long-dormant algorithmic stablecoin sector back into the spotlight.
Decoupling risk and de-dollarization as standards for “true DeFi”
Vitalik’s definition of “genuine DeFi” is based on risk structure decoupling. He categorizes algorithmic stablecoins into two models.
First, pure native asset collateralization. Protocols use ETH and its derivatives as collateral. Even if 99% of liquidity comes from CDPs (Collateralized Debt Positions), fundamentally, this shifts counterparty risk from USD-based trading pairs to market participants and market makers.
This means no frozen bank accounts and no centralized institutions that can suddenly collapse.
Second, highly diversified real-world asset (RWA) collateralization. Even if a protocol introduces RWAs, as long as risk is hedged through diversification and over-collateralization, it can be seen as a significant risk structure optimization.
If an algorithmic stablecoin can guarantee that no single RWA exceeds the system’s over-collateralization ratio, then even if one asset defaults, the principal of stablecoin holders remains safe.
A more forward-looking view is that Vitalik advocates gradually moving stablecoins away from dollar pegs.
Given the potential long-term devaluation risks of sovereign currencies, stablecoins should evolve toward more universal, index-based accounting units, reducing reliance on any single fiat, especially the US dollar.
This also implies that the essence of stablecoins is shifting—from “price stability” to “purchasing power stability.”
Regarding Vitalik’s definition of algorithmic stablecoins, PANews has curated the most compliant projects in the market, though they generally face user acquisition challenges—perhaps why Vitalik is once again rallying for this category.
USDS: “The young dragon becomes a fierce dragon,” controversy over mainstream expansion
Following Vitalik’s tweet, the price of MakerDAO’s MKR token surged by 18%.
Interestingly, the transformed SKY token remained relatively stable, and this divergence itself reflects market sentiment.
As one of the most representative protocols in DeFi history, MakerDAO officially rebranded as Sky Protocol in August 2024, launching a new stablecoin USDS, completing a final transformation called “Endgame.”
USDS is positioned as an upgraded version of DAI and is Sky’s flagship product. As of February 12, USDS rapidly became the third-largest stablecoin in the entire crypto market, with a market cap exceeding $10 billion.
On the surface, this appears to be a successful evolution for DeFi giants. But in essence, it’s a costly “coming of age.”
The main revenue of USDS comes from diversified underlying assets.
Sky utilizes its modular ecosystem, Star, where sub-DAOs allocate collateral to RWAs including short-term government bonds and AAA corporate bonds.
From a risk diversification perspective, this aligns with Vitalik’s second category of algorithmic stablecoins. However, the issue lies in the shift of asset structure focus.
While USDS has taken steps toward diversification, nearly 60% of its reserves are USDC, far exceeding the over-collateralized portion (20%).
This means the underlying value of USDS is heavily reliant on another centralized stablecoin.
Therefore, the protocol’s transformation has always been controversial.
More troubling for DeFi purists is that the protocol has introduced a “freeze” function.
This feature allows Sky to remotely freeze USDS in user wallets upon legal orders or security incidents.
For Sky, this is a pragmatic compromise to address global regulation: without compliance, mainstream adoption is impossible.
Technically, the freeze function aims to combat hacking, money laundering, and other illegal activities, making USDS a compliant financial tool in the eyes of regulators.
But for DeFi believers, this is an unforgivable “concession.”
Some community members argue that Sky has betrayed DeFi’s original anti-censorship promise. Once the protocol is granted the power to freeze assets, USDS essentially becomes indistinguishable from USDC.
Clearly, the protocol is drifting further from what Vitalik envisions. Compared to today’s Sky and USDS, the market may be more nostalgic for MakerDAO and DAI.
LUSD/BOLD: Upholding ETH as the core, pursuing minimal governance
If Sky chose outward expansion, Liquity chose inward deepening.
Vitalik has repeatedly praised Liquity, which exemplifies a “minimal governance” approach, designed with almost no reliance on human intervention.
Liquity’s stablecoin LUSD/BOLD is fully backed by ETH and its staking tokens (LST), representing the most typical example in Vitalik’s first category of algorithmic stablecoins.
Liquity V1, with its innovative 110% minimum collateral ratio and rigid redemption mechanism, established its authority among ETH-collateralized stablecoins. But V1 also faced trade-offs in capital efficiency and liquidity costs:
- Zero interest rate: users pay a one-time borrowing fee (usually 0.5%) at the time of borrowing, with no accruing interest over time. While attractive to borrowers, maintaining liquidity requires continuous rewards (like issuing LQTY tokens), which lacks long-term sustainability.
- 110% minimum collateral ratio: through an instant liquidation system (stability pool), Liquity achieves higher capital efficiency than competitors. If ETH prices fall, the system prioritizes using the stability pool’s LUSD to offset bad debt and distribute collateral.
- Hard redemption: any LUSD holder can redeem ETH at a fixed $1 value, creating a price floor that remains anchored even in extreme market conditions.
However, the single-asset collateral model is a double-edged sword.
