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By Claude Eguienta is the Chief Executive Officer at Mimo

Stablecoins are among the most revolutionary crypto assets ever created. The idea behind them is quite simple – traditional cryptocurrencies like Bitcoin (BTC) and Ether (ETH) can be volatile. This makes it risky to use them as a store of value or medium of exchange. So, in order to eliminate this risk, the inherent volatility needs to be taken away.

This risk is removed by pegging the value of a digital currency to a specific asset. Tether’s USDT, which is now the most popular stablecoin, was one of the first digital assets to do this successfully. Ideally, the value of each token is pegged to something with a stable price (e.g. the US dollar), lending it the stability needed to become a good store of value and medium of exchange.

Tether accomplished its aim quite well. However, there were a few issues, most notably the lack of transparency around Tether’s reserves. This was one of the inspirations for Circle to launch its own stablecoin, USDC. Since then, more stablecoins have been created, like Binance’s BUSD and Maker’s DAI, which are all pegged to the US dollar.

Thanks to this idea, there is now close to $130 billion worth of stable crypto assets in circulation. And while this certainly provides a large enough pillar for the crypto space to lean on, a case can be made that modern stablecoins are yet to represent the best that stablecoins can be. Far from it, in fact. 

Centralization and decentralization both come with problems. 2022 saw a host of centralized entities collapse from various flavors of mismanagement, while decentralized blockchains – stablecoins and otherwise – are still clunky and difficult. 

Centralized vs Decentralized Stablecoins

Most of the current stablecoins are issued and controlled by centralized entities. USDT is issued by Tether, USDC by Circle, and BUSD by Binance. All of these institutions can be censored or engage in censorship themselves and, perhaps most importantly, raise some big questions on transparency. 

Stablecoins like DAI have emerged as a potential solution to this problem. DAI is a stablecoin issued by the Maker protocol. The protocol is controlled by a decentralized autonomous organization (DAO), making it censorship-proof. 

But as history has shown, decentralized stablecoins can also fail.

TerraUSD (UST), the decentralized algorithmic stablecoin of the Terra blockchain, is one of the most notorious examples. UST relied on an algorithm that would burn the blockchain’s other native token, LUNA, to keep its value anchored to $1. It was initially a massive success, becoming one of the largest stablecoins just a few months after launch. 

However, UST’s stay at the top didn’t last long. Its algorithmic and uncollateralized design left it vulnerable to volatility. This weakness would be exposed after a couple of large trades in May 2021 broke UST’s peg to the dollar. All attempts by Terraform Labs, the creator of the Terra blockchain, to help the token regain its peg would fail. 

This failure resulted in investors losing billions of dollars.

If those were the only problems stablecoins faced, they would be enough to send us back to the drawing board. But, just like in a late-night infomercial, there’s more.

A Lack of Returns

The lack of returns isn’t often discussed, but it affects all stablecoins, centralized and decentralized. Assuming the stablecoin works as intended if an investor decides to buy and hold $1000 worth of USDT for a year, it will still be worth $1000 at the end of that period.

Now, there are two ways to look at this. The investor hasn’t suffered from volatility, they have held onto their money, which is a good thing. 

But on the other side, the investor has assumed a centralization risk and hasn’t been paid for it. In fact, factoring in inflation, one can truthfully say that they have lost some value. 

It gets more significant when one considers the missed investment opportunities. Unlike the crypto market, mainstream finance is home to some of the best low-risk investment instruments. These include treasury and corporate bonds, which have seen their yields increase since the pandemic.

Unfortunately, these are only currently accessible via fiat. So, investors who store their money in stablecoins are actually limited, as they can’t access these opportunities unless they take their money off-chain. This limits conventional stablecoins as a store of value even when compared to the fiat dollar. 

Terra, the creator of the stablecoin UST, attempted to solve this problem by creating Anchor. This is a protocol that paid an APY of 19.5% on any deposited UST. This made it the highest-interest savings account for UST holders.

Anchor was essentially offering high interests on a non-interest asset. So with time, people started seeing the protocol as one of the safest investment opportunities on the blockchain, which brought in a lot of UST investors. Unfortunately, Anchor’s yield was not economically sustainable but actually subsidized, unbeknownst to most of its users. 

So then a question arises. Are stablecoins a good investment, or is the asset class too limited? 

What’s the Solution?

A better stablecoin would ideally be an asset that addresses all the above issues. It would perfectly balance centralization and decentralization to minimize the inherent risks of either, while maximizing the benefits of each.

This introduces the idea of a new generation of stablecoins. One that utilizes transparency to garner confidence from the public while expanding on its utility to remove limiting factors such as opportunity cost. 

This new generation of centralized stablecoins will have multiple centralized backers instead of one. This will diminish the centralization risk, and ideally, these centralized backers will span various jurisdictions. 

Stablecoins that generate revenue either for their DAO or for their users will become commonplace. The model of keeping all the earnings derived from the banking – like Circle does – will create opportunities for new entrants. Even the more decentralized stablecoins will likely incorporate things such as liquid staking tokens (LSD) as backing to generate yield.

Decentralized exchanges will become so efficient that you’ll have multiple stablecoins with less liquidity still thriving, making competition more sane. 

The concept of one true stablecoin doesn’t work and will be less likely to work as we grow. In simple terms, it puts too much pressure and dependence on a single entity and is counterintuitive to why DeFi was created in the first place

Non-dollar denominated coins, or even stablecoins that represent a basket of items will grow if the macro context stays unsure. That coincides with the theory of multiple sources of backing above.

Different blockchains are getting traction, and the one true chain ideology doesn’t seem to be sticking, so stablecoins that are able to work on multiple chains seamlessly will benefit users. 

And despite growing concern around CBDCs, they likely won’t pose much of a problem. 

Unless massive regulatory changes come up, CBDCs will not replace stablecoins as their goal will not match what stablecoins will be able to provide. In fact, CBDCs may just fall into the same trap current stablecoins face – the lack of yield, currency hedging, privacy protection, and censorship resistance.

However, there may be a silver lining to CBDCs as well as they could partially back some stablecoins. But the reality is that the best stablecoins we’ll see will offer as many of these advantages as possible. Current industry leaders will face much needed competition, and in the end, the margins of stablecoin operators will shrink – providing better returns and more utility for all. 

About the author:

Claude Eguienta is the Chief Executive Officer at Mimo, a company that creates protocols providing tokenized real-world assets and allowing the minting of multiple price-stable currencies against collateral to its users. Claude has been working for startups and large tech companies for over a decade after graduating with a Masters in Computer Science, focused on distributed systems. In the past he has co-founded Telcoin, a startup focused on financial inclusion via remittances on the blockchain, and Kabotip, a crypto startup which went through the OnLab incubator.

Claude is a software engineer strongly driven by his desire to make the world a better place. He grew up in France, studied in China and the US, and has lived in Japan and the UAE for most of his professional life. He speaks French, English, Chinese and Japanese.