The Stablecoin Landscape

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 decentralised LSTs and earning interest in a stablecoin. In doing so, Chi Protocol creates a crucial profit-generating utility for the governance token, CHI, by allowing its stakers to earn the entire yield from the LSTs 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 for crypto users, as they mimic the price of another asset (e.g., USD). Nevertheless, stablecoin protocols and institutions face a tradeoff of scalability vs decentralisation 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 decentralised but not capital efficient (e.g., LUSD) or they can be slightly capital efficient at the expense of centralisation (e.g., FRAX). The stablecoin trilemma is the major problem limiting the growth of DeFi and allowing centralised issuers to gain a large market share of stablecoins. This is proved by the current statistics, in which, of the $125 billion total stablecoin 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:

Fiat-Collateralised Stablecoins

Stablecoins within the Fiat-Collateralised 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, centralised 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.

Overcollateralised Stablecoins

Cryptocurrency-collateralised 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.

Stablecoins Backed by Centralised Assets

Cryptocurrency-collateralised stablecoins can also be backed by centralised stablecoins (e.g., USDC). Stablecoins of this type include FRAX and DAI, which mainly use USDC and RWA as collateral. The design of FRAX and DAI results in a trust-constrained model for a stablecoin originally introduced as decentralised (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 decentralisation with capital efficiency. This is because stablecoins are over-collateralised 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.

Delta-Neutral Stablecoins

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

Centralised Fragility and Inability to Scale

Decentralised and delta-neutral stablecoins encounter multiple challenges concerning scalability, mechanism design, centralisation, and the absence of inherent yield.

• "Overcollateralised stablecoins" have scaling issues, given their dependence on the on-chain expansion of leverage demand within the Ethereum ecosystem. We believe that as scalable decentralised 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 decentralised alternative, given their reliance on centralised exchanges. Consequently, we perceive these stablecoins as unsustainable for the crypto space, owing to their significant centralisation risks.

Category	USC	Fiat Backed	DAI/FRAX	Overcollateralised	Algorithmic	Delta Neutral
Transparency
Uncensorable
Scalability
Stability
Intrinsic Yield
Non-Custodial
No Centralised Component

Stablecoin Intrinsic Yield: Native Stablecoin Rewards

Stablecoins differ in many ways, including their underlying assets, collateralisation ratios, issuance processes, and mechanisms for price stabilisation. While different stablecoins may be suitable for specific use cases, they all share a common limitation: the absence of interest or real yield generation.

Since most stablecoins do not offer interest, holders face the ongoing erosion of their value due to inflation.

The inherent characteristics of most stablecoins, driven by their issuance mechanisms and underlying assets, make them incapable of generating interest.

Fiat-collateralised stablecoins, typically issued by centralised entities, are backed by cash and Treasury Securities (mainly US). However, due to the centralisation of their business, any yield generated by the collateral is distributed among a few inside players.

Cryptocurrency-collateralised stablecoins are usually issued when users deposit a specific amount of cryptocurrency as collateral. Given that these collateralised cryptocurrencies do not generate interest income themselves, stablecoin issuers face limitations in providing a secure and steady income stream to their holders.

Chi Protocol: The Solution to the Stablecoin Trilemma

In summary, the lack of interest in stablecoins historically stems from their foundational aspects—their creation methods, the backing assets, and their stability mechanisms. The main challenge in the sector has been how to create a DeFi-powered USD that ensures scalability, censorship resistance, and decentralisation, while also delivering returns at the protocol level for all stakeholders. This challenge has persisted until the development of the Chi Protocol. With USC, backed by LSTs and the CHI governance token—which captures all yields from the LST reserves—Chi Protocol introduces a scalable stablecoin that resolves these long-standing issues.