From Human Decision-Making to Code Governance: How Do Third-Party Stablecoins Enable Self-Generating Returns?

Original Title: “Type III Stablecoins”

Original Author: STANFORD BLOCKCHAIN CLUB

Stablecoins, as a key component of the cryptocurrency space, have seen their total market capitalization of liquid assets surpass $200 billion, firmly establishing their central role in today's crypto market. Some believe that the scale of stablecoins has decoupled from the volatile cryptocurrency market—despite a correction in the crypto market in 2025, stablecoins continue to demonstrate strong resilience, with an increasing number of traditional financial institutions integrating decentralized finance (DeFi) into their solutions.

Currently, stablecoins serve two main functions: fiat currency settlement and store of value (SoV). The daily trading volume of stablecoins has reached a historic high of $81 billion, with USDT and USDC capturing over 95% of the market share in both mature economies and emerging markets. They represent not only simple transactions but also financial inclusivity and the demand for low-volatility currencies.

However, the acceptance of yield-bearing stablecoins is vastly different from that of value storage. Despite the continuous innovation in the DeFi space, yield-bearing stablecoins remain a niche application within the stablecoin ecosystem. The total market capitalization of yield-bearing stablecoins is about 10% of the market cap of USDT and USDC.

Why is there such a disparity? More importantly, how can the current state of yield-bearing stablecoins be improved?

This article will explore the evolution of yield-bearing stablecoins, analyze the mechanisms of yield execution, and ultimately discuss how Cap aims to address scalability and security issues.

The "Coming of Age" of Yield-Bearing Stablecoins: The Evolution from "Survival" to "Profit"

In earlier times, the yields of stablecoins primarily came from endogenous mechanisms; yields were entirely derived from DeFi platforms. Specifically, yields were generated through liquidity provision and platform rewards, creating a closed loop of capital flow where users continuously jumped from one protocol to another in search of higher annual percentage rates. Thus, the scale of yields could only increase with the expansion of platforms.

The most representative example is the crypto over-collateralized stablecoin or collateralized debt position (CDP). The most typical example of a CDP is the early MakerDAO, which minted DAI by using ETH as collateral. This model generates yields by charging interest to borrowers who use their collateral to mint stablecoins. The interest is then redistributed to participants in the protocol, and the entire mechanism operates entirely within the DeFi ecosystem. However, the scale of this model can only expand with the growth in demand for ETH.

Another popular model relies on voting-escrowed tokens (veTokens), where locking these tokens allows protocols to distribute rewards to specific liquidity pools. This has led to the so-called "token wars", in which stablecoin protocols compete for control over liquidity pools to earn rewards from decentralized exchanges (DEXs). These token wars, such as CRV and BAL, involve strategies to drive yields by purchasing DEX tokens.

While the total value locked (TVL) in both of these models has reached billions of dollars, their yields often fluctuate dramatically and carry speculative risks. Most importantly, the demand for these models is limited, especially when compared to applications outside of DeFi mechanisms, where demand appears relatively small.

As a result, founders have been working across the industry to push for the expansion of stablecoins to break through the limitations of endogenous yield models. With the rise of more synthetic dollar strategies backed by fiat or other assets, from T-Bills to hedge fund strategy experiments, stablecoins are beginning to attempt to address the scalability issues of yield-bearing stablecoins.

So, what perspective should we adopt to view these new types of stablecoins?

The "Power Games" of Stablecoins: The Survival Rules of Three Types of Players

The core idea of yield-bearing stablecoins is as the name suggests: reserves issue new currency by lending out high-liquidity assets to execute investment strategies.

Aside from choosing supported assets and lending parameters, the core distinction of yield-bearing stablecoins lies in how they execute yields: who decides which strategies to implement? In the event of bankruptcy, how do users protect their rights?

In other words, the framework relied upon when assessing execution mechanisms is the capital allocation mechanism and security guarantees. Currently, there are mainly two execution methods in the DeFi space: dictatorial and committee-based. This article also introduces a third type—the self-reinforcing yield mechanism that the Cap team is pioneering.

The following sections will delve into each type of stablecoin, particularly focusing on capital allocation and security incentive mechanisms, as well as the corresponding trade-offs.

Type One: The Dictator's Dilemma—Efficiency and Risks of "I Call the Shots"

The first type of stablecoin is a unilateral market, where a single entity generates yields using depositor capital. Examples of this type of stablecoin include Ondo, Ethena, Usual, Agora, Resolv, and other team-operated strategies supporting synthetic assets. They are akin to hedge funds, with dApp teams selecting and executing a single (sometimes few) strategy. As the name suggests, the first type of stablecoin is centralized, with the team having the final say on capital allocation and recourse. Depending on the team, they may offer security guarantees that include over-collateralization, decentralization, and transparency, but this is at the team's discretion, so risks are naturally concentrated.

