Reassessing the Development Dilemma of Stablecoins: The Challenges of Decentralization

Stablecoins, as one of the few applications in the cryptocurrency space that have truly found product-market fit, have received significant attention in recent years. The industry widely expects that hundreds of billions of dollars worth of stablecoins will flow into traditional financial markets within the next five years. However, the development path of stablecoins is not smooth sailing.

The Trilemma of Stablecoins

The three dilemmas faced by stablecoins initially include:

1. Price stability: Maintaining a stable peg to fiat currencies such as the US dollar.
2. Decentralization: Avoid single entity control, achieve censorship resistance and trustlessness.
3. Capital efficiency: Maintaining the peg without excessive collateral.

However, after multiple experiments, scalability remains a huge challenge. This has prompted the industry to re-examine and adjust these concepts.

Recent positioning maps of some mainstream stablecoin projects show that Decentralization has been replaced by anti-censorship. Although anti-censorship is one of the fundamental characteristics of cryptocurrency, it is merely a subset of Decentralization. This reflects that most emerging stablecoin projects exhibit some degree of centralized features.

For example, even when using the decentralized exchange (DEX), many projects are still managed by teams that formulate strategies, seek profits, and distribute them to holders. In this model, scalability primarily comes from the scale of profits rather than the composability of the DeFi ecosystem.

Decentralization Setbacks

True decentralization has encountered significant setbacks in the stablecoin space. The market crash on March 12, 2020, exposed the vulnerabilities of decentralized stablecoins like DAI. Since then, many projects have turned to USDC as their primary reserve, which to some extent acknowledges the failure of decentralization in the face of centralized giants like Circle and Tether.

At the same time, the attempts of algorithmic stablecoins like UST and rebase stablecoins like Ampleforth have not achieved the expected results. The tightening of regulations has further exacerbated this trend, while the rise of institution-led stablecoins has also weakened the motivation for Decentralization experiments.

In this context, Liquity stands out due to the immutability of its smart contracts and its pure reliance on Ethereum as collateral. However, its scalability still has shortcomings. The recently launched V2 version of Liquity has enhanced peg security through multiple upgrades and offers more flexible interest rate options when minting the new stablecoin BOLD.

Despite this, Liquity's growth still faces some limiting factors. Compared to competitors with higher capital efficiency such as USDT and USDC, its approximately 90% loan-to-value ratio (LTV) does not have a significant advantage. In addition, competitors like Ethena, Usual, and Resolv, which offer intrinsic yields, have raised their LTV to 100%.

More critically, Liquity may lack an effective large-scale distribution model. It is still mainly limited to the early Ethereum community, with insufficient attention to broader applications such as DEX. Although its cyberpunk style aligns with the spirit of cryptocurrency, failing to strike a balance between the DeFi ecosystem and mainstream user adoption may hinder its mainstreaming process.

Regulatory Trends and Value Propositions

The introduction of the U.S. "Genius Act" is expected to bring more stability and recognition to stablecoins, but it primarily focuses on stablecoins backed by traditional fiat currencies issued by licensed and regulated entities. This leaves decentralized, crypto-asset collateralized, or algorithmic stablecoins either in a regulatory gray area or completely excluded.

In this environment, different types of stablecoin projects are exploring their respective value propositions and distribution strategies:

• Some hybrid projects like BlackRock's BUIDL and World Liberty Financial's USD1 primarily target institutional investors, attempting to penetrate the traditional financial sector.
• Projects from Web 2.0 like PayPal's PYUSD aim to expand their market by attracting native cryptocurrency users, but their lack of experience in this new field has resulted in limited scalability.
• There are also some projects focusing on underlying strategies, such as Ondo's USDY and Usual's USDO, which are stablecoins based on real-world assets ( RWA ), as well as Ethena's USDe and Resolv's USR, which adopt Delta-Neutral strategies, aimed at creating sustainable returns for holders.

The common feature of these projects is varying degrees of centralization. Even projects focused on DeFi with Delta-Neutral strategies are managed by internal teams. Although they may leverage Ethereum in the background, the overall operation is still centralized.

At the same time, emerging ecosystems such as MegaETH and HyperEVM have also brought new possibilities. For example, the CapMoney project aims to gradually achieve Decentralization through the economic security provided by Eigen Layer. Fork projects of Liquity like Felix Protocol have also seen significant growth on emerging public chains.

Conclusion

Centralization is not entirely negative. For projects, it means simpler, more controllable, easier to scale, and more adaptable to regulatory requirements. However, this is contrary to the original intent of cryptocurrency. Assets that are truly censorship-resistant and fully owned by users are a promise that centralized stablecoins find hard to fulfill.

Therefore, although emerging alternatives are highly attractive, we should not forget the three dilemmas that stablecoins initially face: price stability, Decentralization, and capital efficiency. Balancing these three core elements while pursuing scalability and regulatory compliance remains a significant challenge in the field of stablecoins.