We’ve all heard about the story of the Trojan Horse. The real danger of the trojan horse is that they make you feel safe, no threat is ever expected, and it is precisely when you feel the safest that you’re the most vulnerable. Once the trojan horse is let loose, there is nothing you can do but watch as the chaos unfolds.
While this may sound a little cynical, our beloved stablecoins can turn out to be crypto’s very own trojan horse.
Don’t get me wrong, I know the benefits that stablecoins bring. I have written extensively about stablecoins in the past. Apologies for the shameless self-plugging but you can check some of my other work here and here.
If you read these before, then you may be asking, “But Emiri, you seem to speak highly of stablecoins, you seem to think they are an integral part of the system. So why are you calling them a trojan horse?”
Well yes, the problem lies in its success. In my opinion, the most useful thing to come out of crypto so far is stablecoins. USDC/USDT are the best use case in crypto at the moment. They give easy global access to dollars, they have simplified the trading experience, and they prove to be superior payments systems, especially for international transfers.
But stablecoins go completely against the purpose of crypto. Think about it. We are building an alternate financial system which is rid of any ties to the traditional world, but the best product to come out of it is a synthetic fiat currency? Come on now.
The USDC Supremacy
Everyone is aware of the rise of USDC and how its starting to become a very close competitor to Tether’s USDT. In fact, most people are starting to prefer USDC and seem convinced that it will overtake Tether due to constant rumours about the shady dealings that go on behind the scenes at Tether. I mean USDC is starting to become so popular that you have twitter accounts based around being bullish on USDC. Shoutout @USDCbull1.
As we saw, many decentralised stablecoins collapse over the past few months. It was all smooth sailing for the chads chilling in USDC. Unbothered, in their lane, moisturised, focused, and flourishing. There seemed to be no issues on the horizon. Circle constantly gave updates about the state of their USDC reserves and even announced a EURO stablecoin. Everything was fine.
DeFi protocols are now holding large sums of their treasury in USDC, the most active liquidity pools in DeFi have USDC involved in some form or another, and majority of the crypto participants hold a substantial portion of their on-chain net worth in USDC.
However, recent developments have shown that the trojan horse has started revealing its true self. After the OFAC sanctioned Tornado Cash, Circle complied and has now been blacklisting addresses that have interacted with Tornado cash. Now many users and protocols who had any interaction with tornado cash now have a large chunk of their funds blocked. This is just a small example of the power that these centralised stablecoins have. They can blacklist addresses whenever they feel like which means depending on them poses an existential risk to the crypto ecosystem.
USDC started off as a small tumor which was ignored by most, it has now metastasized into a potentially dangerous cancer plaguing every part of the cryptoeconomy and all we can do now is watch as these events unfold.
What stage is the cancer doctor?
Let’s start with the most important Dapp in this scenario, Curve Finance. The most important pool on Curve is the 3pool, at the time of writing it has a TVL of $991M and is doing $95M in volume. The other large pools such as the frax pool, the sUSD pool, and the USDD pool are all linked to the 3Pool. Within the 3crv pool USDC accounts for 40% of the pool which is around $400M at the time of writing.
Let’s look at Uniswap, 4 out of the top 5 pools by TVL have USDC in them. Those top 5 pools cumulatively account for $2.5B TVL and a combined weekly volume of $5B. So the chunk of Uniswap activity is dependent on USDC.
On AAVE, USDC is the coin with the second highest activity after ETH. There is a total of $1.4B USDC supplied on AAVE & $470M borrowed. On Compound, USDC is the second highest in liquidity after ETH with a total of $700M in liquidity.
When MakerDAO shifted to the multi-asset collateral model, the amount of ETH they held as collateral drastically declined and the amount of USDC in their reserves drastically increased. Currently, 60% of DAI collateral is made up by USDC. 47% of the $10B DAI TVL is made up by USDC. So the leading decentralised stablecoin in DeFi is heavily dependent on a centralised stablecoin.
Lets take a look at Frax. It has a USD treasury of $911M out of which 33% is made up by USDC or USDC derivatives. Even when FRAX is highly collateralised, 90% of the collateral is USDC making it almost a proxy USDC at times.
I can go on and on but I think you get the point. USDC is deep-rooted in all the cornerstone pieces of DeFi. Total DeFi TVL is $65B and the top 5 protocols by TVL are MakerDAO, Lido, AAVE, Uniswap, and Curve accounting for a cumulative $36B of the $65B TVL, just a little over half, and a majority of the TVL on 4 of these 5 is made up by USDC.