The primary motivation for adopting this model is to reduce team development costs and enhance user agency. Development costs are low because the protocol focuses on a single strategy (such as basic trading). At the same time, users can switch between different stablecoins of this type, choosing specific strategies.

Incentive Mechanism Adjustments

In this model, the decision-makers are the dApp teams. Generally, the team will optimize yields and security to attract more users. If the yields are not competitive or user funds suffer losses, as more projects are launched, the project may quickly become obsolete. Therefore, the team's attention often focuses on continuously growing TVL and maintaining competitive yields.

In theory, teams should minimize the risks of their strategies. However, these stablecoins mostly exist in the form of bankruptcy-remote entities, and users have no means to protect their rights through regulation or legal means, so teams do not have to prioritize user protection and transparency as strictly regulated financial institutions do.

Trade-offs

The main reason for choosing the first type of stablecoin design is simplicity. Because this model can concentrate resources to achieve a single strategy, they have lower startup costs and can also reduce concerns about potential vulnerabilities. Another advantage is user choice. By focusing on one or two strategies, teams return decision-making power to users, who can move funds between different applications based on market changes.

However, as mentioned earlier, first-type stablecoins often lack effective recourse mechanisms. Their operations resemble unsecured loans to application teams. If a strategy leads to losses, the custodian goes bankrupt, or the team absconds with user deposits, users have little recourse to recover their losses. Moreover, due to the lack of regulation, teams may protect themselves through legal structures, thereby evading responsibility.

Another key issue is the obsolescence of strategies—no strategy can indefinitely generate returns exceeding the market. When teams choose a strategy that aligns with market conditions, they may achieve extraordinary returns exceeding 30%. However, as market conditions change, the teams' yields gradually diminish or are diluted as scale increases. At this point, teams must continuously seek new strategies to adapt to market changes.

Type Two: The Committee's Game—Can "Collective Decision-Making" Cure All Ills?

To address the issue of strategy obsolescence, the second type of stablecoin introduces a mechanism for multiple strategies to operate in parallel. Examples of the second type of stablecoin include Maple and Sky (formerly MakerDAO). They delegate user deposits to various yield strategies, including first-type stablecoin teams and banks and market makers from outside the crypto space, by establishing committees or decentralized autonomous organizations (DAOs). Thus, this model shifts the execution responsibility from a single team to a collectively decision-making organization.

The primary motivation for adopting the second type of stablecoin is scalability. If the current strategy fails to yield substantial returns or carries excessive risks, the DAO can decide to switch to a better strategy, thereby providing users with stronger guarantees of robustness.

Incentive Mechanism Adjustments

Overall, capital allocation decisions are made by governance token holders, representatives, and committees.

The goal of governance token holders is to vote for the most expressive and scalable third-party strategies. Unlike governance tokens in first-type stablecoins, governance token holders in second-type stablecoins have greater decision-making power and can exert more influence on the DAO's decisions in open forums. However, it should also be noted that governance token holders may not necessarily be the participants most knowledgeable about risk management.

Representatives are those actors without governance tokens who exercise voting rights through the authorization of governance token holders. Typically, investors and founders delegate voting rights to professional representatives, DAO service providers, or university blockchain clubs. It is worth noting that representatives may not be bound by the interests of depositors, as their primary source of income comes from fees for proxy services rather than user interests.

The committee serves as the decision-making body within the project, responsible for making a series of specific decisions, including the introduction of new collateral, marketing strategies, and management of other core functions. In the process of allocating capital to generate yields, the committee acts as the direct decision-maker. Similar to representatives, the committee aligns its interests with depositors through monetary rewards obtained from the project. Compared to representatives, the entry requirements for committees are stricter. Members of these committees are often "dxxed"—which adds an extra layer of protection for members who value their public brand.

Trade-offs

A notable feature of the second type of stablecoin is that scalability is achieved through outsourcing. They serve as a layer above yield-bearing stablecoins (including first-type stablecoins), leveraging market forces to achieve large-scale yields. In this model, capital allocation changes with market conditions, and the governance structure reallocates capital based on yield and security performance. Therefore, the second type of stablecoin offers stronger guarantees of robustness compared to the first type.

However, like the first type of stablecoin, the second type also faces the issue of recourse not being guaranteed. If a third-party team incurs financial losses, end users will be unable to recover their losses. Since these organizations are decentralized, legal recourse is also impractical.

Another important factor to consider is the issue of corruption. As past DAO experiments have shown, bribing and corrupting DAO representatives, voters, and committee members can directly influence the security of capital allocation. Special advisory positions, regular payments, and token distributions are common ways to corrupt decision-makers. This directly impacts the security of second-type stablecoins, as corrupted decision-makers may allocate capital to unsafe or malicious actors.

