An innovative algorithm is promising to turn the stablecoin space on its head. Kowala, a blockchain protocol whose tokens are algorithmically tied to the value of fiat currencies, announced the alpha launch of its mainnet today.
Kowala says that its protocol is an improvement from centralized stable coins like Tether, Circle, TrueUSD and DigixGold, whose values are secured by stockpiles of real-world assets. Although these tokens have provided an invaluable refuge from the volatility of Bitcoin and Ethereum, they still rely on trusted third parties and are vulnerable to bad actors and government intervention.
Instead of being supported by a full bank vault, the Kowala token, kUSD, is tied to the dollar by nothing but math and code.
Here’s how it works, according to Kowala’s website and a presentation by Mr. Glover. New kUSD are issued as a mining (or minting) reward on the Boötes blockchain, a high-speed version of Ethereum running a proof-of-stake consensus. The chain is linked to an oracle, which monitors the exchange rate of kUSD to US dollars.
When kUSD prices are slightly higher than the dollar peg, a smart contract increases the mining reward to print more kUSD until supply meets demand. When prices fall below a dollar, the contract reduces the money supply by halting block rewards and burning transaction fees.
Mr. Glover explains the system at length, here:
“Andromeda signals the start of a new era of stablecoins, one in which users won’t have to put their faith in cash and gold reserves, the continuous growth of crypto markets, or, most importantly, the whims of a government, in order to maintain a price-peg,” said CEO Eiland Glover in a statement.
“Our decentralized stablecoin solution makes the Kowala protocol the most trustless anti-volatility project on the market and offers unparalleled monetary liberty, especially to those living in inflationary economies.”
Can Kowala Escape the Stablecoin Graveyard?
This isn’t the first crypto—stablecoin to be launched without a real-world anchor. MakerDAI, the best-known of these, stores a quantity of ethers in a smart contract as a hedge against the market’s volatility—with mixed success, given the precipitous fluctuations in Ethereum values.
NuBits, an assetless stablecoin similar to Kowala, has become a cautionary tale about market forces and adoption. NuBits controls its money supply by incentivizing hodlers to store their assets in a long-term smart contract. Although theoretically sound, the incentive model suffered a crisis of investor confidence earlier this year. The dollar-linked token is currently trading at $0.15, with no recovery in sight.
Kowala’s announcement will come to the relief of a market which is still trembling at rumors of Tether’s solvency. Earlier this year, a much-circulated study discovered a high correlation between Bitcoin price rises and new Tether printings. Although the study did not conclusively find any evidence of mischief, the circumstantial evidence was strong enough to precipitate a sell-off.
Later, markets received a boost from third-party reports that the token was fully backed, although the latter report was far short of an audit.
But there are still many questions to be answered before investors start trusting their money to a smart contract. Human nature, and markets, are notoriously fickle, and it will be hard to judge Kowala’s recipe until after the meal is over.
The author has investments in Bitcoin and Ethereum, which are mentioned here.