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TLDR:

Alchemix is one of the leading stablecoins in anchoring $alUSD to a stablecoin, specifically $DAI. Whereas $DAI is minted by collateralising crypto assets.

If you understand $DAI well, stablecoins are created by debt. That is, you mortgage your property so that you get debt for various purposes. And $alUSD continues to be made up of these debts. This makes $alUSD complicated and unpredictable risks.

We've seen CDSs created by real estate debt and they broke down during the 2008 crisis. I am not here to say that $alUSD is bad or good, but clearly, past events make us more alert. However, $alUSD still has a meaning for the development of the whole Crypto Space.

What is Alchemix?

Alchemix is a no-loss stable coin that uses $DAI as collateral. It includes real inflation and real growth in the ecosystem which makes it quite different. It also talks about capital efficiency. In the early DeFi days people didn’t think so much about capital efficiency and were mostly thinking about over-collateralisation, risk management, and yield.

Today things are a bit different we have grown so much further and can think a little bit more about how to efficiently use our capital to get more returns. There is some over-collateralisation in the Alchemix protocol but it also uses your collaterals to help you earn some form of yield so in that way it kind of offsets it quite a bit.

Alchemix is an evolution to stable coins. It mainly uses reserves to back the stablecoin, while using a bond-like mechanism to reward users. Such similar ideas exist, like $DSD and $ESD. The problem with $ESD and $DSD is that it was just level one to stable coin bond market innovation. They had a great concept but the execution was not as robust or as good. I see Alchemix as a way to make it better and evolve to level two of what crypto bonds could be in terms of stablecoin.

Why is the collateralization 200%?

If the protocol had a lower collateralization ratio then loan repayments would take a lot longer. Right now with the current yield, it's around two years to get repaid but with a lower collateralization ratio that might take five, seven, or even 10 years especially if yields start dropping in DeFi. That's like a lifetime especially in DeFi and crypto so having such a long repayment time is a little bit unrealistic.

The other thing is that let's say you borrow $alUSD and sell it for $DAI then you put it into Alchemix and borrow more alUSD. This can be done in a loop right now because of the collateralization ratio which means that you can basically lever your vault up to 2x. If we had a lower collateralization ratio this kind of recursive strategy could be exploited even more and that wouldn’t have a good effect on the system. It might also destabilize the peg because people would over-leverage their vaults so for the health of the system and reasonable debt repayment times the collateralization ratio is set to 200%.

How does it maintain stability?

The big picture here is that there are two big pools. The first one is the collateral pool where you take your $DAI and put it into the collateral pool to get $alUSD out. Then you have the transmuter pool where you can put $alUSD in and get $DAI out.

One of the important things in this entire game is that 1 $DAI equals 1 $alUSD. Sometimes prices change and it is not always one for one. Let's say 1 $alUSD is now worth $1.5 which is a 50% increase. People will now put $DAI into the collateral pool and get $alUSD out because if you put 100 $DAI you will always get 50 $alUSD out as it is 50% collateral and $alUSD will always be equivalent to one $DAI. Now since 1 $alUSD is worth $1.50 then more people will turn their DAI into $alUSD and increase the supply of $alUSD and reduce the prices back to $1.

When $alUSD is less than $1 you go to the transmuter pool and put $alUSD in it. Let's say your $alUSD is now worth 80 cents instead of $1 and you don't want to spend it because it is not worth that much so you put it in the transmuter pool. Once the pool generates yield and more $DAI then you get to give them 80 cents worth of $alUSD and get 1 $DAI out which is worth $1 because it is one for one in the system.