Di Claude Eguienta is the CEO of Mime
Stablecoins are among the most revolutionary cryptocurrencies ever created. The idea behind it is pretty simple: Traditional cryptocurrencies like Bitcoin (BTC) and Ether (ETH) can be volatile. This makes it risky to use them as a store of value or medium of exchange. Hence, to eliminate this risk, the inherent volatility must be eliminated.
This risk is removed by pegging the value of a digital currency to a specific asset. Tether’s USDT, which is now the most popular stablecoin, was one of the first digital assets to do this successfully. Ideally, each token’s value is pegged to something with a stable price (e.g. the US dollar), giving it the stability needed to become a good store of value and medium of exchange.
Tether served its purpose quite well. However, there were some problems, most notably the lack of transparency around Tether’s reserves. This was one of the inspirations for Circle to launch its own stablecoin, USDC. Since then, multiple stablecoins have been created, such as Binance’s BUSD and Maker’s DAI, all of which are pegged to the US dollar.
Thanks to this idea, now there is close to $130 billion value of stable cryptocurrencies in circulation. And while this certainly provides a large enough pillar for the crypto space to lean on, it can be argued that modern stablecoins have yet to represent the best that stablecoins can be. Far from it, in fact.
Centralization and decentralization both have problems. 2022 has seen a number of centralized entities collapse due to various types of mismanagement, while decentralized blockchains – stablecoins and more – are still clunky and difficult.
Centralized and decentralized stablecoins
Most of the current stablecoins are issued and controlled by centralized entities. USDT is issued by Tether, USDC by Circle and BUSD by Binance. All of these institutions can be censored or engage in censorship themselves, and perhaps most importantly, they raise some big questions about transparency.
Stablecoins like DAI have emerged as a potential solution to this problem. DAI is a stablecoin issued by the Maker Protocol. The protocol is controlled by a Decentralized Autonomous Organization (DAO), making it censorship-proof.
But as history has shown, even decentralized stablecoins can fail.
TerraUSD (UST), the decentralized algorithmic stablecoin of the Terra blockchain, is one of the best-known examples. UST relied on an algorithm that would burn the blockchain’s other native token, LUNA, to keep its value pegged at $1. It was initially a huge success, becoming one of the largest stablecoins just a few months after launch.
However, FSO’s tenure at the top did not last long. Its algorithmic and unsecured design has made it vulnerable to volatility. This weakness would be exposed after a couple of big trades May 2021 broke UST’s peg to the dollar. All attempts by Terraform Labs, the creator of the Terra blockchain, to help the token regain its anchor would fail.
This failure resulted in investors losing billions of dollars.
If these were the only problems faced by stablecoins, they would be enough to send us back to the drawing board. But, just like in a late night commercial, there’s more.
A lack of returns
The lack of returns is not often talked about, but it affects all stablecoins, centralized and decentralized. Assuming the stablecoin works as expected if an investor decides to buy and hold $1000 worth of USDT for one year, it will still be worth $1000 at the end of that period.
Now, there are two ways to look at this. The investor didn’t suffer from volatility, he kept his money which is good.
But on the other hand, the investor took a centralization risk and was not paid for it. Indeed, taking inflation into account, it can honestly be said that they have lost some value.
It becomes more significant when you consider the lost investment opportunities. Unlike the cryptocurrency market, traditional finance is home to some of the best low-risk investment instruments. These include treasuries and corporate bonds, which have seen their yields rise since the pandemic.
Unfortunately, these are currently only accessible via fiat. Hence, investors who store their money in stablecoins are actually limited, as they cannot access these opportunities unless they take their money off-chain. This limits conventional stablecoins as a store of value even against the fiat dollar.
Terra, the creator of the UST stablecoin, attempted to solve this problem by creating Anchor. This is a protocol that paid a 19.5% APY on any UST deposited. This made it the highest interest savings account for UST holders.
Anchor was essentially offering high interest on an interest-free asset. So, with time, people have started to see the protocol as one of the safest investment opportunities on the blockchain, which has attracted many UST investors. Unfortunately, Anchor’s performance was not economically viable but rather subsidized, unbeknownst to most of its users.
Then a question arises. Are stablecoins a good investment or is the asset class too narrow?
What’s the solution?
A better stablecoin would ideally be an asset that addresses all of the above issues. It would perfectly balance centralization and decentralization to minimize the inherent risks of both while maximizing the benefits of each.
This introduces the idea of a new generation of stablecoins. One that uses transparency to gain public trust while expanding its usefulness to remove limiting factors such as opportunity cost.
This new generation of centralized stablecoins will have multiple centralized backers instead of one. This will reduce the risk of centralization and, ideally, these centralized advocates will span multiple jurisdictions.
Stablecoins that generate revenue for both their DAO and their users will become commonplace. The model of keeping all bank-derived earnings – as Circle does – will create opportunities for new entrants. Even the most decentralized stablecoins will likely incorporate things like liquid staking tokens (LSDs) to help them generate yield.
Decentralized exchanges will become so efficient that you will have more stablecoins with less liquidity still thriving, making competition healthier.
The concept of a true stablecoin doesn’t work and will be less likely to work as we grow. In simple terms, it puts too much pressure and reliance on a single entity and is counterintuitive to why DeFi was created in the first place
Non-dollar-denominated coins, or even stablecoins representing a basket of items, will grow if the macro backdrop remains uncertain. This coincides with the multiple sources of support theory above.
Several blockchains are catching on and the one true chain ideology doesn’t seem to be under attack, so stablecoins that are able to run on multiple chains smoothly will benefit users.
And despite growing concern about CBDCs, they probably won’t be a big deal.
Unless massive regulatory changes occur, CBDCs will not replace stablecoins as their goal will not match what stablecoins will be able to deliver. Indeed, CBDCs may simply fall into the same trap that current stablecoins face: lack of yield, currency hedging, privacy protections, and resistance to censorship.
However, there may be an upside to CBDCs and they may partially support some stablecoins. But the reality is that the best stablecoins we will see will offer as many of these benefits as possible. Current industry leaders will face much-needed competition, and eventually stablecoin operator margins will shrink, providing better returns and greater utility for all.
About the author:
Claude Eguienta is the CEO of Mime, a company that creates protocols that provide tokenized real-world assets and enable the minting of multiple currencies at a stable price against collateral for its users. Claude worked for startups and large tech companies for over a decade after graduating with a Masters in Computer Science, focused on distributed systems. In the past he co-founded Telcoin, a startup focused on financial inclusion through blockchain remittances, and Kabotip, a crypto startup that passed through the OnLab incubator.
Claude is a software engineer driven by his desire to make the world a better place. He was raised in France, educated in China and the United States, and has lived in Japan and the United Arab Emirates for most of his professional life. He speaks French, English, Chinese and Japanese.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.