Problem Statements

Some of the problem statements in the current space are

  1. Capital Inefficiency - The stablecoin issuance against crypto assets is currently capital inefficient because the underlying crypto assets are volatile. Currently around $34 bn of crypto assets are locked as excess collateral across lending protocols to back the loans taken. That's an excessive amount of under-utilized capital which affects scalability of purely decentralised stablecoin protocols against their centralised counterparts.

  2. High Liquidations - Due to the volatile nature of the space, their are a lot of protocols whose business models are reliant on capturing revenues through this liquidations which during recently during a high volatile period amounted to around $1 bn. This leads to bad user experience and also limits the extension of use cases towards businesses which also wants exposure to this growing crypto and Defi space and utilise the credit generated in their businesses. Currently, businesses like these who have periodic cash flows cannot take credit against their crypto assets due to the fear of getting liquidated in the midst of getting their next cash flow.

  3. Contradictions in stablecoin intrinsic properties - A money is something which doesn't have a net supply in the system being considered. Like Bitcoin in the crypto ecosystem, gold in the real world and central bank liabilities in form of deposits. All of the mentioned are not in the competitive business. The stablecoins being credit are in the competitive business and currently can't be treated as money. But a purely decentralised stablecoin supply is generated through crypto native assets requiring stablecoin liquidity. Since the crypto native assets which can be acceptable form of collateral is limited but with real world assets tokenization, this limited nature of assets with liquidity needs can be handled. However, bringing real world assets into the balance sheet will lead to loss of decentralisation. Thus, existing fully decentralised stablecoin protocols have difficulty maintaining their stable peg with dollar due to the supply constraints introduced due to limited acceptable crypto assets being utilised as collateral. This is leading to demand supply imbalance and peg deviating above $1. This limited supply constraint has shifted these stablecoins towards being considered as money. Although this can be good for the protocol as it will ultimately help generate an asset which is being treated as money by the people and which can be minted at a premium just like central bank issues currencies against the government debt. However, this introduces contradiction for the protocol as they are left between letting the stablecoin deviate from peg to a higher value but if they do that then user's expectation that the stablecoin will be ultimately re-pegged which ensures trust in that stablecoin protocol will suffer consequences.

  4. Limitations in fully decentralised supply sources - Their needs to more mechanisms for stablecoin supply generation apart from catering to stablecoin supply generation solely through users who are looking for liquidity against their crypto assets. As this mechanism can introduce limited supply constraints as mentioned above and can also affect supply during bearish time period when the demand for credit is low specially if the yields on real world assets like T-bills are higher than what is offered by lending protocols. We believe their are multiple mechanisms of generating this pure decentralised supply like by catering to users looking for volatility hedging, credit risk protection, high duration stablecoin lending by catering to businesses with periodic cash flows, flexible bonds with perpetual maturity etc.

  5. High Velocity of Stablecoins - Velocity refers to the speed at which a currency circulates within an economy. In the case of stablecoins, their velocity is astonishingly high compared to traditional forms of currency. This high velocity is attributed to several key characteristics: Fast Settlement, Settlement Finality, Traceability, Public, Open-Source Protocol & Programmability. The combination of these characteristics gives stablecoins a high natural velocity, creating liquidity without the need for traditional forms of leverage. Historically, monetary policy relied on leverage to generate liquidity, but stablecoins achieve this through technology alone. However this high velocity creates high liquidity risks for the protocol's. Stablecoin deposits are considered “volatile money deposits,” as they can be withdrawn in large sums within minutes. This liquidity risk could lead to payment system risk if not managed effectively. That's why we are seeing, stablecoins become “collateral silos” that wall off high-quality liquid assets for different issuers in the space. So, we have found one solution to tackle this high velocity without losing out on the advantages it brings.

Apart from these, their are definitely other issues like heavy reliance on utilising native tokens for stabelcoin backing which can be detrimental in case of systematic risks being introduced and also loosely a stablecoin credit generation through an equity based mechanism which is a risky venture. Their are issues like limited incentive structures for arbitrageurs to act upon and stabilise the peg which has led to demise of a lot of stablecoin protocols as left a lot of room for irrational behaviours to bloom by not introducing new incentive structures for arbitrageurs, users with credit requirements and high profit motivated leverage taking participants.

Last updated