Rethinking Stablecoins: The Decline of Decentralization and Emerging Challenges

Stablecoins have always been the focus of the cryptocurrency field. Apart from speculation, it is one of the few products that has found a clear product-market fit in the crypto market. Currently, the industry widely expects that tens of trillions of dollars in stablecoins will flow into traditional financial markets within the next five years.

However, surface prosperity does not mean that everything is perfect.

The Trilemma of Stablecoins

New projects often use charts to showcase their advantages over major competitors. However, a recent striking trend is the noticeable decline in Decentralization.

With the development and maturity of the market, the demand for scalability has conflicted with the early ideals of Decentralization. However, a balance should be found between the two.

Initially, the three dilemmas of stablecoin are based on three core concepts:

1. Price stability: Maintaining a stable value linked to a specific asset (usually the US dollar)
2. Decentralization: Avoid single entity control, achieve censorship resistance and trustlessness.
3. Capital efficiency: Maintain the peg without excessive collateral.

However, after multiple controversial experiments, scalability remains a huge challenge. Therefore, these concepts are continually evolving to adapt to new realities.

In recent years, the strategies of some major stablecoin projects have transcended the mere realm of stablecoins, evolving into broader product ecosystems. However, in this process, the concept of Decentralization has gradually been weakened, replaced by the more limited characteristic of anti-censorship.

Although censorship resistance is a fundamental characteristic of cryptocurrency, it is merely a subset of the concept of Decentralization. This shift reflects the centralized features that are commonly found in the latest generation of stablecoin projects (with a few exceptions like Liquity and its forks).

Even if these projects utilize decentralized exchanges (DEX), there is usually a core team responsible for managing strategies, seeking profits, and distributing them to holders similar to shareholders. In this model, scalability mainly comes from the amount of profits rather than the composability within the DeFi ecosystem.

True decentralization seems to be giving way to more pragmatic approaches.

Realistic Challenges

On March 12, 2020, the market crash triggered by the COVID-19 pandemic exposed the vulnerabilities of decentralized stablecoins like DAI. Since then, many projects have turned to using USDC as their primary reserve, which somewhat acknowledges the difficulties of complete Decentralization in a market dominated by Circle and Tether. At the same time, algorithmic stablecoin experiments like UST also failed to achieve the expected results.

The tightening of the regulatory environment has further exacerbated this trend. At the same time, the rise of institutional-level stablecoins has also weakened interest in experimental solutions.

In this context, Liquity stands out for its smart contract immutability and its pure use of Ethereum as collateral. However, it still faces challenges in scalability.

Liquity's recently launched V2 version has enhanced peg security through multiple upgrades and offers more flexible interest rate options when minting the new stablecoin BOLD. However, its growth is constrained by several factors, including a relatively low loan-to-value ratio (LTV) and a lack of large-scale distribution models.

Despite the limited Total Value Locked (TVL), Liquity and its forked projects still play an important role in the cryptocurrency ecosystem, with a total TVL of $370 million for the V1 and V2 versions.

The Balance Between Regulation and Innovation

The recently proposed "Genius Act" could bring more stability and recognition to the stablecoin market in the United States. However, the act mainly focuses on traditional, fiat-backed stablecoins issued by licensed and regulated entities.

This means that Decentralization, crypto collateral, or algorithmic stablecoins may fall into a regulatory gray area or be completely excluded.

Value Proposition and Distribution Strategy

Stablecoin projects are adopting different strategies to create value and expand market share:

• Some hybrid projects primarily target institutional investors and aim to expand into the traditional financial sector.
• Some stablecoins launched by Web 2.0 companies attempt to expand their potential market by attracting native crypto users.
• Some projects focus on underlying strategies, such as Real World Assets (RWA) or Delta-Neutral strategies, to achieve sustainable returns.

The common point of these projects is that, although to varying degrees, they all exhibit a certain level of centralization characteristics. Even projects focused on DeFi are often managed by internal teams.

Emerging blockchain ecosystems (such as MegaETH and HyperEVM) provide new opportunities for stablecoin innovation. Some projects are exploring how to gradually achieve Decentralization on these new platforms while leveraging the "novelty effect" to attract users.

Future Outlook

Centralization is not entirely negative. For projects, it provides a simpler, more controllable, and scalable management approach, making it easier to adapt to regulatory requirements.

However, this trend conflicts with the original ideals of cryptocurrency. True censorship resistance and user asset ownership are still characteristics that centralized stablecoins find difficult to fully guarantee.

Therefore, although emerging alternatives are attractive, we should not forget the original stablecoin trilemma: price stability, Decentralization, and capital efficiency. Balancing these three aspects while pursuing innovation and market share will be an ongoing challenge faced by stablecoin projects.