Stablecoins may come across to many as boring – after all, what upside could there possibly be for a dollar-pegged token? To most, stablecoins are a byproduct of trading: a unit of measurement for most crypto positions. The majority of trading pairs on centralized exchanges today are denominated in stables or US Dollars (USD), while a minority of them are traded against BTC or ETH. This is not surprising as a fiat-based system is something most people are familiar with, making it easier to monitor and manage positions with reference to real-world purchasing power. 

For reasons mentioned above, stablecoins have become a conventional form of digital currency among DeFi users. Collectively, stablecoins are the foundation and key enabler to DeFi composability: its trading volumes far exceed crypto blue chips such as BTC and ETH, ranking highest amongst the various borrowed assets on decentralized lending protocols and the default collateral used on derivative protocols on Ethereum. 

In this article, we will cover the evolution of USD-denominated stablecoins and their impact on the DeFi ecosystem. We have structured our analysis to cover the three major stablecoins categories (Fiat-backed, CDP, Algorithmic) and two other nascent yet up-and-coming stablecoins (Non-pegged and Non-DeFi). In each category, we investigate the mechanics of the major players and evaluate the opportunities and risks before providing our outlook on the entire ecosystem.

Not All Stablecoins Are Created Equal

The stablecoin landscape has changed drastically over the past few years, with many new stablecoins having innovative mechanics and use-cases. By and large, the stablecoins mechanism can broadly be classified into three categories: Fiat-backed, Collateralized Debt Position (CDP) and Algorithmic (Algo).

Due to differences in their underlying design concepts, each category often tackles (or claims to tackle) two out of three key attributes that are deemed vital for stablecoins: decentralization, stability, and capital efficiency. Here’s what each attribute means:

  • Decentralization: Collateral being held by a distributed network as opposed to an intermediary
  • Stability: Minimal variation from the intended peg to maintain stable purchasing power
  • Capital efficiency: Having no over-collateralization requirements for the creation and borrowing of stablecoins

These three features collectively constitute the stablecoin trilemma as there are tradeoffs to be made when optimizing certain attribute(s), similar to the blockchain trilemma.

Overview of DeFi Stablecoins Ecosystem

As of 1Q22, the combined market capitalization of the top three stablecoins in each category sits at US$184.16bn, constituting about 97.2% of the total stablecoins market capitalization. For the rest of the article, we will use the top three stablecoins by market capitalization as a proxy for their respective categories.

At a high level, the fiat-backed stablecoins market capitalization is five times larger than the combined market capitalization of CDP and Algo stablecoins. In addition, out of the ten largest stablecoin by market capitalization, five of them belong to fiat-backed stablecoins, further outlining the huge disparity in terms of market dominance.

This is partly attributable to their first-mover advantage, with Tether USD (USDT) established as early as 2014. Despite the increased adoption of new entrants, they still have a lot of room to catch up. Fiat-backed stablecoins contribute about 82.3% of the aggregated market capitalization of all stablecoins. In addition, the total volume in this category hovers near $100bn daily – representing a whopping 98% of the entire stablecoins market.

Given its longer history in the market, fiat-backed stablecoins have seemed to reach maturity with many of the other categories quickly outpacing its growth rate.

CDP over the last year has expanded by 414% and now represents about 6.8% of the twelve stablecoins in our data universe. The strong growth in CDP market capitalization from October 2021 onwards was largely driven by Magic Internet Money (MIM), which went from $2.36bn to $4.68bn during that period.

The strong growth in CDP is nothing compared to the stratospheric 1130% growth in Algo stablecoins. Terra USD (UST) was the main driver in this category, having gone from a mere $1.73bn to $19.61bn in market capitalization in the last 12 months.

Non-pegged stablecoins gained massive popularity in 4Q21, printing above 10,000% growth in market capitalization before crashing back down. However, the market clearly believes that this category remains a distant future, with thirteen stablecoins having a larger market capitalization than the largest non-pegged stablecoin, Olympus DAO. In addition, non-pegged stablecoins are not officially recognized by sites like CoinMarketCap and CoinGecko as stablecoins.

DeFi Stablecoin Mechanisms

Fiat-Backed Stablecoins

Fiat-backed stablecoins, as its name suggests, are backed by fiat currency reserves. The three largest stablecoins in this category are:

  1. Tether USD (USDT): Issued by Tether
  2. USD Coin (USDC): Issued by Circle and Coinbase
  3. Binance USD (BUSD): Issued by Binance and Paxos

These stablecoins are backed by the USD although there are others backed by different currency reserves.

