According to Sam Kazemian, founder of Frax Finance, Stablecoin projects should take a more collaborative approach to increase liquidity with each other and the ecosystem as a whole.

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Speaking to Cryptooshala, Kazemyan explained that as long as “stablecoin liquidity grows in proportion to each other” through shared liquidity pools and collateral schemes, there will never be real competition between stablecoins.

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The Kazemian FRAX stablecoin is a fractional-algorithm stablecoin where parts of the supply are collateralized and other parts are algorithmically collateralised.

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Kazemian explained that the growth of the stablecoin ecosystem is not a “zero-sum game” as each token is increasingly intertwined and dependent on each other’s performance.

FRAX uses Circle’s USD Coin (USDC) as collateral. DAI, a decentralized stablecoin backed by the Maker Protocol, also uses USDC as its pledge more than half of the tokens in circulation. As FRAX and DAI continue to increase their market capitalization, they are likely to need more USD collateral.

However, Kazemyan noted that if one project decides to abandon another, this could have negative consequences for the ecosystem.

“It’s unpopular to say, but if Maker gets rid of their USDC, it will be bad for Circle because of the income they make from them.”

USDC is key

Currently, the top three stablecoins by market capitalization are Tether (USDT), USDC, and Binance USD (BUSD). DAI and FRAX are the fourth and fifth best decentralized stablecoins.

USDC posted the biggest gain of the three in the past year, with its market capitalization more than doubling last July to $55 billion, making it almost within arm’s reach of USDT, according to the data. CoinGecko.

Kazemyan believes that USDC’s proliferation in the industry and perhaps greater transparency in its reserves should make it the most valuable stablecoin to collaborate within the ecosystem.

He called USDC a “low-risk, low-innovation project” and acknowledged that it serves as a baseline for further innovation of other stablecoins. He said:

“We and DAI are an innovative layer on top of USDC, like a decentralized bank on top of a classic bank.”

Algo stablecoins don’t work

Although the FRAX stablecoin is partially algorithmically stabilized, Kazemian says pure algorithmic stablecoins “just don’t work.”

Algorithmic stablecoins like Terra USD (UST), which plummeted in May, maintain their peg with sophisticated algorithms that adjust supply based on market conditions rather than traditional collateral.

“In order to have a decentralized stablecoin on the network, it must have collateral. It doesn’t need over-collateral like Maker does, but it does require exogenous collateral.”

The death spiral in Terra’s ecosystem became apparent when UST, now known as USTC, lost its anchor.

The protocol has begun minting new LUNA tokens in order to provide enough tokens to support the stablecoin. The rapid minting caused the price of LUNA, now known as LUNC, to drop, causing a complete retail sale of the tokens, dooming any hopes of a repeg.

The liquidity protocol uses stablecoins to ensure zero non-permanent losses.

A few weeks before UST depeg, Terraform Labs founder Do Kwon stated that his project needed to partially back the stablecoin with various forms of collateral, especially BTC.

“Eventually, even Terra realized their model wasn’t going to work,” Kazemyan added, “so they started buying up other tokens.”

By the end of May, Terra had sold nearly all of its $3.5 billion worth of BTC.

Since then, Terra has shut down other projects, including Deus Finance’s DEI stablecoin, which has also failed to return to a dollar peg at the time of writing.