The stablecoin market is welcoming a new player. Tron is launching its own stablecoin: USDD. As of May 5, 2022, the algorithmic stablecoin will go live. The news comes barely two weeks after NEAR announced it will also launch its own stablecoin. The stablecoin market has grown by hundreds of percents in the last two years to approximately $180 billion.

USDD will be available on Ethereum and Binance Chain. The principle on which Tron founder Justin Sun models its stablecoin is very similar to UST (Terra). Terra uses its own currency LUNA to keep UST's price stable. This is how USDD is going to work as well.

Suppose the price of USDD drops slightly below a dollar. Users can always exchange a dollar of Tron for 1 dollar of USDD. Thus, at a slightly lower USDD rate, that amounts to a little more than 1 USDD. Because this so-called arbitrage process increases the demand for USDD, the price of USDD moves back up to $1. The money changers pocket the profit. A similar, reverse process pulls the price of USDD back to $1 when USDD is slightly above it.

Preventing a death spiral

These economic incentives keep USDD at $1, at least in principle. But the system is vulnerable to big price shocks of Tron. All algorithmic stablecoins are at risk of falling into what is known as a death spiral. That happened recently to the Neutrino stablecoin from the Waves network. Neutrino lost its peg and is now worth about 86 cents.

To avoid this, some issuers of algorithmic stablecoins borrow the principle of non-algorithmic stablecoins, which is to set up a capital buffer. Compare it to the way gold can back a country's currency. In a comparable way stablecoins can be backed by something of value from the "real world". This is the way the first stablecoins function: USDT and USDC. These are backed by assets from the traditional financial system.

Terra and Tron are doing something similar, except they have their stablecoin backed by crypto assets. Terra, for example, is already amassing a fund of billions in Bitcoin, Avalanche and perhaps other crypto. Tron also says it is going to load up on ten billion worth of crypto assets. It is not yet known which crypto.