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Decentralized stablecoins address many issues of centralized ones. These stablecoins rely on protocols (smart contracts, e.g. code) built to maintain the value of the tokens they issue to the desired peg. Since everything occurs on the blockchain and relies on open source code, these currencies and protocols are decentralized and much more transparent. This openness and auditability differs from their centralized counterpart.
The first important thing to understand with these protocols is that since they are on-chain, they can only accept crypto-currencies as collateral: fiat-USD could not be backing a decentralized stablecoin. However, centralized stablecoins pegged to USD, like USDT, could be backing a decentralized stablecoin. The volatile nature of most on-chain cryptocurrencies is what makes building robust and sustainable decentralized stablecoin protocols so challenging. You may have 1 ETH in reserve backing 2000 stable USD, but if the price of ETH decreases, reserves will be too small to back the stable dollars issued.
As of early 2021, there are two wide categories of decentralized stablecoins: collateralized and under-collateralized protocols, each having their own sub-categories. In this article, we will be focusing on over-collateralized protocols, that is to say on protocols that are built to always have more collateral backing the value of the stable tokens than stable tokens issued.
The most successful over-collateralized decentralized stablecoin is DAI, created by MakerDAO, which is pegged to the USD, collateralized by ETH, USDC, and WBTC and many other collateral types. Many protocols, like Mirror, Synthetix (backed by SNX) or even
Noe
Maker’s protocol aims for a collateral ratio above 150% for most collateral types meaning that the value of the collateral is at least 150% that of the stable assets minted.
In this model, you generate DAI by locking crypto collateral (ETH for instance) in smart contracts called Collateralized Debt Positions (CDP) or vaults.
Precisely speaking, funds need to be lent to a vault to issue DAI. If 150$ worth of ETH is put in a vault, up to around 100 DAI can be issued and borrowed by the vault owner. To get back the ETH put in the vault as collateral, the borrowed DAI needs to be paid back along with some interests fixed by a rate called the stability fee.
When the value of the ETH in the vault falls such that there is less than 150% of ETH for the DAI minted, the vault can get liquidated and the vault’s collateral is offered in an auction. This ensures that there is always more collateral in the protocol than stable assets issued.
While ensuring that there is always more collateral backing the stablecoins is the core part of Maker’s system, it does not guarantee the stability of DAI by itself. So far, and except on rare occasions (like on Black Thursday) DAI has managed to keep the peg with the USD.
We won’t go too much into the details here, but if you want to know more about black Thursday, you can look at this incredible article from Linum Labs!
Since DAI is tradable on the open market but not directly convertible against collateral (like centralized stablecoins are), how can DAI remain stable? The main lever used to maintain the peg is called the stability fee. When DAI is trading below $1, to discourage borrowing and encourage vault owners to repay their debt and decrease the supply of DAI, the stability fee is increased. Conversely, when DAI trades above $1, this fee is decreased. Limits of Systems Like DAI
Limited Stability without USDC as collateral
Note that this stability fee cannot be decreased under zero, meaning that if the price of DAI increases by too much, it starts to become difficult for Maker’s governance to restore the peg by decreasing the stability fee. Note also that this mechanism with fees is not automatic at all and requires an active governance to be involved.
If the system was limited to that, there would be nothing obvious with the stability of DAI. At no point in time with Maker, there would be direct profitable opportunities for arbitrageurs to bring the peg back to $1. We explore below some very indirect arbitrage opportunities in this case:
If DAI trades below $1: then, to bring the peg back, the solution would be to have some incentives to reduce the supply of DAI. Where this incentive can be found is among vault owners which sold the DAI they issued at a higher price. They can buy DAI for less than $1, and then repay their debt to get their collateral back, thus making a profit through this very indirect operation, and help restore the peg. Still, restoring the peg in this situation assumes that there are enough people that sold the DAI they issued at a higher price than the current one and that are willing to do the operation to repay their debt (instead of staying leveraged on ETH).
If DAI trades above $1: again there are no clear arbitrages to restore peg that result in direct profits. The best way to make a profit in this situation would be to mint DAI from your vault, sell it on the open market for more than $1, and wait for the price to go back to $1 to repay your debt. This can only work if the price of DAI decreases, which is not obvious at all, especially when the stability fee is already low.
Regardless of that, DAI has been working really well (thanks to them for paving the way for decentralized stablecoins). The reason for this is that Maker introduced a small tweak in the system and USDC can be used to back DAI. As of July 2021, 60% of DAI have been minted using USDC.
With USDC, people can open up vaults with just 100% collateralization and use the DAI they issue to arb DAI price: it is almost as if USDC was directly convertible to DAI and conversely. Unless it keeps relying on USDC as a collateral, in times of extreme demand, there is no guarantee that the protocol will be able to maintain its peg.
