Revisiting the Trilemma of Stablecoins: The Current Decline of Decentralization

Article Author: Chilla

Article Compiled by: Block unicorn

Introduction

Stablecoins have garnered significant attention, and this is not without reason. Beyond speculation, stablecoins are one of the few products in the cryptocurrency space that have a clear product-market fit (PMF). Today, there is global discussion about the trillions of dollars in stablecoins expected to flow into traditional finance (TradFi) markets over the next five years.

However, all that glitters is not gold.

The Initial Stablecoin Trilemma

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

The market is evolving and maturing. The demand for scalability clashes with past anarchic dreams. However, a balance should be found to some extent.

Initially, the stablecoin trilemma was based on three key concepts:
Price Stability: Stablecoins maintain a stable value (usually pegged to the US dollar). Decentralization: No single entity controls it, providing censorship resistance and trustlessness. Capital Efficiency: Maintaining the peg without excessive collateral.

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

The above image is taken from one of the most prominent stablecoin projects in recent years. It deserves praise, mainly due to its strategy of transcending the stablecoin category and evolving into more products.
However, you can see that price stability remains unchanged. Capital efficiency can be equated with scalability. But decentralization has been redefined as censorship resistance.

Censorship resistance is a fundamental characteristic of cryptocurrencies, but compared to the concept of decentralization, it is merely a subcategory. This is because the latest stablecoins (aside from Liquity and its forks, along with a few other examples) exhibit certain centralized characteristics.

For instance, even if these projects utilize decentralized exchanges (DEX), there is still a team responsible for managing strategies, seeking yields, and redistributing them to holders, who essentially act like shareholders. In this case, scalability comes from the amount of yield rather than the composability within DeFi.
True decentralization has been compromised.

Motivation

Too many dreams, not enough reality. On Thursday, March 12, 2020, the entire market crashed due to the COVID-19 pandemic, and the plight of DAI is well-known. Since then, reserves have largely shifted to USDC, making it an alternative and, to some extent, acknowledging the failure of decentralization in the face of Circle and Tether's dominance. Meanwhile, attempts at algorithmic stablecoins like UST or rebase stablecoins like Ampleforth have not achieved the expected results. Subsequently, legislation further worsened the situation. At the same time, the rise of institutional stablecoins has undermined experimentation.

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

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

However, several factors limit its growth. Compared to the more capital-efficient but yield-less USDT and USDC, its stablecoin's loan-to-value (LTV) ratio is about 90%, which is not high. Additionally, direct competitors offering intrinsic yields, such as Ethena, Usual, and Resolv, have also reached an LTV of 100%.

But the main issue may be the lack of a large-scale distribution model. Because it remains closely tied to the early Ethereum community, there is less focus on use cases like diffusion on DEX. While the cyberpunk atmosphere aligns with the spirit of cryptocurrency, failing to balance with DeFi or retail adoption may limit mainstream growth.

Despite limited total value locked (TVL), Liquity is one of the projects with the highest TVL in cryptocurrency, with a combined total of $370 million for V1 and V2, which is fascinating.

The "Genius Act"

This should bring more stability and recognition to stablecoins in the U.S., but 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 altogether.

Value Proposition and Distribution

Stablecoins are the shovels in the gold rush. Some are hybrid projects primarily aimed at institutions (like BlackRock's BUIDL and World Liberty Financial's USD1), designed to expand into the TradFi space; others come from Web 2.0 (like PayPal's PYUSD), aiming to expand their total addressable market (TOMA) by reaching native cryptocurrency users, but they face scalability issues due to a lack of experience in new domains.

Then, there are some projects that focus primarily on underlying strategies, such as RWA (like Ondo's USDY and Usual's USDO), aiming to achieve 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), focusing on generating yields for holders.
All these projects share a commonality, 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, overall management remains centralized. In fact, these projects should theoretically be classified as derivatives rather than stablecoins, but this is a topic I have discussed previously.
Emerging ecosystems (like MegaETH and HyperEVM) also bring new hope.

For example, CapMoney will adopt a centralized decision-making mechanism in its initial months, aiming to gradually achieve decentralization through the economic security provided by Eigen Layer. Additionally, there are Liquity's fork projects like Felix Protocol, which are experiencing significant growth and establishing their position among the native stablecoins on 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 possesses censorship resistance? Is it merely an on-chain dollar, or is it a genuine user asset?

No centralized stablecoin can make such a promise.

Therefore, while emerging alternatives are attractive, we should not forget the original stablecoin trilemma:

• Price Stability
• Decentralization
• Capital Efficiency