In this category, issuers (i.e. Tether for USDT) act as custodians to manage their reserves when users deposit fiat in exchange for stablecoins. The issuer mints the respective amount of stablecoins equivalent to the fiat deposit.

When users sell their stablecoins back for USD, the issuer burns the corresponding amount of stablecoins to remove supply from the blockchain before sending the USD back to users. This mechanism ensures that each quantity of stablecoin is backed by an equal amount of reserves as seen by Tether’s disclosure. From the disclosure, it can be seen that Tether holds not only cash and cash equivalents but also corporate bonds, funds, precious metals and digital tokens. Meanwhile, reserves from Circle and Paxos show that both USDC and BUSD are 100% backed by cash and short-duration US treasuries.

Collateralized Debt Position (CDP)

The three largest stablecoins in this category are:

  1. Dai (DAI): Minted by Maker
  2. Magic Internet Money (MIM): Minted by Adacadabra
  3. Liquity USD (LUSD): Minted by Liquity

Launched in late 2017, MakerDAO was the pioneer of the overcollateralization model. At the core of it, Maker is a lending protocol and DAI is issued as a byproduct of its borrowing demand. DAI enters circulation when users borrow against collateral deposited into the Maker vaults. The collateral issued must always be higher than the amount borrowed to ensure DAI is supported in the event that the value of the underlying collateral asset falls. Maker influences the demand of DAI (pegged to the USD) through the interest rates charged on loans.

Liquity and Abracadabra are newer entrants that mimic the overcollateralization model to mint their own version of stablecoins, LUSD and MIM respectively. Following MakerDAO’s initial single-collateral system, Liquity only accepts ETH as collateral but with a better capital efficiency ratio and a fixed borrowing fee. Abracadabra, however, takes a different approach by allowing interest-bearing assets (ibTKNs), such as xSushi, to be posted as collateral. MIM has a wide variety of collateral choices and is deployed onto multiple chains.

Algorithmic (Algo) Stablecoins

As of 1Q22, the top three algo stablecoins in the market are Terra USD (UST), Frax (FRAX) and Fei USD (FEI). Each of these stablecoins’ peg is maintained through an issuance and redemption mechanism to match the level of demand in the market. Algo stablecoins allow for one unit of stablecoin to be exchanged for $1 worth of assets, in the form of its governance token and/or its backed asset. This means that market participants can arbitrage any price deviation from its peg so that the algo stablecoins can maintain their peg to the dollar. Due to the varying mechanisms of the three algo stablecoins, we will analyze them in separate sections below.

Mechanics: Terra USD (UST)

Terra’s swap function allows users to always swap $1 equivalent of Luna for 1 UST, and vice versa. In the event that UST trades below its underlying peg, for example at $0.9 per UST, market participants can arbitrage by:

  1. Buying 1 UST in the open market for $0.9, 
  2. Swapping 1 UST for $1 equivalent of LUNA in Terra Station’s market swap function,
  3. Selling the corresponding LUNA for $1, making a profit of $0.1.

When users swap UST for LUNA, the protocol also burns UST and mints LUNA in exchange, driving UST’s supply lower and putting upward pressure on UST’s price. This works the opposite way when UST trades above its peg of 1 USD. LUNA effectively balances the supply and demand of UST and serves as the de-facto reserve currency behind UST.

Mechanics: Frax Protocol (FRAX)

Frax’s model is similar to that of UST, except that the stablecoin is also partially collateralized by USDC. Compared to DAI, Frax’s collateralization ratio (CR) is dynamically adjusted based on the demand for FRAX. The CR determines the proportion of its governance token (FXS) required for the minting and redemption process. 

For instance, if the CR is 85%, 1 FRAX can be minted with $0.85 USDC locked in Frax Finance and $0.15 of FXS burned. At the same CR, the redemption process will net the user $0.85 of USDC and $0.15 worth of minted FXS for every FRAX. 

In the event that FRAX trades below its peg, users can arbitrage by:

  1. Buying FRAX in the open market, 
  2. Redeeming it for USDC and newly minted FXS, and 
  3. Selling the corresponding FXS for a profit.

