The Landscape of Stablecoins

Solving The Stablecoin Trilemma with USC

Chi Protocol is the world’s first scalable stablecoin solution providing a stable asset, known as USC, backed by decentralized LSTs and earning interest in a stablecoin. In doing so, Chi Protocol also creates a crucial profit-generating utility for the governance token CHI by letting its stakers earn the entire LSTs’ yield of the reserves backing USC.

Solving the Stablecoin Trilemma - How does Chi Protocol achieve this?

The Stablecoin Trilemma

Stablecoins are cryptocurrencies designed to provide a safe store of value to crypto users as they mimic the price of another asset (e.g., USD). Nevertheless, stablecoin protocols and institutions face a tradeoff of scalability vs decentralization to achieve stability. This is also called the “stablecoin trilemma” - a problem that Chi Protocol has solved.

In essence, the above figure tells us that to be stable, stablecoins can be either decentralized but not capital efficient (e.g., LUSD) or they can be slightly capital efficient at the expense of centralization (e.g., FRAX). The stablecoin trilemma is the major problem limiting the growth of DeFi and allowing centralized issuers to gain a large market share of stablecoins. This is proved by the current statistics, where of the $125b total stablecoins market cap, 90% dominance comes from Tether and Circle.

There are currently three types of stablecoin available on the market today, proving the stablecoin trilemma:

  1. Fiat Collateralized Stablecoins

Stablecoins within the Fiat-Collateralized category are issued with fiat currencies like USD, EUR, and others serving as collateral. Examples of these stablecoins include Tether (USDT), USD Coin (USDC), and TrueUSD (TUSD). Typically, centralized institutions issue and oversee these stablecoins and maintain a 1:1 collateral ratio. This means that for each stablecoin issued, an equivalent unit of legal currency is required as collateral.

  1. Overcollateralized Stablecoins

Cryptocurrency-collateralized stablecoins are stablecoins issued with cryptocurrencies (such as ETH, WBTC, stETH) as collateral, such as DAI, LUSD, and eUSD. The collateral ratio of these stablecoins is relatively high, usually, 1:1.5 or 1:1.75, which means that to issue every one of a stablecoins, $1.5 or $1.75 worth of cryptocurrencies need to be deposited as collateral. Overcollateralised models provide stability at the expense of capital inefficiency for their users.

  1. Stablecoins Backed by Centralized Assets

Cryptocurrency collateralized stablecoins can also be backed by centralized stablecoins (e.g., USDC). Stablecoins of this type include FRAX and DAI, which mainly uses USDC and RWA as collateral. The design of FRAX and DAI results in a trust-constrained model for a stablecoin originally introduced as decentralized (e.g., de-peg of USDC stablecoin implies de-peg of FRAX as shown in March 2023)

None of these options provides a design which combines decentralization with capital efficiency. This is because stablecoins are over-collateralized by volatile cryptocurrencies, or the underlying collateral is fiat or fiat-backed stablecoins. Furthermore, they do not themselves accumulate interest in a stablecoin, and their governance token does not accrue any rewards from the collateral in the reserves.

  1. Delta Neutral Stablecoins

Stablecoins that achieve delta neutrality, such as USDe by Ethena, provide a scalable alternative compared to stablecoins that require excessive collateralization. However, they do come with certain trade-offs, primarily associated with custody and centralization risks. These stablecoins depend on centralized liquidity sources to participate in futures markets, resulting in a fragile system exposed to highs risks such as custody and exchange failure risks.

Centralized Fragility and Inability to Scale

Decentralized and delta-neutral stablecoins encounter various challenges concerning scalability, mechanism design, centralization, and the absence of inherent yield.

  • "Overcollateralized stablecoins" have scaling issues, given their dependence on the on-chain expansion of leverage demand within the Ethereum ecosystem. We believe that as scalable decentralized stablecoins become more prevalent, the market share of these existing stablecoins will continue to decline.

  • "Algorithmic stablecoins" confront hurdles associated with their inherently fragile and unstable mechanism designs. These designs, in our assessment, lack sustainability in scalability.

  • "Delta-neutral synthetic dollars" face difficulties in providing a decentralized alternative, given their reliance on centralized exchanges. Consequently, we perceive these stablecoins as unsustainable for the crypto space, owing to their significant centralization risks.

Chi Protocol: The Solution To The Stablecoin Trilemma

The central question at hand is how 
to establish a DeFi-powered USD that delivers scalability, censorship
resistance, and decentralization while 
providing protocol-level returns for all 
stakeholders involved. This particular challenge has remained unresolved until
the arrival of Chi Protocol with USC - a scalable stablecoin backed by LSTs and CHI - governance token accumulating the entire LST yield of the reserves.

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