A Different Look at Stablecoins: Elastic Supply Tokens

The DeFi ecosystem continues to grow as individuals interact freely with one another without requiring an arbitrator, trust, permission, or central banks. Smart contracts power blockchain-based DeFi services, which allow people to earn passive income through "yield farming," a staking protocol that rewards individuals with cryptocurrency for lending their cryptocurrency.

The pool of funds makes it simple to borrow flash loans without collateral. Essentially, an individual borrows crypto assets, uses them for their desired purpose, profits, and then repays the loan. The programming in smart contracts, which are typically on the Ethereum blockchain, handles any losses.

Due to the volatile nature of cryptocurrencies, stablecoins like Tether were developed. These coins are pegged to a fiat currency, typically the dollar, to maintain their stability in a volatile market.

The idea of developing elastic supply tokens was to reduce volatility without relying on fiat assets, but not eliminate it. Instead of tying the token to a fiat currency, its supply can be adjusted over time to raise the cryptocurrency's price to the desired level.

In this article, we'll explain how elastic supply tokens work through rebases. We will also go over some of the most prominent examples of elastic supply tokens.

What are Elastic Supply Tokens?

Elastic supply tokens are assets that have a supply that changes based on how much they cost. Rebase is a method that is used to algorithmically change the supply of these tokens, hence the name "rebase tokens."

These changes to the supply are made automatically to increase or decrease the number of tokens when the price of a token goes above or below the target price. These supply changes try to reduce volatility while pursuing a target price by changing the number of tokens in circulation over time, often every 24 hours (based on the Time Weighted Average Price; TWAP).

Let’s assume you have 200 $ELST with each token worth $10. In this scenario, if the price of the token increases to $20, this supply adjustment will leave only 100 $ELST in your wallet.

From the example above, the total value of the token in your wallet remains the same (i.e., $2000) even when the price doubled within a short period, thereby absorbing price volatility.

It's important to keep in mind that your token allocation relative to the overall supply never changes. Although the number of coins in your wallet has changed if you had 1% of the tokens available before the rebase, you would still hold that same amount of tokens relative to the entire supply.

How Elastic Supply Tokens Work

Elastic supply tokens (or elastic stablecoins) are a type of cryptocurrency that operate through smart contracts. Smart contracts are self-executing contracts that enforce the terms of the agreement between the buyer and seller through lines of code. This technology allows for specific procedures to be automated, such as adjusting the supply of a token based on market demand.

When creating an elastic stablecoin, a formula is established in the smart contract to alter the token's supply. This formula is determined by the current market value of the token and the desired price set by the buyer.

For instance, if the market price of an elastic stablecoin falls below the target price, the token's supply will decrease, bringing the price back up to the intended value. Conversely, if the market price exceeds the target price, the token's supply will increase.

This process is referred to as a "rebase," and it typically occurs on a set schedule, such as once every 24 hours. Following a rebase, the smart contract uses the predefined formula to adjust the token's supply automatically.

Why are Elastic Supply Tokens Necessary?

The fundamental tenet of this approach is that supply changes allow the value of these tokens to remain steady.

Since the goal of elastic supply tokens is to keep their value stable, they are often compared to stablecoins. However, there are some differences between the two.

Stablecoins are based on the fixed exchange rate principle, which keeps the price of a coin stable by tying it to the price of something else.

Elastic supply tokens, on the other hand, use a time-varying token supply to reach a target price. Unlike stablecoins, elastic supply tokens don't always aim to reduce volatility. Instead, they want to scale it back so that the token's intended value may be realized.

When the price of the project goes up, the total supply is changed so that it goes up as well. The price of each token decreases as the supply grows.

In a similar way to how the price of a project goes up, the total supply of the project goes down. As you can see, the same demand and supply principles govern the project's overall token supply.

Who Controls Elastic Supply Tokens?

