🎆Stablecoins are Broken

This section only pertains to decentralized stablecoins that are backed by a collateralized basket of crypto assets, rather than those that are centrally issued or algorithmic.

Complexity in Protocol Design

The Maker Protocol System Diagram • Image credit: https://docs.makerdao.com/

Decentralized stablecoins often employ overly complex designs in their systems like peg stability modules, governance structures, and upgradable proxy contracts. However, it's worth questioning whether all of these functions are truly necessary. With so many moving parts, the potential for vulnerabilities increases and the protocol becomes more difficult to maintain.

Centralized Assets as Collateral

Decentralized stablecoins often fall short of the decentralization many believe them to have. Some of the most popular decentralized stablecoins are backed by centralized collateral.

• 30% of MakerDAO's DAI stablecoin is backed by USDC

• 63% of Hubble Protocol's USDH stablecoin is backed by USDC

• 70% of Angle's agEUR stablecoin is backed by USDC

• 93% of Hedge's USH stablecoin is backed by USDT and USDC

While using centralized stablecoins as collateral can help with peg stability, relying on them creates what is essentially a wrapped version of a centralized stablecoin, with added complexities and risks. The question arises: What happens if the centralized stablecoin issuer blacklists the address containing the collateral that backs a decentralized stablecoin?

Data collected using DefiLlama on March 8th, 2023

Centralization in DAO Governance

Most DAOs are predominantly controlled by a small group of token holders who possess a substantial amount of governance tokens. Take MakerDAO's recent vote on the proposed "Endgame Plan" as an example. The co-founder of the protocol was the biggest voter, and he was also the proposer of the proposal itself.

Economic Challenges of Decentralized Stablecoins

Decentralized stablecoins often have high fees and minimums, low collateral ratio requirements, and misaligned incentives for users who aid in the protocol's operation.

High Fees and Minimums

Many decentralized stablecoins, particularly those using collateral-debt positions, often enforce high fees and minimums, which may dissuade user participation.

Low Collateral Ratio Requirements

Many decentralized stablecoins operate with lower collateral ratio requirements to encourage borrowing and capital efficiency. Although beneficial in the immediate term, this approach could cause instability if the value of the underlying collateral experiences a swift decline.

Misaligned Incentives

In many stablecoin protocols that utilize collateral-debt positions, users participating in liquidations receive a small percentage of the collateral for their efforts. This may not provide enough incentive for users to take on the risk and responsibility of liquidation, especially amidst market volatility.