Why Algorithmic Stablecoins Must Evolve or Be Excluded from Major AMM Pairs

Algorithmic stablecoins rely on external price feeds for rebalancing and liquidation. This creates a single point of failure that can be manipulated to drain AMM pools.

• Flash loan attacks on Chainlink oracles can trigger mass, incorrect liquidations.
• Stale price data during high volatility leads to arbitrage losses for LPs.
• The attack is systemic, not isolated to the stablecoin's own contracts.

The peg mechanism itself becomes the failure mode. A drop in price reduces collateral backing, triggering mint/burn cycles that exacerbate the sell pressure.

• UST/LUNA demonstrated the terminal velocity of this feedback loop.
• LPs are left holding de-pegged assets while arbitrageurs extract value.
• Creates permanent loss magnitudes worse than standard volatile pairs.

Algo-stables attract TVL with high yields, creating the illusion of deep liquidity. During a de-peg, this liquidity evaporates, crippling the entire AMM.

• Concentrated Liquidity pools (e.g., Uniswap V3) suffer massive impermanent loss as price exits the range.
• Protocol-owned liquidity models like OlympusDAO simply transfer the insolvency risk to the AMM.
• Results in pool insolvency and contagion to paired assets.

Providing liquidity for an unregistered security-compatible asset opens LPs to existential regulatory clawback risk, a concern for institutional capital.

• SEC actions against Terraform Labs set a precedent for secondary market liability.
• Creates an unquantifiable counterparty risk beyond smart contract audits.
• Major protocols like Aave and Compound now explicitly exclude algorithmic designs.

The only viable path is to adopt the MakerDAO model with real-time, on-chain proof of reserves. This shifts risk from the AMM to the stablecoin's governance.

• DAI uses >150% collateralization with diversified assets (ETH, stETH, RWA).
• Ethena's USDe uses delta-neutral staked ETH collateral, though introduces custodial risk.
• Enables risk-based pool parameters (e.g., higher fees, tighter ranges) for LPs.

AMMs must treat algo-stables as inherently risky assets and isolate them. This means separate, permissioned pools with mandatory LP coverage.

• Curve Finance employs gauges and vote-locking to permission pool creation.
• Protocols like Nexus Mutual or Risk Harbor can offer de-peg insurance as a pool parameter.
• Transforms LP yield from pure speculation to a priced risk premium.

Pure-rebase or seigniorage models like Terra's UST create reflexive death spirals. Their failure contaminates AMM pools, leading to massive impermanent loss for LPs and protocol insolvency.

• $40B+ in value destroyed across major failures.
• Zero intrinsic value makes them toxic assets in Uniswap V3 concentrated liquidity positions.
• Exchanges and protocols blacklist them post-collapse, destroying composability.

Projects like MakerDAO's DAI and Liquity's LUSD succeed by enforcing verifiable, excess collateralization. Their stability is a function of cryptoeconomic security, not market sentiment.

• DAI's >100% collateral ratio is transparently auditable on-chain.
• LUSD's 110% minimum with ETH-only backing simplifies risk assessment.
• This proof enables integration into Curve Finance meta-pools and Aave as collateral, creating flywheel effects.

New models like Ethena's USDe use delta-neutral derivatives strategies to generate yield from external markets. The stablecoin's backing grows autonomously, decoupling stability from pure mint/burn mechanics.

• Backing includes stETH yield + short futures premiums.
• Creates a native yield, competing with Treasury bills.
• This capital efficiency argument is crucial for convincing Uniswap governance to approve new stablecoin pairs.

Frax Finance v3 demonstrates evolution by modularizing risk. Its AMO (Algorithmic Market Operations) controllers can be paused, and the protocol holds $2B+ in off-chain assets (like Treasuries) as a final backstop.

• Multi-layered backing (collateral, algorithmic, real-world assets) diversifies failure points.
• Isolated risk prevents a single module failure from tanking the entire peg.
• This design is essential for risk committees at Balancer or Curve when whitelisting new stable assets.