Stablecoins are rightfully in the spotlight. Beyond mere speculation, they represent one of the few products in the crypto space with clear product-market fit (PMF). There is widespread discussion about the trillions of dollars in stablecoins expected to flow into traditional finance (TradFi) in the coming years.
However, not all that glitters is gold.
The Original Stablecoin Trilemma
New projects often use comparison charts to position themselves against major competitors. What is striking, yet frequently downplayed, is the recent apparent regression in decentralization.
The market is evolving and maturing. The need for scalability clashes with past anarchic dreams. Yet, a balance must be found somewhere.
Originally, the stablecoin trilemma was built on three core concepts:
- Price Stability: The ability of a stablecoin to maintain a steady value, typically pegged to a currency like the US dollar.
- Decentralization: The absence of a single controlling entity, offering censorship resistance and trustless operation.
- Capital Efficiency: The ability to maintain the peg without requiring excessive collateral.
After numerous contentious experiments, scalability remains a challenge. Consequently, these concepts are evolving to meet these demands.
A common chart from one of the leading stablecoin projects in recent years is illustrative. It is commendable, largely due to its strategy of evolving beyond a mere stablecoin into a broader product suite.
In such charts, price stability remains constant. Capital efficiency can be equated to scalability. But decentralization is often replaced with "censorship resistance."
Censorship resistance is a fundamental property of cryptocurrency, but compared to the concept of decentralization, it is merely a sub-category. This shift occurs because most newer stablecoins (with exceptions like Liquity and its forks) possess certain centralized characteristics.
For instance, even if these projects utilize decentralized exchanges (DEXs), a core team often remains responsible for managing strategies, seeking yield, and redistributing it to holders, who essentially act like shareholders. In this model, scalability comes from the amount of yield generated, not from internal DeFi composability.
Genuine decentralization has taken a back seat.
The Driving Forces Behind the Shift
Too much dream, not enough reality. The events of March 12, 2020 ("Black Thursday") are well-known, where a market-wide crash triggered by the COVID-19 pandemic caused significant issues for decentralized stablecoins like DAI. Since then, its collateral backing shifted primarily to USDC, making it a quasi-substitute and, to some extent, an admission of decentralization's failure in the face of the dominance of centralized entities like Circle and Tether.
Simultaneously, attempts at algorithmic stablecoins like UST or rebase tokens like Ampleforth did not achieve their intended results. Subsequent legislation has further complicated the landscape. Meanwhile, the rise of institutional stablecoins has dampened experimental fervor.
However, one attempt at decentralization has seen growth. Liquity stands out due to the immutability of its contracts and its use of Ethereum as the sole collateral, pushing for pure decentralization. Yet, its scalability has been lacking.
Their recent V2 launch introduced multiple upgrades to enhance peg security and offer better interest rate flexibility when minting its new stablecoin, BOLD. Nevertheless, several factors limit its growth. Its loan-to-value (LTV) ratio for loans generating its stablecoin is around 90%, which is not high compared to the capital efficiency of non-yielding giants like USDT and USDC. Furthermore, direct competitors offering intrinsic yield, such as Ethena, Usual, and Resolv, can offer LTVs up to 100%.
The primary issue, however, may be the lack of a massive distribution model. It remains closely tied to the early Ethereum community, with less focus on use cases like proliferation on DEXs. While its cyberpunk ethos resonates with crypto purists, it may limit mainstream growth if not balanced with broader DeFi or retail adoption.
Despite its limited Total Value Locked (TVL), it's fascinating that Liquity is one of the most forked projects in crypto by TVL, with V1 and V2 combined holding over $370 million.
Regulation and The "Genius Act"
Proposed legislation, often nicknamed the "Genius Act," aims to bring more stability and recognition to stablecoins in the United States. However, it focuses exclusively on traditional, fiat-backed stablecoins issued by licensed and regulated entities.
Any decentralized, crypto-collateralized, or algorithmic stablecoin falls into a regulatory gray area or is explicitly excluded. This legal pressure further incentivizes the development of centralized models, sidelining decentralized alternatives.