In addition, Frax protocol will increase the CR which invariably increases the supply of FRAX backed by USDC. The opposite applies when FRAX trades above its peg. Prior to Feb 21, the CR changed hourly in increments of 25bps. It is now controlled by a PID controller which is based on the change in the inflation ratio of FXS. In essence, the new system aims to ensure that the market has enough liquidity for the new FXS to be sold in the market whenever FXS is minted. Hence, the CR will decrease when FXS liquidity grows relative to the supply of FRAX.

Mechanics: Fei Protocol (FEI)

FEI is an algo stablecoin that employs the collateralization model. However, unlike FRAX, FEI is backed by its Protocol Controlled Value (PCV) reserves1. The reserves, which initially consist of ETH at its genesis event, include a variety of assets ranging from stablecoins like DAI to Ethereum DeFi tokens. The PCV was deployed into various DeFi protocols (Rari Fuse, Curve, etc) to bootstrap FEI’s liquidity and generate yields from the liquidity provider (LP) fees. There is a bigger emphasis on liquidity than overcollateralization for FEI. 

However, after a disappointing launch, there were several key changes made with its v2 release on Oct 21. Firstly, its PCV now serves as a 1:1 redeemability ratio between FEI and its underlying assets (currently only DAI).

Secondly, Fei protocol algorithmically manages its PCV reserves by utilizing Balancer’s Investment Pool. It aims to mitigate risk by changing its allocation of volatile assets depending on its current CR. 

The third change was made to its governance token, TRIBE. Due to the volatile nature of the PCV collateral, FEI may change from overcollateralized to undercollateralized. When PCV is larger than the protocol equity2, some of it will be used to buy back TRIBE. However, if the PCV is undercollateralized, TRIBE will act as a backstop and be sold to fund FEI’s redemptions.

Non-Pegged Stablecoins

As revolutionary as algo stablecoins are, another category of protocols competing for market share is non-pegged stablecoins. Pegged stablecoins are subject to the contagion of monetary policy and inflation, which can cause purchasing power to fall over time. In contrast, non-pegged stablecoins are offering an alternative model – one whose value is independent of the fiat monetary system. The top three non-pegged stablecoins are Reflexer (RAI), Float Protocol (FLOAT) and Olympus DAO (OHM).

Mechanics: Reflexer Labs (RAI)

The mechanics of RAI shares similarities with LUSD, as RAI only accepts ETH as collateral on an overcollateralization model. RAI is created by users who deposit ETH into the SAFE and mint the equivalent amount of RAI. Users can redeem their collateral by paying back their RAI plus an interest. In the event of sudden price drops of ETH, where the collateral ratio drops below the minimum threshold, RAI has a “savior”3 function which aims to provide an extra cover layer on the borrower’s position.

RAI strives to be a stablecoin operating similarly to a managed float regime that is not pegged to any fiat currencies. In order to achieve a relatively stable price action and fiat independence, it relies on three key parameters: 

  1. Redemption price: RAI’s own target price on the secondary market. It is also used as the price to mint and redeem RAI. It is largely floating and does not reference any specific peg
  2. Market price: The actual price of RAI on the secondary market
  3. Redemption rate: The rate at which RAI is changing its value. The protocol varies the redemption rate to influence the redemption price 

RAI is not pegged to any fiat currency but its market price is heavily influenced by its redemption price. When RAI’s market price falls below its redemption price, the protocol starts to set a positive redemption rate which will make the redemption price grow every second. This incentivizes RAI holders to pay off their debt as they can redeem for more ETH during settlement which reduces the supply of RAI. In addition, these users will likely buy RAI from the market as soon as possible to close their position. The same principle applies when RAI market price rises above its redemption price, the redemption rate becomes negative to incentivize people to borrow more debt. The logic behind this is reminiscent of algo stablecoins, though the mechanism differs. 

At its core, RAI is not designed to be pegged to anything. Similar to the greenback, RAI market value is dependent on market forces of demand and supply. The parameters behind the redemption rate, which help to converge the redemption and market price, are set by a PID controller. The controller accounts for the deviation between the redemption price and market price, the duration of the deviation and the velocity of change. These inputs will help to churn out an ideal redemption rate to influence the market price back to equilibrium.

Mechanics: Float Protocol (FLOAT)

Like RAI, FLOAT is based on a managed float regime. This is managed around a “target price” set by the protocol based on market conditions and the value of crypto assets it owns (i.e. The basket). The basket forms the PCV and is used as part of the auction process to maintain price stability.

