Revisiting the trilemma of stablecoins: The current decline of Decentralization

Written by: Chilla

Compilation: Block unicorn

Foreword

Stablecoins are receiving a lot of attention, and this is not without reason. Besides speculation, stablecoins are one of the few products in the cryptocurrency 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) market over the next five years.

However, not all that glitters is gold.

The original stablecoin trilemma

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

The market is developing 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: Maintaining the peg without excessive collateral.

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

The above image is taken from one of the most important stablecoin projects in recent years. It is commendable, primarily due to its strategy of going beyond 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 cryptocurrency, but compared to the concept of decentralization, it is merely a subcategory. This is because the latest stablecoins (with the exception of 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 profits, and redistributing them to holders, who are essentially like shareholders. In this case, scalability comes from the amount of profits rather than the composability within DeFi.

True decentralization has been hindered.

motive

There are too many dreams and not enough reality. On Thursday, March 12, 2020, the entire market plummeted due to the COVID-19 pandemic, 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 rebasing stablecoins like Ampleforth, have not achieved the expected results at all. Subsequently, legislation further worsened the situation. At the same time, the rise of institutional stablecoins has weakened experimentation.

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

Now, they have recently launched V2, enhancing hook security through multiple upgrades and providing better interest rate flexibility when minting their new stablecoin BOLD.

However, some factors limit its growth. Compared to the more capital-efficient but unprofitable USDT and USDC, the loan-to-value (LTV) ratio of its stablecoin is around 90%, which is not high. In addition, direct competitors that offer intrinsic yields, such as Ethena, Usual, and Resolv, have also reached 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, it pays less attention to use cases such as diffusion on DEX. While the cyberpunk atmosphere aligns with the spirit of cryptocurrency, failing to balance with DeFi or retail adoption could limit mainstream growth.

Despite the limited Total Value Locked (TVL), Liquity is one of the projects with the highest TVL in cryptocurrencies among its forks, with a total of 370 million dollars for V1 and V2, which is fascinating.

The Genius Act

This should bring more stability and recognition to stablecoins in the United States, 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 and distribution

Stablecoins are the shovels for mining gold. Some are hybrid projects aimed primarily at institutions (e.g., BlackRock's BUIDL and World Liberty Financial's USD1), designed to expand into traditional finance (TradFi); others come from Web2.0 (e.g., PayPal's PYUSD), aimed at expanding their total addressable market (TOMA) by reaching deep into native cryptocurrency users, but they face scalability issues due to a lack of experience in the new field.

Then, there are some projects that mainly focus on underlying strategies, such as RWA (like Ondo's USDY and Usual's USDO), aimed at achieving 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 income for holders.

All 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 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 discussed earlier.

Emerging ecosystems (such as MegaETH and HyperEVM) have also brought 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 such as 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 and leverage the advantages of the "novelty effect."

Conclusion

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

However, this does not align with the original spirit of cryptocurrency. What can guarantee that a stablecoin truly has censorship resistance? It is not just an on-chain dollar, but a real user asset? No centralized stablecoin can make such a promise.

Therefore, despite the appeal of emerging alternatives, we should not forget the original trilemma of stablecoins:

Price Stability

Decentralized

Capital Efficiency