USDD vs UST: Is Justin Sun's new stablecoin just a clone of UST?

UST, a stablecoin that issupposed to maintain a 1:1 price peg to the U.S. dollar , fell to as low as $0.10 this month. After UST’s massive rise in just a few months, only a few people predicted its huge collapse, especially with stablecoins dominating the market.

Stablecoins have become a dominant force in the crypto market because they allow investors to hold funds in U.S. dollars without leaving the crypto asset market. Decentralized finance( DeFi ) is one of the main beneficiaries of stablecoins, as they power much of the lending and liquidity provision across many DeFi protocols.

Inthe wake of UST's debacle, another stablecoin backed by a well-known crypto entrepreneur has hit the market, which aims to playbetter against the algorithm than UST.

Read on to learn about Justin Sun 's new stablecoinUSDD, and its striking similarities to the recently crashed UST.

What are algorithmic stablecoins?

Before we dive all the way into this new stablecoin, let’s lay the groundwork by taking a deep dive into the concept of an algorithmic stablecoin.

Stablecoins are generally defined as "digital currencies that maintain a price peg to other assets by using them as collateral." But we already know that this definition does not always apply because there are different types of stablecoins.

Fiat-collateralized stablecoins are backed by fiat currency reserves of central entities. They are often criticized by crypto enthusiasts for their centralization and lack of transparency since their reserves are off-chain.

Commodity-collateralized stablecoins are backed by real assets such as oil, precious metals, real estate, etc. through a central entity. They face the same criticisms as fiat-collateralized stablecoins.

Crypto-collateralized stablecoins are backed by smart contracts holding other crypto assets as collateral. While they fit a decentralized model and allow for transparency, they are not capital efficient as they require over-collateralization for stability.

Algorithmic stablecoins aim to solve the challenges faced by other stablecoins by removing any form of collateral or reliance on central issuers. They maintain a price peg to other assets through a process that requires cryptographic token burning and minting mechanisms.

The process typically requires two tokens — one to serve as a stablecoin and the other to help maintain its stability — to keep prices pegged by regulating supply and demand between the two tokens. Some protocols choose to do both by employing algorithmic mechanisms and still keeping crypto assets in reserves.

However, a closer look at algorithmic stablecoins reveals that when their price pegs break, death spirals can occur — asrevealed by UST and its sister token, Terra’s LUNA.

But even so, algorithm-backed stablecoins don’t plan to leave the crypto market anytime soon. In an event that led tothe decoupling of UST, controversial crypto entrepreneur andfounder of the Tron ( TRX ) blockchain Justin Sun, along with the Tron DAO (Decentralized Autonomous Organization), launched a new algorithmic stablecoin called USDD.

What are USDD?

USDDis a new algorithmic stablecoin that aims to maintain a tightly pegged price to the U.S. dollar through an algorithm that incentivizes arbitrage tradersto trade between Tron’s native token, TRX, and USDD.

The minting/burning process involves burning 1 USD worth of TRXwith 1 USDD when the price of USDD rises above the peg . Therefore, reduce the supply of TRX and increase the supply of USDD. When the price of USDD falls, USD 1 will be burned into $1 worth of TRX tokens, reducing the supply of USDD and increasing the supply of TRX in the process.

According to Justin Sun, USDD was born out of the vision of making a stablecoin in the crypto industry that would be “asdecentralized as Bitcoin.”

USDD is managed by Tron DAO, which helps manage interest rates up to 30% (higher than UST) when you stake USDD. Tron DAO will also help maintain USDD stability in the event of a market crash that could cause an algorithmic failure by accumulating $10 billion in Bitcoin, TRX and other stablecoins in reserves.

According to data from Coinmarketcap, USDD’s market cap has reached $542.9 million. While thisis a far cry from the pre-crash market caps of top stablecoins like USDT ($73.2 billion), USDC ($53.3 billion), BUSD ($18.4 billion), DAI ($6.6 billion), or UST, it shows Compared with Terra's Do Kwon, the market seems to have more trust in Justin Sun's ability to maintain the peg.

The collapse of UST

On May 9, 2022, UST lost its peg to the dollar for the first time in a long time, trading below 92 cents. To defend the peg, the Luna Foundation Guard (LFG) began selling its BTC reserves to buy UST.

However, the strategy employed by LFG turned out to be counterintuitive as UST eventually dropped to $0.1 within a few days, losing almost all of its value. The fallout from the crash also greatly affected UST's sister token, LUNA, which plummeted in value from over $84 to essentially zero ($0.0001).

One theory is thatthe UST crash was a coordinated attack where attackers borrowed funds to attack UST's peg and then made the killing on short BTC positions knowing LFG would sell their BTC reserves in an attempt to maintain UST's peg. While this has yet to be confirmed, the general consensus in the community is that this is bound to happen.

UST and LUNA lost about $60 billion in combined market capitalization in the crash.

Similarities and differences between USDD and UST

Both USDD and UST are algorithmic stablecoins that are not backed by collateral. Given the recent collapse of UST, investors have become skeptical of stablecoins, especially those of the algorithmic category.

USDD has come under fire because its algorithm and framework appear to be the same as UST -USDD is minted by burning TRX, andTRX is minted by burning USDD.

USDD is also backed by the Tron DAO, which plans to manage a $10 billion reserve of different crypto assets to back its peg. This is similar to LFG's plan to hold $10 billion in Bitcoin and AVAX to support theUST peg.

Whilethe fundamentals of USDD appear to be the same as UST, Justin Sun pointed out in a recent conference that operational differences in USDD make it quite different from UST.

He believes thatUST has grown too fast and used excessive leverage in a short period of time, citing UST's huge market cap and relatively small reserves before the crash. He also pointed to Anchor Protocol's high yield and lack of proper consideration of market variables as areas of technology where UST failed.

According to Justin Sun, USDD plans to focus on healthy growth by keeping its market cap lower than TRX, Tron DAO reserves, and the entire cryptocurrency market cap. He said the reserves will primarily consist of Bitcoin and TRX as well as other top stablecoins such as USDT, USDC, BUSD, DAI and TUSD. IfUSDD falls below the pegged exchange rate, stablecoins can be deployed immediately, thus gaining time to gradually liquidate other assets.

UnlikeAnchor Protocol, which has a constant interest rate of 20% and no withdrawal limit, Sun Yuchen said that USDD aims to establish a structure that affects interest rates and withdrawal limits.

Will Justin Sun's USDD follow the same path as UST?

Giventhe similarities in USDD's fundamentals to UST, it makes sense to assume that USDD will eventually suffer the same fate as UST. Additionally, no algorithmic stablecoins have been successful so far due to the obvious attack vectors they possess.

At the same time, it's important to acknowledge that Justin Sun andTron have much deeper pockets than Do Kwon and LFG, meaning their ability to maintain the dollar peg is likely to be higher.

However, now that there is a very public playbook on how to attack a stablecoin like this, the chances of more market participants trying to do so increase.

While a fully functioning, stable algorithmic stablecoin would be an excellent addition to the growing DeFi market, recent attempts to create stablecoins show that there is more work to be done before they can truly succeed.