FLOAT protocol utilizes a two-token system – FLOAT, the stablecoin that ties its value to a collection of digital assets, and BANK, the protocol’s governance token. BANK serves two additional purposes beyond governance of FLOAT:

  1. To accrue the profit created in times of excess demand for FLOAT.
  2. To periodically support the price of FLOAT in times of low demand.

In deciding when to stabilize the price of FLOAT, the protocol uses the time-weighted average price (TWAP) of ETH, FLOAT, and BANK.

If there is high demand for FLOAT (TWAP > FLOAT’s target price), the protocol increases the supply by minting and selling FLOAT via a dutch auction for ETH and BANK. The ETH will then be added to the Basket while BANK is burned. 

When there is a low demand for FLOAT (TWAP < FLOAT’s target price), a reverse dutch auction is used as the protocol reduces the supply by buying up and burning FLOAT using a combination of ETH and newly-minted BANK.

In summary, the demand for FLOAT and the price of BANK are positively correlated. As demand for FLOAT rises (TWAP > FLOAT’s target price), the burning mechanism drives the price of BANK upwards and vice versa.

Mechanics: Olympus DAO (OHM)

Touting itself as “The Decentralized Reserve Currency”, Olympus DAO aims to create a free-floating reserve currency, OHM. Drawing similarities to how a central bank manages its currency through fiat reserves, OHM is backed by an underlying basket of crypto reserves such as DAI and FRAX. Additionally, OHM also functions as the governance token for the DAO.

To achieve its “reserve currency” status while ensuring that the value of OHM remains above its reserves, Olympus DAO has introduced two mechanisms that aim to stabilize prices. There are as follows:

  1. Controlling supply

When the market capitalization of OHM is higher than its reserves, the protocol will mint and sell new OHM. This increases the supply of OHM, bringing it closer to parity. When the market capitalization of OHM is lower than its reserves, the protocol will buy and burn OHM from the market. This reduces the supply of OHM, bringing it closer to parity. This set of actions achieves similar results to central banks’ open market operations, which influence the supply of liquidity in the secondary market.

  1. Bonds

Bonds allow buyers to purchase OHM at a discounted price from the market in exchange for crypto assets. Buyers are incentivized to do this as their OHM will vest to the market price after five days. The assets sold to the DAO from the buyer will go straight to the DAO treasury, where it will become Protocol Owned Liquidity (POL). Essentially, POL from bonds = Discounted OHM price – Reserves per OHM. Here’s an example:

In our example, the $30 in new POL will also be used to back new OHM that is minted and distributed to stakers as rewards.

OHM can be staked in return for sOHM which allows OHM holders to accrue protocol profits and participate in Olympus DAO governance. When the Olympus DAO treasury distributes profits to the staking contract, stakers’ sOHM balances rebase up to match the new amount of OHM in the contract so 1 sOHM always equals 1 OHM. This allows stakers to receive and compound yield without manually reinvesting the rewards, thus saving gas. According to Olympus DAO’s V2 upgrade, sOHM will be transitioning to gOHM, which allows multiple bonds to be taken at once.

Two Sides of a (Stable) Coin

Fiat-Backed Stablecoins

Very Liquid, Very Stable

Since 2014, fiat-backed stablecoins have achieved mass adoption as they served as the bridge between fiat and crypto assets like BTC and ETH. With daily trading volume in the billions since 2020, exchanges are incentivized to offer these assets on their platform to generate greater fee revenues. This creates a flywheel effect as more exchange listings increase the volume, liquidity and adoption of fiat-backed stablecoins. 

Fiat-backed stablecoins have also been through multiple market cycles. Despite some depegging events observed in the past (i.e. 30% and 4% depeg for USDT and USDC in 2018), fiat-backed stablecoins are still relatively stable over the long run. In 1Q22, the deviation from this category’s peg (measured by annualized 90d standard deviation of prices) is a mere ~3.4%: lower than their CDP (~7.6%) and Algo (~8%) counterparts.

Fiat-Backed? Not Always

As centralized currencies, entities like Tether and Circle are trusted by institutions to act in good faith. However, this is not always the case. Tether was fined multiple times in 2021 for lying about the constituents of their fiat reserve.

