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Creating a stable-coin in the volatile cryptocurrency marketplace is a difficult task. Ampleforth is a project that brings a novel approach to trying to create a stable token that can serve as an accepted form of collateral and stability in an otherwise volatile and unpredictable asset class.
1:1 Bank deposits (USDT)
One method for achieving a dollar peg is to simply mint and burn tokens like USDT on a 1:1 basis against a holding bank account. This means that if you deposit a dollar into the bank account, then you are issued a USDT dollar token which represents a claim on a single dollar in that bank account. If you claim that dollar, then the token used to claim it is burnt and destroyed.
In principle, this should work. However, in practice it is not a transparent system as the bank accounts can only be periodically audited and reconciled against the current token supply. This audit is conducted on behalf of the issuing party, which means that it can be difficult to have 100% trust in the system.
In addition, this method of having a dollar peg relies on the legacy banking system. If the bank account was seized or the bank failed, the system would collapse immediately as the tokens would be worthless.
Collateralised Loans (DAI)
Another way to approach the stability problem is to lock up cryptocurrency collateral into a smart contract such as that offered by the MKR/DAI system. By locking up assets in the contract, you are issued DAI tokens. These tokens represent a claim of 1 US dollar on the collateral. So, you can spend and receive these tokens knowing that you can expect to be able to claim the equivalent value in crypto assets.
The advantage of this system is the fact that the smart contracts are transparent and easily auditable by anyone. You can check that the collateral is sufficient for the current DAI issuance.
However, the fact that cryptocurrencies are incredibly volatile means that these loans require a very high over-collateralisation ratio (up to 600% for some protocols!) to ensure that the issued tokens really have enough assets backing them. When the ratio falls below a certain amount, then the collateral is sold immediately to recoup and burn the corresponding issued tokens. This is necessary action but undesirable as it starts to dissuade people from locking up collateral. In extreme flash market drops, the collateral sale might not even be enough to cover the issued tokens.
Again, this system requires the existence of a US dollar to measure the collateral value against. Not enticing if the object of cryptocurrencies is to REPLACE the fiat system!
Rebasing (AMPL)
Ampleforth has an algorithmic way of trying to maintain a target peg of the 2019 USD. In essence, the token is allowed to just trade normally on the market for whatever value the market decides that it is worth. However, if the market value strays too far from the desired market peg, then the system increases or decreases the supply once a day (known as rebasing) to incentivise the price back towards the peg.
If the market price of AMPL is too high, then the system will PRINT more tokens in order to dilute the value of the tokens. Everyone gets proportionally more tokens (your percentage of the total supply always remains the same), and so the pressure is to sell tokens at the higher price before other people do. This creates a sell pressure back down towards the peg.
If the market price of AMPL is too low, then the system will BURN tokens (proportionally to the wallet size, your percentage of the total supply remains the same). This creates a buying incentive, as it is now easier to increase your proportion of the total supply by buying cheaper tokens at a smaller total supply! This will have the effect of moving the market price upwards back towards the desired peg.
This is an application of the ideas of abundance and scarcity. If things are too abundant, then they are worth less and vice versa.
Conclusion
The AMPL rebasing mechanism for stabilising a token is quite a novel idea. It has an advantage over the other two methods in that it is transparent AND independent of the fiat system or any collateral. This means that it could quite easily serve as a collateral in it's own right.
In these earlier stages of the project, the token still does see some swings away from the peg, but that is likely to decrease as there are more participants in the system. More participants would have a larger buy/sell pressure to force the market price back to the peg.
There are in-principle weaknesses of the system. If all the participants colluded, then the token could be kept away from the market peg. However, the game theory and profit motive is likely to quickly break attempts at collusion. The biggest weakness would have to be the amount of participants. The protocol does rely on an active marketplace to keep the peg in sight. If this doesn't exist or is too small, it will not have the necessary pressure to force the price back towards the peg. However, the economic incentives are there to entice more traders as it is easy profit for those who are seeking it if AMPL is off the peg for an extended period of time!