Since LUSD only supports ETH collateral, rising ETH staking rates mean opportunity costs for users—borrowing while missing out on staking rewards.
This has led to a continuous decline in LUSD supply over the past two years.
To address V1’s limitations, Liquity launched V2 and the new stablecoin BOLD, introducing a key innovation: “user-set interest rates.”
In Liquity V2, borrowers can choose their own interest rate based on their risk appetite. The protocol sorts debt positions by interest rate, with lower rates being more likely to be liquidated first.
- Low-interest strategy: suitable for users sensitive to capital costs but willing to accept early liquidation risk.
- High-interest strategy: for users aiming for long-term holdings and to hedge against liquidation risk.
This dynamic game mechanism allows the system to automatically find market equilibrium without human intervention:
Borrowers, to avoid losing collateral during ETH downturns, tend to set higher interest rates, which directly flow to BOLD depositors, creating real yield without token issuance.
Additionally, V2 breaks the single-asset limitation, supporting wstETH and rETH.
This enables users to earn staking rewards while maintaining BOLD liquidity.
More importantly, V2 introduces a “one-click multiplier” feature, allowing users to leverage their ETH exposure up to 11x, greatly improving capital efficiency.
Liquity’s evolution marks a solid step from idealism toward pragmatism in algorithmic stablecoins.
RAI: An industrial-minded monetary experiment with high opportunity costs for holders
If Liquity is pragmatic, Reflexer is a pure idealist.
The protocol issues the stablecoin RAI, which is not pegged to any fiat currency, with its price regulated by a PID algorithm borrowed from industrial control theory.
RAI does not aim for a fixed $1 price but seeks extremely low volatility.
When RAI’s market price deviates from its internal “redemption price,” the PID algorithm automatically adjusts the redemption rate, effectively changing the system’s interest rate.
- Positive deviation: market price > redemption price → redemption rate becomes negative → redemption price drops → borrowers’ debt decreases, incentivizing minting and selling RAI for profit.
- Negative deviation: market price < redemption price → redemption rate becomes positive → redemption price rises → borrowers’ debt increases, incentivizing buying back RAI to close positions.
Despite praise from Vitalik, RAI’s development path is fraught with challenges:
- User perception issues: RAI is nicknamed “bleeding coin” because its long-term negative interest rate causes asset value to shrink over time.
- Liquidity scarcity: without a dollar peg, RAI is hard to adopt widely in payments and trading; its use as collateral is limited to niche crypto circles.
- Complexity: compared to Liquity’s fixed $1 peg, RAI’s PID control model is difficult for investors to predict.
RAI demonstrates the elegance of theoretical algorithmic stablecoins but also exposes harsh realities of user adoption.
Nuon: A stablecoin anchored to a purchasing power index, highly dependent on oracles
As global inflation intensifies, a more radical stablecoin paradigm—Flatcoins—may emerge.
These stablecoins aim not to peg to a fiat currency but to real living costs or purchasing power.
Traditional stablecoins (USDT/USDC) lose value in inflationary environments. If the dollar’s purchasing power declines 5% annually, holders of these stablecoins suffer hidden capital losses.
In contrast, Flatcoins track independent cost-of-living indices (CPI), dynamically adjusting their face value.
Take Nuon, the first Flatcoin protocol based on cost of living, which connects to on-chain verified real-time inflation data to adjust its peg accordingly.
- Target asset: a basket of food, housing, energy, and transportation indices.
- Purchasing power parity: if inflation data shows a 5% increase in living costs in the US, Nuon’s target price also rises 5%, ensuring one Nuon can still buy the same basket of goods and services in the future.
- Mechanism: Nuon employs an over-collateralization model, where the algorithm automatically adjusts minting/burial logic as inflation data changes, protecting holders’ real value.
For residents in high-inflation countries like Turkey or Argentina, traditional dollar stablecoins can mitigate local currency devaluation but cannot escape the “hidden tax” of dollar inflation. Flatcoins offer a non-dollar, decentralized alternative to fight inflation and preserve purchasing power.
Despite the forward-looking design, Flatcoins face significant technical risks in practice.
The composition of the cost-of-living index is complex, and the accuracy of data depends heavily on oracle robustness.
Inflation data on-chain can become a target for manipulation—any small tampering with data sources could instantly erode Flatcoin holders’ purchasing power.
Furthermore, the dynamic balance of Flatcoins requires sufficient liquidity.
In extreme market conditions, whether arbitrageurs will maintain a rising peg remains uncertain.
Flatcoins represent a bold leap in the algorithmic stablecoin narrative, but from concept to adoption, there are vast technological and financial chasms to cross.
From Liquity’s steadfast backing, to Reflexer’s experimental approach, to Flatcoins’ radical innovation, the landscape of algorithmic stablecoins is unfolding with unprecedented diversity and depth of thought.
Currently, algorithmic stablecoins still face challenges like capital efficiency, liquidity shortages, and user experience issues, but their core principles—risk decoupling, minimal governance, and monetary sovereignty—remain the holy grail of DeFi.
The revival of algorithmic stablecoins is only just beginning.