Up till 2018, custodians like Tether were unregulated, only maintaining “manual tabs” on its reserve levels. According to the CFTC, Tether never had more than US$62mil in cash reserves despite having over 440mil USDT tokens in circulation between June to September 2017. What was backing the remaining ~$380mil in USDT tokens? The CFTC found that Tether also held the following in their reserves:

  1. Commercial paper
  2. Secured loans to non-affiliated entities
  3. Corporate bonds
  4. Funds
  5. Precious metals
  6. “Other” investments, including digital tokens 

While fiat-backed stablecoins issuers are forced to adopt a more stringent and transparent standard of reporting, users should not downplay the risks associated with a dishonest issuer. Moving forward, users have to trust that these centralized players will always act in good faith and continue to uphold the required reserves between audits.

Collateralized Debt Position (CDP)

Lived To Tell The Tale

MakerDAO’s existence today proves that the overcollateralization model still works. Although not immune to depegging, DAI has survived through it all without going bust. Many new entrants today follow the overcollateralization model which speaks volumes of MakerDAO’s success.

Fundamentally, DAI was created as a decentralization alternative to fiat-backed stablecoins. Fiat-backed stablecoins worked because they were backed by cash and cash equivalents and were redeemable at a 1:1 rate for US dollars. In order to replicate the same faith, MakerDAO backed its DAI stablecoin against ETH initially but required overcollateralization from users since ETH was volatile.

Dependence on Overcollateralization…

However, the biggest issue with the overcollateralization model is that it resulted in low capital efficiency. Users will always be required to post more assets than the amount borrowed, leaving a system that is highly capital intensive and hard to scale.

… and Partially Centralized

Moreover, when ETH collapsed on Black Thursday, MakerDAO was unable to restore the DAI peg for 3 months through its stability mechanism. The protocol had to introduce centralized assets like USDC as a way to resolve the issue. This effectively forced DAI to abandon a degree of decentralization for stability. As of 1Q22, more than 50% of DAI’s collateral comes directly from USDC.

Both MIM and LUSD are considered to be more decentralized than DAI given that MIM has less than 10% of its collateral from centralized stablecoins while LUSD only accepts ETH as collateral.

The cost of decentralization is to increase the collateralization ratio. Case in point: LUSD has the highest collateralization ratio among the three. The current ratio is at about 200% (as of 1Q22) despite stating the minimal collateral ratio is at 110%.

Algorithmic (Algo) Stablecoins

The Dark Horse of The Stablecoins Ecosystem

Algo stablecoins aim to be highly scalable on-chain decentralized protocols. Unlike CDP, they are not burdened by an over-collateralization model.

Given that Algo stablecoins rely on redemptions and issuances as their key stability mechanism, it relieves them of the two issues that plague fiat-backed and CDP stablecoins:

  1. Centralization
  2. The need for overcollateralization

Algo stablecoins are less susceptible to the trust and transparency issues seen in fiat-backed stablecoins. Having no need for overcollaterization, algo stablecoins are a much more capital-efficient instrument to transact with.

Additionally, algo stablecoins is the fastest-growing category among its peers, with daily trading volumes growing from a mere $1.5mil on Jan 21 to $600mil by Feb 22. Given the dominant web 3.0 narrative in 2022, we think that the push for decentralization will drive further adoption of algo stablecoins.

A recent example of this would be the alliance formed between Terra, Frax and Redacted to create a 4Pool on Curve that contains USDC, USDT, UST and FRAX. As of 3rd April 2022, the alliance holds 41.1% of all DAO-owned CVX and they will use it to direct emissions to the 4Pool, incentivizing deep liquidity for it. This will likely have a second-order effect on the dominant pool on Curve, 3Pool (DAI, USDC, USDT) as we see liquidity providers rotate to the 4Pool for higher APRs. Currently, about $1.5bn DAI is held in the current 3Pool, contributing approximately 45% to 3Pool’s liquidity. With the “master of stablecoin” calling on every CVX holder to the 4Pool after announcing Olympus DAO’s participation in the alliance, this rotation may pan out sooner than later.

“By my hand $DAI will die.”
– Do Kwon 🌕 on Twitter

Far From Perfection

Algo stablecoins rely heavily on its counterbalancing assets and market forces, e.g. arbitrageurs, to maintain its peg. These assets run a risk of losing its volatility absorption capability in the event of a large dip in prices, resulting in a loss of faith to act even as normal market conditions return.