Value Proposition and Distribution Models
Stablecoins are the shovels in a gold rush. Their models vary significantly:
- Hybrid/Institutional Projects: Initiatives like BlackRock's BUIDL aim to bridge TradFi by targeting institutional players.
- Web2 Entrants: Projects like PayPal's PYUSD seek to expand their total addressable market (TAM) by reaching native crypto users but face scalability issues due to a lack of experience in the new domain.
Strategy-Focused Projects: These include:
- Real-World Asset (RWA) Backed: Stablecoins like Ondo's USDY and Usual's USDO aim for sustainable returns based on real-world yield (as long as interest rates remain high).
- Delta-Neutral Strategies: Projects like Ethena's USDe and Resolv's USR focus on generating yield for holders through sophisticated financial engineering.
All these projects share a common trait, albeit to varying degrees: centralization.
Even DeFi-focused projects employing delta-neutral strategies are managed by an internal team. While they may leverage Ethereum in the backend, the overall management is centralized. Arguably, such projects should be classified more as derivatives than stablecoins.
New emerging ecosystems like MegaETH and HyperEVM also bring fresh hope for decentralization. Projects built on them, such as CapMoney, plan to start with a centralized decision-making model with the goal of gradually decentralizing through economic security provided by layers like EigenLayer.
Additionally, Liquity forks like Felix Protocol are experiencing significant growth, establishing themselves as the native stablecoin on their respective chains. These projects choose to focus on a distribution model centered on emerging blockchains, leveraging the "novelty effect."
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Frequently Asked Questions
What is the stablecoin trilemma?
The stablecoin trilemma is a concept stating that it's extremely difficult for a stablecoin to simultaneously achieve perfect price stability, full decentralization, and high capital efficiency. Optimizing for two of these attributes often requires compromising on the third.
Why are most stablecoins becoming more centralized?
The push for scalability, yield generation for holders, and navigating an increasingly strict regulatory landscape have made centralized models simpler, more controllable, and more adaptable for project developers. Centralized entities can more easily integrate with traditional finance.
Is centralization always bad for a stablecoin?
Not necessarily. Centralization can offer benefits like stronger operational control, faster decision-making, and easier regulatory compliance, which can lead to greater short-term stability and adoption. However, it often comes at the cost of censorship resistance and alignment with crypto's original ethos of decentralization.
What is an example of a decentralized stablecoin?
Liquity (LQTY) and its fork, Felix Protocol, are prominent examples. They use excess crypto collateral (like ETH) to mint stablecoins without relying on centralized asset managers or real-world assets, maintaining a high degree of decentralization and censorship resistance.
How does regulation impact decentralized stablecoins?
Current regulatory proposals, particularly in the U.S., primarily focus on licensing issuers of fiat-backed stablecoins. This creates a challenging environment for decentralized, algorithmic, or crypto-collateralized stablecoins, potentially classifying them differently or restricting their operation, thus stifling innovation in decentralized models.
Can a stablecoin be truly censorship-resistant?
A stablecoin can approach censorship resistance if it is sufficiently decentralized, with no single point of control that can freeze funds or block transactions. This requires robust, immutable smart contracts and a collateral system not reliant on centralized assets. True censorship resistance remains a key differentiator for purist crypto projects.
Conclusion
Centralization is not inherently negative. For projects, it is simpler, more controllable, more scalable, and more adaptable to legislation. It often provides the path of least resistance for growth and stability.
However, this compromises the original ethos of cryptocurrency. What guarantees that a stablecoin is truly censorship-resistant? That it is not just an on-chain dollar IOU but a genuine user-owned asset? No centralized stablecoin can make that promise.
Therefore, while emerging hybrid alternatives are attractive for their yield and efficiency, we should not forget the original stablecoin trilemma and the continued pursuit of its three core pillars:
- Price Stability
- Decentralization
- Capital Efficiency
The balance between these ideals continues to define the evolution of money in the digital age.