Revisiting the Trilemma of Stablecoins: The Current Decline of Decentralization

Stablecoins are highly followed, and this is not without reason. Besides speculation, stablecoins are one of the few products in the crypto assets field that have a clear product-market fit (PMF).

Written by: Chilla

Compiled by: Block unicorn

Preface

Stablecoins are garnering a lot of attention, and it's not without reason. Apart from speculation, stablecoins are one of the few products in the Crypto Assets space that have a clear product-market fit (PMF). Nowadays, the world is discussing the trillions of stablecoins expected to flow into the traditional financial (TradFi) markets over the next five years.

However, not all that glitters is gold.

The Initial Stablecoin Trilemma

New projects often use charts to compare their positioning with major competitors. What is striking but often downplayed is the recent apparent regression in decentralization.

The market is evolving and maturing. The demand for scalability clashes with the anarchic dreams of the past. However, a balance should be found to some extent.

Initially, the stablecoin trilemma is based on three key concepts:

• Price stability: Stablecoins maintain a stable value (usually pegged to the US dollar).
• Decentralization: No single entity controls it, bringing features of censorship resistance and trustlessness.
• Capital efficiency: Maintain the peg without excessive collateral.

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

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

However, you can see that price stability remains unchanged. Capital efficiency can be equated with scalability. But decentralization has been changed to censorship resistance.

Resistance to censorship is a fundamental characteristic of Crypto Assets, but compared to the concept of decentralization, it is merely a subcategory. This is because the latest stablecoins (aside from Liquity and its forks, as well as a few other examples) exhibit certain centralized features.

For example, even if these projects utilize decentralized exchanges (DEX), there is still a team responsible for managing strategies, seeking returns, and redistributing them to holders, who essentially act like shareholders. In this case, scalability comes from the amount of returns rather than the composability within DeFi.

True decentralization has been hindered.

Motivation

Too many dreams, not enough reality. On Thursday, March 12, 2020, due to the COVID-19 pandemic, the entire market crashed, and DAI's experience is well known. Since then, reserves have mainly shifted to USDC, making it an alternative, and to some extent acknowledging the failure of decentralization in the face of the dominance of Circle and Tether. Meanwhile, attempts at algorithmic stablecoins like UST, or rebase stablecoins like Ampleforth, have not achieved the expected results at all. Afterwards, legislation further worsened the situation. At the same time, the rise of institutional stablecoins weakened experimentation.

However, one attempt has achieved growth. Liquity stands out for its contract immutability and the use of Ethereum as collateral to promote pure decentralization. However, its scalability is somewhat lacking.

Now, they have recently launched V2, which enhances peg security through multiple upgrades and offers better rate flexibility when minting their new stablecoin BOLD.

However, several factors limit its growth. Compared to the capital-efficient yet unprofitable USDT and USDC, the loan-to-value (LTV) ratio of its stablecoin is around 90%, which is not very high. In addition, direct competitors that offer intrinsic yields, such as Ethena, Usual, and Resolv, have also achieved an LTV of 100%.

However, the main issue may be the lack of a large-scale distribution model. Because it is still closely related to the early Ethereum community, there is less focus on use cases such as diffusion on DEX. Although the cyberpunk atmosphere aligns with the spirit of Crypto Assets, failing to balance with DeFi or retail adoption may limit mainstream growth.

Despite the limited Total Value Locked (TVL), Liquity is one of the projects with the most TVL in its forks in the Crypto Assets, with a total of $370 million for V1 and V2, which is fascinating.

The Genius Act

This should bring more stability and recognition to the United States' stablecoin, but at the same time, it only focuses on traditional, fiat-backed stablecoins issued by licensed and regulated entities.

Any decentralized, encrypted collateral or algorithmic stablecoin falls either into a regulatory gray area or is excluded.

Value Proposition and Distribution

Stablecoins are the shovels for digging gold mines. Some are hybrid projects aimed primarily at institutions (such as BlackRock's BUIDL and World Liberty Financial's USD1), intending to expand into traditional finance (TradFi); others come from Web 2.0 (like PayPal's PYUSD), aiming to increase their total addressable market (TOMA) by deeply engaging with native crypto asset users, but they face scalability issues due to a lack of experience in new fields.

Then, there are some projects that mainly focus on underlying strategies, such as RWA (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), as well as Delta-Neutral strategies (like Ethena's USDe and Resolv's USR), which focus on generating income for holders.

All these projects have one thing in common, although to varying degrees, and that is: centralization.

Even projects focused on decentralized finance (DeFi), such as Delta-Neutral strategies, are managed by internal teams. While they may utilize Ethereum in the background, the overall management remains 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, aiming to gradually achieve decentralization through the economic security provided by Eigen Layer. In addition, there are fork projects of Liquity like Felix Protocol, which is experiencing significant growth and establishing its position among the native stablecoins of the chain.

These projects choose to focus on distribution models centered around emerging blockchains, leveraging the advantages of the "novelty effect."

Conclusion

Centralization itself is not negative. For projects, it is simpler, more controllable, more scalable, and better adapted to legislation.

However, this does not align with the original spirit of Crypto Assets. What can guarantee that a stablecoin truly possesses censorship resistance? Is it merely an on-chain dollar, or is it a real user asset? No centralized stablecoin can make such a promise.

Therefore, even though emerging alternatives are very attractive, we should not forget the original stablecoin trilemma:

• Price Stability
• Decentralization
• Capital Efficiency