To draw an analogy to traditional finance, even large and highly liquid bond ETFs run deep into NAV discount during the Mar 20 global market crash driven by COVID-19 pandemic – the arbitrageurs either capitulated or simply stopped trading as they waited for the uncertainty to fade. In UST’s case, the lack of “arbitraging” (the term is in quotes because technically such trades are not entirely without risks) in UST-LUNA burning and minting can lead to more UST redemptions which result in a further decline in LUNA prices which drives even more UST outflows, causing a loss of faith in the system. This may ultimately result in a “death spiral” scenario as seen by projects such as Basis Cash and Empty Set Dollar where they became unrecoverable.

In addition, most of UST demand comes from the lending and borrowing protocol, Anchor, which provides 17-20% deposit APY returns on UST. With the recent governance vote passed on Anchor, the inorganic demand for UST will likely fall once the dynamic earn rate goes live and likely settles below the current heavily subsidized rate. The outflow from UST-LUNA, if large and synchronized with another market-wide sell-off, could pose challenges to the UST peg again.

Terra ecosystem’s founders are aware of such vulnerability in their flagship stablecoin product and have taken multiple steps to strengthen UST’s credibility. 

First, Terraform Lab has formed a diversified reserve of BTC under Luna Foundation Guard (abbreviated very aptly as LFG) to back UST. This mitigates depegging risks to some extent, although not entirely, as the BTC collateral backs only a small portion of the whole UST supply. BTC, like LUNA, is also susceptible to market volatility.  

Secondly, a couple of dApps have allowed the retail community to be peg-maintainers (White Whale) and bLUNA liquidators (Kujira); these protocols partially solved the problem of arbitrageurs “waiting the volatility out”, as the codes will automatically execute arbitraging trades once users deposit UST into these smart contracts.  

Thirdly, LUNA and UST have been integrated into many other ecosystems, such as Cosmos, Avalanche, Aurora, among others; the increased adoption has technically not removed, but merely distributed, the vulnerability we discussed above, making LUNA-UST “Too Big To Fail” to some extent. Last but most importantly, UST’s real-world use cases in payment and settlements have ramped up, as the previously Korea-dominant payment use cases are expanding globally. Such real-world purchasing power could significantly lift UST’s value accrual capabilities, although there are still substantial uncertainties, including regulation risks, down this route.  

As for FRAX and FEI, their approach has similar limitations to DAI. FRAX’s approach suffers from centralization issues as it accepts only USDC as its collateral. FEI, on the other hand, is capital inefficient due to the high collateralization ratio (~219%) required for its volatile PCV reserve.


True Monetary Independence

Non-pegged stablecoins offer an alternative to users who do not wish to be affected by a central bank’s policy decisions by having an independent value. Having an independent value removes the consequences of monetary policy development, such as sustained inflation seen in the past year. 

This was one important factor behind El Salvador’s acceptance of Bitcoin as legal tender, although USD was its official currency (i.e. Dollarization). Given that El Salvador does not have its own central bank, they are vulnerable to the actions of the Federal Reserve, as the latter’s policy is only catered toward the US economy. Many developing countries right now are also experiencing the consequence of dollarization – imported inflation, predatory capital flows etc.  

Furthermore, fiat-pegged stablecoins may be exposed to regulatory risks from the governments. For example, fiat-backed stablecoins have already been targeted by US federal agencies and may eventually look to regulate all dollar-pegged stablecoins, clashing against one of the core principles of DeFi – decentralization.

Lack of Traction and Adoption

Currently, the adoption of non-pegged stablecoins is insignificant compared to the other categories of stablecoins. As of 1Q22, this category comprises only 0.31% of the total stablecoins market capitalization.

In this category, OHM was the only one that had everyone excited although it quickly faded as its model proved to be unsustainable. It is also arguable that OHM was viewed and valued more like a hedge fund than a decentralized reserve currency.

Largely, wealth is still valued in fiat currencies. Thus, dollar-pegged stablecoins provide a good “middle ground” for users to interact with the wider crypto ecosystem. The problem of independent currencies stems from the inability of everyday consumers to accurately measure its “real purchasing power”. In short, they lack a unit of account when referenced to real-world assets. A useful thought experiment would be to estimate the price of a 2022 Toyota Camry in terms of OHM, in absence of any fiat systems. Sounds tough, doesn’t it?

In addition, we will need to see independent currencies accepted as a medium of exchange beyond the crypto ecosystem. However, acceptance for currencies will only happen when people are able to estimate their real purchasing power – clearly a circular issue as we go back to the unit-of-account problem. Will we see a light at the end of the tunnel? Yes, but only with radical changes towards our perception of wealth creation.

