Today I want to open an important topic that intimately impacts the future of SILK. In this post, I want to outline the trade-offs that stablecoins take, while pointing out various potential paths that SILK can take within a tri-attribute paradigm. The balance of ethos and pragmatism can be a slippery slope - and I want to acknowledge the risks that are absorbed by leaning too heavily one way or another during the lifespan of a stablecoin, as well as some general observations about existing stablecoin projects.
The Stablecoin Trilemma
The three key attributes of any stablecoin are as follows:
Stability: the ability of a stablecoin to maintain its target peg.
Efficiency: the amount of capital required to mint or burn a stablecoin in relation to changes in demand for the stablecoin.
Security: the degree to which underlying collateral is decentralized - the more centralized the collateral, the greater the risk that the underlying collateral could be controlled in a way that negatively impacts the stability of the peg.
A stablecoin that is maximized for stability would have 1000000000x backing per stablecoin issued. Unfortunately, the amount of capital required to mint the extremely backed stablecoin is extremely capital inefficient.
A stablecoin maximized for efficiency would mint 1 stablecoin for $0 of value. This means the ability to expand the supply is not backed by an assets - allowing for rapid expansion of the supply in relation to changes in demand. This, of couse, violates the principle of stability as users would rapidly find that redeeming these stablecoins have not asset backing.
A stablecoin maximized for security would mint 1 stablecoin while demanding 1000000s of different micro-pieces of collateral tied to permisionless and truly decentralized assets. This violates components of efficiency (as expanding supply introduces collateral minting fraction) as well as violation of the stability principle (the more types of collateral included in the peg, the greater the chance one of them will fail).
edit: it was noted that the more collateral types involved, the more risk is hedged (which is correct). Observation made above was about likelihood of a single component of the collateral failing, not about the distribution of risk from said hedging. I’ll also note in this hypothetical example that including arbitrary #s of more collateral doesn’t automatically make things safer as each collateral has its own set of risks. It’s better to have 5 really really good pieces of collateral, than 5 really good pieces of collateral + 5 terrible pieces of collateral.
Naturally, stablecoins exist within a set of sliders between all three variables of the stablecoin trilemma. These sliders ultimately determining the fundamental attributes of any stablecoin, leaving it up to the market to determine what it values and demands.
I want to express that where SILK falls on the trilemma spectrum should be optimized to match long-term product-market demand, our collective ethos, as well as the need to bring SILK to said late game in relation to adoption & stability.
Before we proceed, let’s walkthrough some existing stablecoins:
Stability: strong - issuance is 1:1 backed by highly liquid financial instruments that can be converted easily to USD, which is what USDC is pegged to.
Efficiency: strong - users can deposit at a 1:1 ratio
Security: weak - only a single issuer is behind this that must comply with external actors, introducing risk to holders byh nature of the permissioned nature of USDC (accounts can be frozen)
Stability: strong - issuance is ~150% backed by collateral, albeit with risks tied to the liquidity of the underlying collateral. Part of the stability comes from the fact that nearly 60% of all assets backing DAI are centralized assets like USDC.
Efficiency: meh - users have to deposit at a 150% ratio in order to mint DAI, but some of this has been resolved by using other stables as accepted collateral, lowering the LTV required to mint DAI closer to a 1:1 ratio which is considered capital efficient.
Security: okay - roughly 60% of collateral could be impacted by centralied issuers, introducing risk to holders byh nature of the permissioned nature of USDC (accounts can be frozen). Its difficult to quantify the probability of this collateral being frozen as the market impact would be an almost immediate death spiral of DAI that would cause a massive amount of contagion on the entire domain. Some of my thoughts on the Tornado Cash / USDC situation.
Stability: alright - issuance is ~90% backed by collateral, aiming to be a fractionalized reserve. This is the closest thing crypto has to a “safe” algorithmic stablecoin.
Efficiency: excellent - users have to deposit stables at a 90% stable + 10% FRAX-Shares rate (burned). Targets the optimal 1:1 mint ratio target.
