Stablecoin Triangle

Stablecoins triangle is basically a trilemma between perpetual peg stability, capital efficiency, and decentralization. In designing a stablecoin, most designs and mechanisms end up having to choose between two out of 3.

There are 3 components to the triangle and we will try and understand each:

1. Peg Stability → One of the characteristics of a good stablecoin comes in it’s ability to maintain the peg to a value despite buy and sell action in the market.
2. Decentralization → Decentralized systems are those which have no single point of failure, and require a majority to push changes through the system. Decentralization is a measure of how less concentrated this control is. More decentralization implies that the system is less susceptible to an attack.
3. Capital Efficiency → Any currency typically issued with some collateral asset as backing. Often the value of this collateral needed maybe higher than the value of the asset itself to guarantee against fluctuations, and allow for capacity to buy back. It is ideal to have a system where it is cheap and capital efficient to issue stablecoins.

What are the tradeoffs?

A sufficiently decentralized and capital efficient stablecoin always runs the risk of a potential deviation from the peg. This jeopardizes long-term stability of the peg. For example, UST (Terra) issued stablecoins without sufficient collateral, and sudden sell pressure can lead to the system destabilizing and a potential depeg as in the case of Terra.

Centralized stablecoins may have a higher capital efficiency but come at the cost of being centralized and thereby lacking security. For example, USDT (Tether) is a centralized stablecoin that comes at the cost of an inability to fully audit the system.

If a stablecoin is decentralized and looks to guarantee maintenance of the peg, then it comes with an over-collateralization requirement. For example, DAI requires 1.5x the value of issuance as collateral in order to combat volatility.

Mento's stable assets on Celo currently presents a mechanism that is capital efficient, decentralized and has maintained peg stability.

With money becoming inherently programmable, and more creative workarounds for the design constraints, I am confident that we will soon see stablecoins that are decentralized, perpetually stable and capital efficient.