Most elastic supply tokens are managed by decentralized autonomous organizations (DAOs), which are organizations without centralized control. A community is formed with a particular set of rules that are enforced on a blockchain, and it is this community that makes decisions.

Staking rewards, the elastic stablecoin's profit-distribution mechanism, essentially states that all profits made by the Treasury go to the stakers.

Let’s consider the Olympus DAO, the protocol shares tokens to the staking contract without requesting sOHM. As a result, there is a rebase to make up for the discrepancy, which raises the ratio of OHM staked to sOHM outstanding.

For instance, let’s assume there are 500k OHM staked and 500k sOHM outstanding. The protocol made a $5k profit for the day and used the profit to mint and back 5k OHM. The protocol then transfers the OHM to the staking contract. Now a total of 505k OHM is staked and 500k sOHM is outstanding.

To return to balance, the supply of sOHM must increase by 5k (or by 1%). Hence, sOHM is rebased by about 1%.

Examples of Rebase Tokens (or Elastic Supply Coins)

Ampleforth

Ampleforth (AMPL) is a popular elastic stablecoin. The token's supply is changed every 24 hours to maintain a price of around $1.

If the price of AMPL goes up by more than a few cents, any wallet that already has AMPL will get more tokens in proportion to how much AMPL it already has. As a result, everyone continues to hold the same proportion of all AMPL in circulation.

As there are more tokens in circulation, fundamental economic factors tend to bring their price back down near the target. Tokens are proportionately taken from holders' wallets when the price drops below a certain threshold.

The key point is that while the total value of all the AMPL tokens you own can still change, each AMPL token you own will still be worth about $1.

Yam Finance

Yam Finance launched its system and the price-elastic YAM coin on August 11, 2020. Although it had not been audited, the project was tagged as an "experiment in fair farming, governance, and elasticity."

Nonetheless, quite a few DeFi users immediately came together to support Yam's idea, and the project quickly gained traction. The project was created as a DeFi Frankenstein, using the staking mechanism from Synthetix, the elastic supply from Ampleforth, and the governance module from Compound.

However, the Yam protocol is more than the sum of its parts because it was designed to accumulate yCRV tokens during positive rebases for Yam's governable treasury.

BASE Protocol

Base Protocol ($BASE) has a price that equals 1:1 trillion to the total market value of all cryptocurrencies. Traders can use BASE to speculate on the whole cryptocurrency market with just one token.

For instance, if the cryptocurrency market cap is $1 trillion, BASE is correlated to $1. If the crypto market is worth $2.5 trillion, this elastic token is correlated to $2.50.

Olympus Finance

Olympus Finance ($OHM) governs a floating price set by the market without 1:1 dollar collateral backing. This algorithmic stablecoin is not directly pegged to the USD. Each of the OHM tokens is backed by 1 DAI in its treasury.

The CEXs and DEXs in the network have a fair amount of liquidity, and the network tries to keep prices stable to protect the buying power of consumers. The token can be paired with many different assets in Web3, used as a reliable backing to secure other assets or put into the treasuries of protocols.

Klima DAO

Klima DAO is an elastic supply token that allows web3 developers and consumers to use the KLIMA token to engage in the carbon market. The ERC20 token is backed by at least 1 tonne of tokenized, validated carbon offsets that are locked in the KlimaDAO treasury. Holders of the KLIMA token can vote on Klima DAO policy.

Just like how a central bank controls the monetary policy of a fiat currency, the DAO acts as a "decentralized" bank, managing the monetary policy of the new carbon-backed currency. The project aims to promote adoption and unlock the growth of crypto-carbon to create an economy around KLIMA.

Pros and Cons of Rebase Tokens

Like any new idea, elastic stablecoins (or elastic supply coins) have both pros and cons, some of which are discussed here.

