Revisiting the Stablecoin Trilemma: The Current Decline of Decentralization

Author: Chilla

Compiled by: Block unicorn

Preface

Stablecoins are getting a lot of attention, and for good reason. Beyond speculation, stablecoins are one of the few products in the crypto space that have a clear product-market fit (PMF). Today, the world is talking about the trillions of stablecoins that are expected to flood into the traditional finance (TradFi) market in the next five years.

However, all that glitters is not gold.

The original stablecoin trilemma

New projects often feature charts comparing their positioning to their main competitors. What is striking, but often downplayed, is the apparent recent setback from decentralization.

The market is developing and maturing. The need for scalability collides with the anarchic dreams of the past. But a balance should be found to some extent.

Originally, the stablecoin trilemma was based on three key concepts:

• Price stability: Stablecoins maintain a stable value (usually pegged to the US dollar).
• Decentralization: There is no single entity controlling the system, which makes it censorship-resistant and trustless.
• Capital efficiency: No excessive collateral is required to maintain the peg.

However, after many controversial experiments, scalability remains a challenge. Therefore, these concepts are constantly evolving to adapt to these challenges.

The above image is from one of the most prominent stablecoin projects in recent years. It deserves praise, mainly due to its strategy of going beyond stablecoins and developing into more products.

However, you can see that price stability remains the same. Capital efficiency can be equated with scalability. But decentralization is changed to censorship resistance.

Censorship resistance is a fundamental property of cryptocurrencies, but it is only a subcategory compared to the concept of decentralization. This is because the latest stablecoins (with the exception of Liquity and its forks, and a few other examples) have some centralized characteristics.

For example, even if these projects utilize decentralized exchanges (DEX), there is still a team responsible for managing the strategy, seeking returns and redistributing them to holders, who essentially act like shareholders. In this case, scalability comes from the amount of returns, not the composability within DeFi.

True decentralization has been thwarted.

motivation

Too much dreaming, not enough reality. DAI’s experience is well known on Thursday, March 12, 2020, when the entire market plummeted due to the COVID-19 pandemic. Since then, reserves have been mainly transferred to USDC, making it an alternative and a certain admission of the failure of decentralization in the face of the hegemony of Circle and Tether. At the same time, attempts at algorithmic stablecoins like UST, or rebase stablecoins like Ampleforth, have not yielded the expected results at all. Later, legislation further exacerbated the situation. At the same time, the rise of institutional stablecoins has weakened experimentation.

However, one attempt has gained ground. Liquity stands out for its immutability of contracts and its use of Ethereum as collateral to drive pure decentralization. However, its scalability is lacking.

Now, they recently launched V2 with several upgrades to enhance the peg security and provide better interest rate flexibility when minting their new stablecoin BOLD.

However, several factors have limited its growth. Its stablecoin’s loan-to-value ratio (LTV) is about 90%, which is not high compared to the more capital-efficient but yield-free USDT and USDC. In addition, direct competitors that offer intrinsic returns, such as Ethena, Usual, and Resolv, also have LTVs of 100%.

However, the main problem may be the lack of a large-scale distribution model. Because it is still closely related to the early Ethereum community, less attention is paid to use cases such as diffusion on DEX. Although the cyberpunk atmosphere is in line with the spirit of cryptocurrency, it may limit mainstream growth if it is not balanced with DeFi or retail adoption.

Despite its limited Total Value Locked (TVL), Liquity is one of the projects whose forks hold the most TVL in crypto, with V1 and V2 totaling a fascinating $370 million.

Genius Act

This should bring more stability and acceptance to stablecoins in the U.S., but at the same time it only focuses on traditional, fiat-backed stablecoins issued by licensed and regulated entities.

Any decentralized, crypto-collateralized, or algorithmic stablecoin either falls into a regulatory gray area or is excluded.

Value Proposition and Distribution

Stablecoins are shovels for digging gold mines. Some are hybrid projects that are mainly for institutions (such as BlackRock's BUIDL and World Liberty Financial's USD1) and aim to expand the traditional financial (TradFi) field; some are from Web2.0 (such as PayPal's PYUSD) and aim to expand their total potential market (TOMA) by deepening the native cryptocurrency users, but they face scalability issues due to lack of experience in new fields.

Then, there are projects that focus primarily on underlying strategies, such as RWAs (like Ondo’s USDY and Usual’s USDO), which aim to achieve sustainable returns based on real-world value (as long as interest rates remain high), and Delta-Neutral strategies (like Ethena’s USDe and Resolv’s USR), which focus on generating yield for holders.

All of these projects have one thing in common, albeit to varying degrees: centralization.

Even projects focused on decentralized finance (DeFi), such as Delta-Neutral Strategies, are managed by internal teams. While they may leverage Ethereum in the background, the overall management is still centralized. In fact, these projects should theoretically be classified as derivatives rather than stablecoins, but this is a topic I have discussed before.

Emerging ecosystems such as MegaETH and HyperEVM also bring new hope.

For example, CapMoney will adopt a centralized decision-making mechanism in the initial months, with the goal of gradually achieving decentralization through the economic security provided by the Eigen Layer. In addition, there are forked projects of Liquity such as Felix Protocol, which is experiencing significant growth and has established itself as the native stablecoin of the chain.

These projects choose to focus on distribution models centered around emerging blockchains and take advantage of the “novelty effect.”

in conclusion

Centralization itself is not a negative. It is simpler, more controllable, more scalable, and more amenable to legislation for projects.

However, this is not in line with the original spirit of cryptocurrency. What guarantees that a stablecoin is truly censorship-resistant? It is not just a dollar on the chain, but a real user asset? No centralized stablecoin can make such a promise.

So, while emerging alternatives are attractive, we should not forget the original stablecoin trilemma:

• Price stability
• Decentralization
• Capital efficiency