Indirect Leverage and Stability
Another remark is that people minting DAI and thus issuing stablecoins are quite often volatility seekers: they are people willing to get leverage on the USD price of the tokens used as collateral by borrowing stablecoins they can later exchange back to the tokens. To be able to get this volatility, they need to find on the market people ready to swap their DAI against collateral and thus looking for stability.
This way to get leverage on Maker is very indirect. You need to open a vault, issue DAI, and then swap these DAI against ETH or the token you want to buy. Also, as vaults need to be over-collateralized by at least 150% (more or less depending on the collateral type), unless you do repeated loops, you can never get more than 1.5x leverage with this design.
To this extent, as a protocol to get leverage, Maker is very equivalent to Compound and Aave except for the fact that you can only borrow DAI which is a form of wrapped USDC and that you barely accumulate interests on the collateral you deposit.
Complex Logistics
If you are a person looking for stablecoins or without knowledge about how to handle a vault, there is no point in interacting directly with Maker’s protocol: you should directly go on the open market. As of July 2021, according to Dai Stats, Maker only has 25k vaults opened for around 5.5 billion DAI in circulation. This means that on average each vault mints 220k DAI. Overall, to create supply in DAI, Maker needs “whales” to interact with its protocol, who usually use it as an indirect way to get leveraged rather than to ensure the stability of the protocol. “whales” that are most of the time not here for the main purpose of stability of the protocol.
Lack of Scalability and Capital Efficiency
Like many other stablecoin protocols, Maker cannot generalize to multiple stable assets. Other similar protocols like Synthetix and Mirror however manage to do so. Unfortunately, and this is mostly the case for Synthetix, everything is centered around USD, and there is not a lot of liquidity for stablecoins pegged to other currencies like EUR or CNY.
Last but not east, over-collateralized stablecoin systems like Maker are typically capital inefficient for most of the collateral types they accept (not for USDC obviously). As an ETH vault owner, to mint 1 of stablecoin, you need at least 1.5 of ETH (or 1.3 ETH if you accept to pay a higher stability fee). Too much capital needs to be locked up to keep up with the number of issued tokens or coins. TL;DR
There is nothing obvious with the stability of DAI without USDC as collateral, and Maker does not seem to have the tools to make it stable in all situations except if it keeps relying on USDC
People issuing the DAI stablecoins are often volatility seekers looking for on-chain leverage in an indirect way
Issuing DAI is complex and requires important domain expertise
Issuing DAI and over-collateralized stablecoins using vaults in general is very capital inefficient for most collateral types
There have been several approaches to improve Maker while keeping the vault-like structure. We invite you to take a look at Liquity which tries to be a capital-efficient version of Maker backed by ETH allowing direct redeemability of the stablecoins against collateral. Liquity has managed to keep its peg quite well since its inception.
Angle aims to make the best of Maker like approaches while still keeping its advantages, but unlike Liquity, it does so without keeping the same design involving vaults or other forms of collateralized debt positions.
Overall, like Maker and other over-collateralized and decentralized protocols:
Angle is decentralized
Angle is over-collateralized: there is always more collateral in the protocol than stablecoins issued, which increases the robustness of the protocol in case of a bank run
Still contrary to most Maker-like protocols:
Arbitrage is obvious with Angle and does not require an active governance to be involved: the stability of the stablecoins can be more easily ensured because of the full convertibility between stable assets and the collateral backing them
Angle is capital efficient regardless of the collateral used: to mint 1 of stablecoin, only 1 of collateral is needed. When burning 1 of stablecoin, 1 of collateral is redeemed.
Angle is easy to use and does not require any specific knowledge. Anyone can take part in the protocol even without domain expertise
People minting stablecoins on Angle are really looking for stability and not volatility
On Angle, leverage can be obtained in one transaction from the protocol, rather than with many interactions with other protocols
Angle could be used to issue any kind of stableasset on-chain provided that there is an oracle
One solution to solve this scalability/capital-efficiency issue for all collateral types can also be with under-collateralized protocols: these are stablecoins for which the value of collateral backing the coins is most of the time less than the value of the stablecoins minted. While this is not a new idea in crypto, many new protocols like FEI or FRAX came in recently with new designs.
In Part 3, we are introducing algorithmic and meta stablecoins.
The forward-looking statements in this announcement are subject to numerous assumptions, risks and uncertainties which are subject to change over time. Such assumptions, risks and uncertainties could cause actual results or developments to differ materially from the results and developments anticipated by Angle Labs Inc. Even if our anticipated results and developments are realized, such results and developments may nevertheless fail to achieve any or all of the expected benefits anticipated by this announcement. We reserve the right to change the plans, expectations and intentions stated and implied herein at any time and for any reason or no reason, in our sole and absolute discretion, and we undertake no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future developments or otherwise.
This announcement is not intended to provide legal, financial or investment or other advice and we recommend that you do not rely on, and do not make any financial or other decision based, on this announcement.
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