Doctor: I’m afraid to say but it looks like stage 3 cancer.
What does the Oncologist recommend?
“Just diversify bro” seems to be the common solution proposed on twitter. All treasuries and protocols should move away from supporting USDC and start looking towards more decentralized and censorship resistant alternatives.
That’s of course what everyone would love to do, but only if it was that easy. We need to consider what diversifying out of these centralized stablecoins would actually look like for DeFi.
People love to talk about the lego like structure of DeFi. However, if you look at the baseplate protocols such as the ones mentioned above, the entirety of the DeFI ecosystem is dependent on them in some way. They are either built on top off these base protocols, execute strategies on them, or hold a significant chunk of the native tokens in their treasury. So the ripple effect of moving away from USDC is likely to be catastrophic. The baseplates collapse which will cause the entire structure to immediately crumble. Many up and coming protocols with genuine potential will unfortunately have to close up shop early and many existing protocols which have steadily been growing might also have to close shop.
How I see it, there are two general ways to go if you want to diversify out of USDC. One is for protocols to diversify into other stablecoins and the other is to diversify into a basket of other crypto assets.
When it comes to diversifying into other stablecoins, the assumption is that you diversify into other decentralised stablecoins. The best options at this point are DAI and FRAX but as we’ve seen before, both of them are now heavily reliant on USDC. So a diversification away from USDC will likely lead to some sharp volatility on DAI and FRAX themselves. Then when it comes to other alternative they prove to be very risky because most of them have not been stress tested enough. We know how easy it is for stablecoins to collapse which is why relying on a newer stablecoin is not a good move.
Even if you look at a truly decentralised stablecoin with no peg such as RAI. That would seem to be the optimal solution but the issue comes from user adoption. It is difficult in terms of mindset to onboard people to such a stablecoin and start pricing things in RAI, additionally its poorly integrated with the rest of DeFi.
So switching from centralised stablecoin to decentralised stablecoin will have to start with decentralised stablecoin protocols, this switch will initially hurt the decentralised stablecoins with a chance of some surviving. This in turn will trickle down into the rest of DeFi leaving a sea of dead bodies in its wake.
The other method is to diversify from USDC into a basket of crypto assets. While this may make sense from a ‘decentralization’ aspect, it doesn’t make sense from a business aspect. It will result in a situation similar to one we had before stablecoins existed. Every reserve and every treasury will hold crypto assets which are high risk and highly volatile and in adverse market conditions will likely cause most protocols to shut down.
So where do we go from here? Does a chad dev come along with a ground breaking solution? Or do we simply BEND THE KNEE.
Do we really need stablecoins?
All this stablecoin talk raises the question as to whether stablecoins are necessary at all. There have been many decentralised experiments but they are either not truly decentralised or they end up imploding. No meaningful competition to centralised stablecoins has arrived or likely will arrive.
Boiling it down to its core, stablecoins have 3 key benefits. Trading, Payments, and Access. 2/3 of these can be solved but unprecedented access to dollars (or any other currency) is a role that only fiat pegged stablecoins can fulfil.
Payments & trading can be solved by ETH itself. If you consider crypto to be the financial layer of the internet or the ‘metaverse’ then ETH is already showing signs of becoming that base currency. Granted its very early days and it will take time for people to not denominate their ETH wealth in USD, but it’s a gradual process. All NFTs are already priced in ETH, and all new shitcoin listings are already priced in ETH.
A way to look at stablecoins is to look at it on a very long time frame. In that case, they are simply a temporary solution that act as a bridge between fiat and crypto. Once a significant portion of global liquidity is onboarded into crypto, then things like ETH or whatever else is popular at the time can start to become base currencies simply because all crypto transactions will be priced in them.
Concluding thoughts
This is not the only mole in our system. Centralised stablecoins are just one example. Oracles which almost every protocol rely on are often centralised. Key infrastructural players such as Infura are centralized. With trust being placed in so many different cancers to the space, the likely result seems a complete abandonment of decentralization, censorship resistance, and permissionless transacting.
We can hope that there is a way to shift our dependency away from these centralised entities and move to something that is more in line with the original crypto ethos. In the event that we do manage to pull this off, we are likely to experience extreme pain in the medium term given how deep rooted these entities are. Regardless of the pain, I’m certain crypto won’t die, it has proven its resilience time and again and will likely do the same one more time.
In the meantime, I can just hope someone much smarter than me can come along and fix things and if they do I’ll be here to cover it. If not, then oh well, I’ll still be here because wtf else am I going to do.
Thank you for reading. I hope you enjoyed.
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