Non-DeFi Stablecoins: An “Existential Threat”?

Central Bank Digital Currencies (CBDCs)

Central Bank Digital Currencies (CBDCs), as the name suggests, are commissioned by the federal government to use as legal tender in a particular country. 

CBDCs fall into two buckets: retail and wholesale. 

Retail CBDCs are issued to the general public and can be used by the everyday consumer to transact in payments, goods, and services. In contrast, wholesale CBDCs are used by financial institutions for interbank transactions and to hold reserves with central banks. 

The first CBDC, Sand Dollar, was issued back on Oct 20 by The Central Bank of Bahamas and is still fully operational today. Sand Dollar follows the retail model and is currently accessible through a mobile application or a physical payment card. Currently, Sand Dollar is only available for use within the Bahamas and only with merchants that have a central bank-approved wallet.

According to, countries such as Sweden, Malaysia, Australia, and Japan are at the “proof of concept” stage, an advanced research phase. Countries such as China, Canada, South Korea, and Saudi Arabia are amongst countries that have already begun a pilot for their CBDC project.

More Efficient, Secure, and Inclusive

CBDCs offer a more efficient and secure alternative to traditional banking services due to the ability for users to interact with the central bank directly when conducting transactions. This removes the need for a middle-man and reduces any form of intermediary risk. Depending on the digital ledger technology (DLT) infrastructure used, payments may potentially be faster, safer, and cheaper, relative to legacy solutions, which may take up to days for cross-border transfers.

Additionally, CBDCs offer greater financial inclusion that greatly impacts the unbanked and underbanked communities in emerging countries. Financial inclusion can provide these communities access to a wider variety of payment options and financial services for both that were not traditionally made available to them if they did not have a commercial bank account or a robust credit score.

Issues with Centralization and Lobbying

Centralization is often frowned upon by crypto-maxis as it defeats one of the main objectives of DLTs. By having the transaction data recorded on the blockchain and the identity of parties involved in a transaction, central banks can use these data to track criminal activity (i.e. fraud and money laundering) or for policymaking (i.e. minimum LTV ratio for microloan applications). As such, users of CBDCs will not have complete privacy over the use of their assets. This might deter the sophisticated crypto users while creating adoption headwinds for others.

Next, the federal government might receive heavy resistance from existing commercial banks, whose bottom line relies on payment volume. While the government has legislative authority over these entities, the prospect of their huge lobbying power cannot be ignored. Excessive lobbying may result in undue influence and affect fair policy-making.

Private Currencies

A newer form of non-DeFi stablecoins is those that are created by commercial entities, intended for use within their respective ecosystems or as an alternate means of payment to existing cryptocurrencies, traditional payment systems, and CBDCs.

In Feb 22, J.P. Morgan (JPM) became the first bank to announce its own private currency, the JPM coin. The coin will be built on Onyx Digital Assets, a blockchain-based network by JPM’s digital-first subsidiary, Onyx. The JPM coin is intended for use as a medium of exchange amongst clients. Additional features of the Onyx platform include an intraday repo that enables intraday financing by exchanging cash for tokenized collateral.

Potential for Utility and Greater Efficiency

Aside from being a medium of exchange, private currencies can also function as a utility token for corporations to expand their network effect and boost wallet share amongst customers. Using a Software-as-a-Service (SaaS) company as an example, customers who are also holders of private currencies can gain access to features not made available to regular customers. This creates intrinsic demand for the coin while also maintaining some level of exclusivity amongst customers.

Next, these private currencies also reduce payment settlement times, leading to higher customer satisfaction. For example, credit card refunds take seven to ten business days on average, causing some customers to feel anxious due long waiting times. This also creates some inconvenience amongst customers as they may find it cumbersome to track their cash flows. With DLT, refunds can be initiated and received on the same day, creating a better customer experience.

Regulatory Overhang and Centralization

Regulations governing the creation of one’s own currency are still not well defined. We think that the degree of regulation will be highly dependent on the nature and utility of the tokens. For example, the SEC uses the “Howley test” to determine if a digital asset should be classified as securities. As regulations for digital assets are still very rudimentary, uncertainty hovers above corporations looking to venture into this space.

As discussed in the CBDCs section, centralization is one factor that could limit the adoption of private currencies. Depending on the number of information users have to divulge when patronizing the services of private currency providers, privacy may be a concern. Given that information appropriation is not an uncommon phenomenon in today’s digital age, users may choose to avoid using such tokens altogether.

