Apparently, no stable coin can be capital efficient, decentralized, and “stable” at the same time. At best, they can only achieve two simultaneously.
But don’t take my word for it, take a look. Fiat-backed stables like USDT are very capital efficient, you only need $1 to mint 1 USDT. They’re also fairly stable since they have the simplest peg maintenance mechanism (the best imo). But that’s at the expense of decentralization.
Crypto collateralized stables like $LUSD and $RAI are also stable, thanks to their over-collateralization. And more importantly, they are decentralized. But their over collateralized nature means you need more than $1 to mint one stable coin making them capital inefficient. Algorithmic and fractional reserve stables like UST and IRON tried to achieve all 3.
Capital efficiency – they weren’t over collateralized. They were decentralized. But this has proven to be achieved at the cost of peg stability which is the most important feature of a stable btw. But what if someone solved it?
There’s another class of stable coins that theoretically solves the trilemma using an insanely simple method. Delta-neutral stable coins. Here’s how they work.
To mint 1$ of the stable, you only have to provide 1$ collateral. $0.5 is held in spot while the other half is used to open a short position on the coin provided as collateral.
Both positions cancel out each other so the overall collateral always remains 1$. But the next issue becomes funding rates.
@UXDProtocol solves this by saving and investing the positive funding rates in tokenized U.S. treasury bills. And then paying the negative funding rate from that reserve. It works so well that the protocol actually generates yield.But even if we have an extended period of -ve rates, they also have measures in place for that.
But imo, I think that can easily be solved by placing a perp long with the other half of the collateral instead of holding it in spot. That way, the stable is unaffected by funding rates. But here’s the major problem I see with this method.
The protocol has to rely on another protocol to provide the perp dex where the short position will be placed. This adds another layer of risk since an exploit on the perp would also affect the stable coin. berachain’s stable coin $HONEY also works with this model and this risk is mitigated since they have their own native perp DEX.
The peg maintenance mechanism for these stables is arbitrage just like fiat-backed stables. The simplest mech there is.This all seems too good and has me wondering why these stables haven’t seen better adoption. Coz it seems they just solved the trilemma.
PROBLEMS ASSOCIATED WITH STABLE COINS (USDT)
While USDT (Tether) is one of the most popular stable coins in the cryptocurrency market, it has faced several controversies and concerns. Here are some of the problems associated with USDT
LACK OF FULL TRANSPARENCY
Tether Limited, the company behind USDT, has been criticized for not providing regular audits to prove that the amount of USDT in circulation is fully backed by an equivalent amount of fiat currency reserve
RESERVE BACKING CONCERNS
USDT claims to be backed 1:1 by the US dollar. However, due to the lack of transparency, doubts have been raised about whether Tether has sufficient reserves to fully support all the USDT tokens in circulation
LEGAL AND REGULATORY ISSUES
Tether has been subject to investigations by the U.S. Department of Justice (DOJ) over allegations of market manipulation. Additionally, concerns have been raised about potential risks associated with the lack of regulatory oversight and compliance
POTENTIAL IMPACT ON THE BROADER CRYPTO MARKET
As USDT is widely used as a stablecoin for trading and liquidity purposes in the cryptocurrency market, any adverse events related to its stability or lack of backing could have a negative impact on the entire market
Users who hold USDT on exchanges or other platforms face counterparty risk, meaning that if the platform becomes insolvent or faces legal issues, the value of their USDT holdings could be at risk
ALTERNATIVE STABLE COIN COMPETITION
With the emergence of various other stablecoins, such as USDC, BUSD, and DAI, USDT has faced increased competition, and some users may choose to switch to other stablecoin options due to concerns about USDT’s transparency and stability
It’s important to note that while these problems have been highlighted, USDT remains widely used and has maintained its status as the largest stablecoin by market capitalisation but the question still remains is Tether going to fail?