Type Three: Mechanisms as Rules—When Stablecoins Learn to "Self-Sustain"

The third type of stablecoin represents a shift away from human subjective decision-making towards an automatically executed system of mutual rewards and penalties. In a sense, they resemble a protocol rather than a traditional hedge fund. Immutable rules set by smart contracts replace the process of capital allocation and recourse handling conducted by human decision-makers.

The core motivation for adopting the third type of stablecoin is to enhance security and reduce latency. Users are protected at the smart contract level, allowing them to inspect the code to verify the recourse mechanism when strategies fail. Additionally, the response speed to strategy switches in the open market is greatly accelerated, enabling rapid adjustments to market dynamics. This allows the third type of stablecoin to fully leverage market forces and quickly deploy multiple parallel yield strategies.

Cap's Ambition: Creating a "Yield Perpetuum Mobile" for Stablecoins

Currently, there are no third-type stablecoins on the market, and Cap is the first to pioneer this category.

Cap utilizes lending markets and a shared security model (SSM) to provide efficient capital allocation and credible financial guarantees, thereby innovating the first third-type stablecoin. The protocol supervises the ability of third-party operators to generate yields by publishing smart contract-level participation rules. Interested readers are encouraged to read the introductory article for an overview of its mechanisms.

Cap is a three-party market that integrates operators, re-stakers, and end users.

Operators are financial institutions responsible for generating yields. Their participation is regulated by smart contracts and market dynamics. Before operators borrow any assets, the protocol first checks for common over-collateralization or excessive guarantees in the crypto lending market. The difference here is that operators do not invest capital themselves, as doing so would reduce capital efficiency; instead, they accept re-stakers' delegation, using locked crypto assets as collateral. Previously idle re-staked assets begin to earn yields through this new use. Operators must persuade re-stakers to delegate their stakes to them.

Capital allocation to operators is economically adjusted through interest rates set by the lending market mechanism. It is not the team that decides how much funding each operator should receive; rather, operators choose whether to join the protocol based on whether they can provide yields at the current benchmark interest rate. The benchmark interest rate is also programmatically determined—it is the deposit rate of the main lending market plus Cap's usage premium. This usage premium is calculated as a percentage of the borrowed capital, indicating the competitiveness of capital supply under specific market conditions.

Re-stakers earn rewards by delegating to operators. This interest rate is determined by re-stakers and operators through the protocol. Similarly, end users also receive rewards for providing funds, with the interest rate determined by the benchmark yield. The amounts they earn are recorded and distributed on-chain, ensuring the protocol's transparency.

If operators engage in malicious behavior or experience black swan events that lead to losses in borrowed amounts, re-stakers will suffer penalties. The penalties will remove re-stakers' held cryptocurrencies as collateral to compensate end users. The penalized funds will be redistributed to end users, ensuring that recourse is always available and can be verified through code.

Incentive Mechanism Adjustments

Since third-party operators must obtain re-stakers' delegation to borrow, the decision-makers in Cap are effectively the re-stakers. Re-stakers have the final say on which third parties can enter the protocol and generate yields.

Re-stakers are incentivized through the delegation premium provided by operators. Re-staked assets, being locked crypto assets, have low opportunity costs and low capital premiums. In other words, these assets cannot be used to generate significant returns. Therefore, re-stakers have the motivation to delegate this idle value to operators for use. While holding decision-making power, re-stakers are also directly exposed to the outcomes of those decisions, encouraging them to prioritize safety.

It is noteworthy that Cap's ultimate goal is to become a fully permissionless, minimally governed protocol where operators and re-stakers can participate freely. However, given the novelty of the design, in the early stages of the protocol, re-stakers and operators will be certified institutions and will be whitelisted. This provides a safety mechanism for re-stakers, as they have a way to reach agreements with each other and execute legal recourse.

Trade-offs

The key advantage of this model lies in its security. Since decision-makers bear the full risk of their decisions, retail holders need not worry about the yield generation process. All rules are enforced by smart contracts, eliminating the need for human arbitration. This provides retail investors with stronger regulatory protection than traditional finance.

Similar to the second type of stablecoin, the latency in identifying and adopting new strategies is reduced. The system incurs no conversion costs when reallocating capital. Unlike the second type of stablecoin, capital allocation does not require lengthy DAO and committee deliberations. Each re-staker has the right to allocate capital to operators individually and simultaneously.

However, compared to the second type of stablecoin, the third type has higher complexity. This complexity may introduce risks associated with smart contracts, as the entire system relies on code to govern the execution process.

Conclusion: A Paradigm Shift is Inevitable

Currently, interest yields are still far from sufficient to unlock the potential of DeFi. As the stablecoin market continues to grow, there will be an increasing number of strategy-supported interest yield stablecoins. However, unless a paradigm shift occurs in the fundamental design of these stablecoins, the same risks and fatigue will resurface, preventing scalability. Therefore, there is an urgent need to develop a more efficient, scalable, and secure system that transcends the limitations of traditional human decision-making and promotes the widespread adoption of stablecoins.