Revisiting the Stablecoin Trilemma: The Current Decline of Decentralization

Written by: Chilla  Compiled by: Block unicorn

Foreword

Stablecoins are getting a lot of attention, and for good reason. Beyond speculation, stablecoins are one of the few products in the cryptocurrency 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 financial (TradFi) market in the next five years.

However, all that glitters is not gold.

The initial stablecoin trilemma

New projects often use charts to compare their positioning with their main competitors. What is striking, but often downplayed, is the obvious regression in decentralization in the near future.

The market is developing and maturing. The need for scalability collides with the anarchic dream of the past. But there should be a balance 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: No single entity controls, bringing censorship resistance and trustlessness.

• Capital efficiency: No excessive collateral is required to maintain the peg.

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

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

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

Censorship resistance is a fundamental feature of cryptocurrencies, but it is only a subcategory compared to the concept of decentralization. This is because the latest stablecoins (except Liquity and its forks, and a few other examples) have certain 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 are essentially like shareholders. In this case, scalability comes from the amount of returns, not the composability within DeFi.

True decentralization has suffered.

Motivation

Too much dreaming, not enough reality. DAI’s fate 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, to a certain extent, an admission of decentralization’s failure in the face of the hegemony of Circle and Tether. Meanwhile, algorithmic stablecoins like UST, or attempts at rebasing stablecoins like Ampleforth, have not yielded the expected results at all. Later, legislation further exacerbated the situation. Meanwhile, the rise of institutional stablecoins has dampened experimentation.

However, one attempt has seen growth. 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 peg security and provide better interest rate flexibility when minting their new stablecoin BOLD.

However, a few 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 non-yielding USDT and USDC. Additionally, direct competitors that offer intrinsic returns, such as Ethena, Usual, and Resolv, also have LTVs of 100%.

However, the main issue may be the lack of a large-scale distribution model. Because it is still closely associated with the early Ethereum community, there is less focus on use cases such as proliferation on DEX. While the cyberpunk vibe fits the cryptocurrency ethos, it could limit mainstream growth if it is not balanced with DeFi or retail adoption.

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

The Genius Act

This should bring more stability and acceptance to stablecoins in the US, 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 stablecoins either fall into a regulatory gray area or are excluded.

Value Proposition & Distribution

Stablecoins are the shovels that dig into the gold mine. Some are hybrid projects that are primarily institutional (such as BlackRock's BUIDL and World Liberty Financial's USD1) and aim to expand the traditional finance (TradFi) space; others are from Web2.0 (such as PayPal's PYUSD) and aim to expand their total addressable market (TOMA) by reaching out to native cryptocurrency users, but they face scalability issues due to their lack of experience in new areas.

Then, there are projects that focus primarily on underlying strategies, such as RWAs (such as 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 (such as 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 in-house 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 in the native stablecoin of the chain.

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

Conclusion

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

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

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

• Price stability

• Decentralization

• Capital efficiency