How Does a ‘Death Spiral’ Relate to Under-Collateralization?
A ‘death spiral’ is a catastrophic feedback loop that can occur in under-collateralized or poorly designed algorithmic stablecoins. It starts when the stablecoin loses its peg and falls below $1.
The algorithm attempts to restore the peg by issuing a secondary, volatile asset (like a governance token) to absorb the stablecoin supply. If the stablecoin’s price continues to drop, the value of the secondary asset collapses, creating a lack of confidence that leads to mass selling of both tokens, further driving down prices and leading to the system’s failure and permanent under-collateralization.
Glossar
Algorithmic Death Spiral
Mechanism ⎊ An algorithmic death spiral describes a severe feedback loop in algorithmic stablecoins or decentralized finance protocols where a token's price decline triggers further selling pressure.
Depegging Spiral
Dynamic ⎊ This describes a self-reinforcing feedback loop initiated when a pegged asset deviates from its target parity, often seen with stablecoins or synthetic instruments.
Under Collateralization Definition
Exposure ⎊ Under collateralization in cryptocurrency derivatives signifies a scenario where the value of assets pledged as collateral by a market participant is insufficient to cover potential losses arising from their open positions, particularly within perpetual swaps or options contracts.
Mining Death Spiral Risk
Threat ⎊ Mining Death Spiral Risk is a theoretical threat to a Proof-of-Work cryptocurrency where a rapid, significant drop in the asset's price causes a large number of miners to become unprofitable and cease operations simultaneously.
Death Spiral Event
Scenario ⎊ Death Spiral Event describes a feedback loop, often seen in undercollateralized algorithmic stablecoins or tokenized debt instruments, where declining asset value triggers automated selling or redemption that further depresses the price, leading to terminal failure.
Death Spiral Example
Scenario ⎊ The death spiral scenario describes a catastrophic, self-reinforcing feedback loop most notably observed in certain algorithmic stablecoin designs, where the stablecoin's de-peg triggers a cascade of selling pressure on its volatile collateral or governance token.
Death Spiral Prevention
Mitigation ⎊ Death Spiral Prevention, within cryptocurrency and derivatives, centers on preemptive capital management strategies designed to counteract cascading liquidations.
Financial Downward Spiral
Dynamic ⎊ A Financial Downward Spiral describes a severe, self-reinforcing cycle of asset price depreciation, where initial losses trigger forced selling, which further drives prices lower, leading to greater losses.
Stablecoin Vulnerabilities
Weakness ⎊ Stablecoin Vulnerabilities are specific exploitable weaknesses in the design or operation of a stablecoin mechanism that can lead to a loss of parity with its reference asset, often becoming apparent during periods of extreme market stress.
Mining Death Spiral
Mechanism ⎊ The Mining Death Spiral is a theoretical, self-reinforcing negative feedback loop initiated by a severe cryptocurrency price drop that pushes a significant portion of the network's hash rate below its marginal cost of production.