Security: at risk - FRAX was really built on the back of LP tokens (in the form of centralized stables) + USDC + ETH. FRAX Dune Analytics. Interesting to note is the infographic below - this was at the very beginning of the FRAX journey in January of 2021 when FRAX was 90.75% collateralized by USDC. Note that this number has decreased overtime, pointing towards a trend towards more decentralization.
This of course, leaves us with SILK. Let’s start with some observations:
- The most successful stablecoins by TVL (note, there are other ways to benchmark success) are decentralized stablecoins that have tied themselves closely to centralized collateral.
It is important to note that the market is demanding stability as the #1 attribute it prioritizes above anything else. SILK could make the decision to deviate away from market demand, but I want to acknowledge that there are adoption risks and potentially stability risks by having no interactions with centralized stablecoins in any capacity.
- The Cosmos ecosystem has not chosen its primary decentralized stablecoins yet - it has however signalled demand for USDC (81% of stablecoin trading volume is coming from USDC on Osmosis)
There is a scenario here where SILK ignores any sort of centralized stablecoin inflows in the Cosmos. It’s important to note that some other stablecoin in the Cosmos will more than likely take heavy advantage of USDC as a proxy for stability within the Cosmos, which in turn can accelerate growth and adoption of said stablecoin at a faster rate than stables that don’t rely on centralized stablecoin inflows.
Some counter-points to this fear: SILK is already positioned as a non-dollar stablecoin, so by default we are already attracting a different audience that cares about the decentralization of the peg, privacy/sovereignty, and more than likely also the decentralization of the underlying collateral.
Counter-point to the above counter-point:
- We don’t know the probability that USDC or any centralized stable will be a threat vector that gets used against SILK within the next Y years.
That is to say, if the ShadeDAO accepts USDC into its treasury for SILK minting in order to bootstrap growth, what are the odds we encounter a Tornado Cash scenario within 1 year? 2 years? 5 years? 10 years?
Within the balancing act of understanding the target market for SILK, the real competitive pressure to fill the TVL void in Cosmos, understanding the utility of stability proxies (such as USDC), while understanding our goal of having both a decentralized peg and decentralized collateral, I would propose the following strategy.
- 40% of collateral minted against centralized stables
- 60% of collateral against all other collateral types (decentralized stables, LP tokens, decentralized collateral such as $SCRT & $ATOM)
Y2 SILK (update fees to push towards this)
- 30% of collateral minted against centralized stables
- 70% of collateral against all other collateral types (decentralized stables, LP tokens, decentralized collateral)
- 20% of collateral minted against centralized stables
- 80% of collateral against all other collateral types (decentralized stables, LP tokens, decentralized collateral)
- 10% of collateral minted against centralized stables
- 90% of collateral against all other collateral types (decentralized stables, LP tokens, decentralized collateral)
- 100% of collateral against all other collateral types (decentralized stables, LP tokens, decentralized collateral)
Operation Touch-&-Go gives SILK half a decade to achieve full decentralization of underlying collateral - giving time for various Treasury Operations & primitive revenue streams be able to partake in this long-term transition of quality of decentralized collateral. With this strategy, the importance of year-1 bootstrapping SILK adoption is acknowledged, with a clear long term plan to achieve indepedence from the risks of the collateral used.
I would love to hear others thoughts and opinions on this topic. My opinion is that SILK should optimize for growth & adoption in the short-term, with a lazer sharp plan to head towards decentralized collateral. Other projects such as FRAX & DAI never had a clear long-term plan for this from day 1, and as such were sucked into the growth-over-decentralization paradigm that have put them into the current situation of incurring centralized collateral risk.
I think we can balance the need for growth with the wisdom to clearly migrate away overtime - using governance and the community to hold ourselves accountability for the vision of SILK:
Private. Global. Stable.
-Carter Woetzel (Shade Protocol Researcher)