Can Every Currency Be a Stablecoin?

While most of the market is dominated by USD stablecoins, we can only wonder if it is appropriate for all currencies to follow a tokenization model. 

In Oct 20, StraitsX launched the XSGD token, a stablecoin for the Singapore Dollar (SGD). XSGD follows the fiat-backed stablecoin model, where users can exchange SGD and XSGD for a 1:1 ratio on the StraitsX platform. Also, MaiCoin is expected to launch TWDC, a stablecoin for the New Taiwan Dollar (TWD). TWDC will also be following the fiat-backed model.

In economics theory, the concept of the “Impossible Trinity” of a country’s monetary policymaking (not to be confused with the stablecoin trilemma) states that a sovereign state cannot boast 1. a fixed exchange rate, 2. free capital flow, and 3. sovereign monetary policy at the same time. In essence, central bankers would have to compromise at least one factor in the pursuit of the other two.

In contrast to the Fed, the SGD and TWD policymakers have different emphases along the trinity. While the Fed has opted for free capital flow and sovereign monetary policy, the Monetary Authority of Singapore (MAS) gave up the power to make monetary policy (i.e. Singapore benchmark interest rates will follow the path of that of the US) while Taiwan’s de facto central bank (CBC) gave up on free capital flow.

In our view, we think that fiat dollar tokenization is not the most effective move for Taiwan, given its high export orientation and capital controls. By introducing TWDC, CBC will face increased pressure to maintain competitive exchange rates with an appreciating TWD. Additionally, the capital controls imposed on the remittance and transaction of TWD are subject to prevailing reporting requirements. This defeats the purpose of tokenization in the first place, as foreign investors are not exempted from the restrictions.

In Singapore’s case, we see the case for the XSGD, given MAS’s pursuit of free capital flow. Currently, StraitsX has the approval to mint an unlimited amount of XSGD, as long as it remains backed by SGD. However, this move creates an unintended internationalization of the SGD, which creates additional pressure on MAS to maintain the managed float. We think that a ceiling on the amount of XSGD minted could potentially alleviate any unintended appreciation of SGD.

Final Closing Thoughts

When Bitcoin was first introduced to the world, it implanted an idea that the future could include a non-sovereign digital currency that rids itself of unnecessary intermediaries. However, it soon became obvious that Bitcoin was not stable enough to be used as a medium of exchange or a unit of account. Following the lessons learned from the collapse of the Bretton Woods System, BTC was better served as a store of value like gold or as a reserve. Dollar-pegged stablecoin was the bridge between Bitcoin and fiat currencies and was the foundation block responsible for the growth of DeFi landscape. As the industry continues to evolve, DeFi users seek out stablecoins that offer the best tradeoff with reference to the Stablecoin Trilemma. 

However, dollar-pegged stablecoins remain at the mercy of central banks and regulators.  Non-pegged stablecoins, in some ways, represent the ideology behind the creation of Bitcoin. Bitcoin, under a utopian proposition, serves as the decentralized medium of exchange, legal tender, and store of value. Hence, it is not “stable” in the sense of keeping peg to fiat, but rather stable as in its representation of perceived independence (no central bank behind, although undeniably its current market capitalization has been floated by Fed easing), fairness (consensus mechanism & max supply), and open access. The critics, however, believe its too volatile to be an effective medium of exchange. Non-pegged stablecoins solve that by combining the decentralized nature of Bitcoin with the stability of dollar-backed stablecoins.

Not wanting DeFi natives to dominate the space, CBDCs and other non-DeFi stablecoins are joining the royal rumble. Their existence creates doubt whether DeFi stablecoins can have real-world applications. Though in their infancy, its existence demonstrates that governments and institutions are no longer overlooking the importance of stablecoins.

Theoretically, stablecoins have the potential to replace all of the world’s money. This opportunity is one of the largest, if not the largest, given that the world’s money today sits at approximately $40T. It is crystal clear why everyone wants a piece of it… Not quite boring as you first thought!


1 PCV is a categorization of Total Value Locked (TVL) which represents all assets that are ultimately not redeemable by users.

2 Protocol equity refers to the amount of PCV that would remain if all user-circulating FEI were redeemed for PCV collateral

3 The function allows users who provided RAI/ETH LP tokens on Uniswap to automatically withdraw the additional liquidity from the DEX and bring your collateral ratio back to the desired level.


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