Pros of Rebase Tokens

So, what are the benefits of using elastic stablecoins? These are some of the disadvantages that you need to know:

Possibility of Greater Adoption

Elastic stablecoins may be more enticing to consumers and businesses that are wary of using traditional cryptocurrencies because of their volatility since they offer consistent pricing. As a result of this, elastic stablecoins may become more widely adopted and used, which might raise demand and value.

Decentralization

Since elastic stablecoins are decentralized, they are not under the jurisdiction of a single organization. This increases their resistance to censorship and reduces their susceptibility to manipulation.

Price Stability

The biggest benefit of elastic stablecoins is that they can keep their prices stable. Elastic stablecoins can maintain their price relatively stable even under volatile market conditions by automatically altering the supply in response to changes in demand. Those who desire to use cryptocurrencies as a medium of trade or a store of value may find this to be interesting.

Cons of Rebase Tokens

Although there may be some good things about elastic stablecoins, there are also some bad things that need to be known:

Volatility

Although the goal of elastic stablecoins is to keep their prices stable, they are not immune to price fluctuations. There is no assurance that elastic stablecoins will be able to sustain a stable price over the long run; their price is still subject to severe fluctuations.

Complexity

The underlying technology and operation of elastic stablecoins are both intricate. Hence, some people may find it difficult to use and understand them.

Risk of Failure

An elastic stablecoin could fail at any time, just like any other cryptocurrency. This might be caused by several factors, including security flaws, technological difficulties, or a lack of adoption.

Risks of Elastic Supply Tokens

It may be risky to invest in elastic supply tokens. This is because elastic supply tokens may increase the likelihood of financial loss. Although they can increase your profits, they can also increase your losses. If rebasing takes place as the price of the token falls, you will not only lose money as the price of the token falls, but you will also own fewer tokens after each rebasing.

The fact that elastic supply tokens are an experimental asset makes it more likely that companies' smart contract codes will have bugs.

The Prospect of Elastic Supply Tokens

While the potential for generating enormous gains may be highly motivating and intriguing, investing in elastic stablecoins (or elastic supply coins) solely for this purpose should not be the main goal. As an investor, it is important to have a clear understanding of your investments. Therefore, before investing in or purchasing a coin with rebase mechanics, it is crucial to understand the rebase target. Doing so will help prevent you from losing your hard-earned money.

Elastic supply tokens have been receiving a lot of attention, which has attracted the attention of greedy and dishonest individuals looking to con unsuspecting members of the crypto community. Users need to remain vigilant and keep an eye out for potential scams, as the cryptocurrency industry is known for its glitches and unexpected occurrences.

All things considered, elastic stablecoins (or elastic supply coins) offer a unique system that functions as a means of exchanging goods, similar to money. The rebase process proportionally distributes tokens to users, thereby allowing supply and demand to determine their value. This theoretically makes the supply scarce, providing potential for increased value over time.

Conclusion

The concept of elastic supply tokens is gaining traction in the DeFi space, with recent advancements in the field. However, there is a debate about the usefulness of these projects in the current digital currency arena. While some argue that these price-elastic projects are native to the world of crypto and introduce innovative forms of finance, others question their significance.

Regardless of your stance, it is undeniable that price-elastic token projects are capturing significant attention, leading to the involvement of unscrupulous individuals driven by greed. While a project's popularity may be a factor in its success, it does not necessarily guarantee its safety.

One of the most popular price-elastic tokens is Ampleforth, although it is not without its flaws. Therefore, it is important to exercise caution when investing in newer and lesser-known projects to ensure your safety.

In 2023, the exploration of Stablecoins takes a nuanced turn with the increased prominence of Elastic Supply Tokens. These innovative tokens present a dynamic approach to value stabilization in the volatile crypto markets, autonomously adjusting their supply in response to market demands. Unlike their traditional counterparts, which often maintain value stability through collateralization, Elastic Supply Tokens leverage advanced smart contracts to enact supply modifications—expanding or contracting in real-time to counteract price fluctuations, thereby representing a cutting-edge evolution in the realm of stable digital assets.