Fluff and Air: A Stablecoin Publication

Welcome to Fluff and Air, a brand new hopefully recurring publication by 0xcarnation and ct_zpy where we fud try to better understand your stablecoins. Meow.

Just a heads up: This post is just for education, and this post is not financial nor mathematical advice. We may hold tokens of some of the projects mentioned here.

Typically, stablecoins are cryptocurrency tokens pegged to the US Dollar. However, the main reason stablecoins are pegged to the USD is that the USD is the world’s reserve currency. As a result, the US Dollar is the best risk-off asset available and commonly used to denominate global trade. Thus, we should define a true stablecoin as assets where both the risk of loss and risk of gain are 0. However, it’s important to note that “stablecoins” we talk about are just tokens, which can trade at any price. The best solution we have so far is to come up with ways to peg them to the USD.

We will attempt to cover a range of stablecoins and build up some intuition and insight.

USDC and USDT

The most simple stablecoins are USDC and USDT. These two stables are backed by centralized companies. People trust that Circle and Tether have assets to back their coins up, and thus their coins maintain peg. You can read Circle’s latest attestation here, and Tether’s latest attestation here. According to these statements, both are fully backed.

As centralized stablecoins, USDC and USDT are not permissionless. Circle and Tether can decide to freeze the coins in your wallet at their discretion. However, this may not necessarily be a bad thing, as the Kucoin Hacker had their funds frozen by Circle. (Devs finally did something.) But this carries a major drawback: these centralized entities could receive political or legal pressure to freeze (blacklist) the funds of any individual.

Despite these caveats, one could argue that USDC and USDT are the strongest and most trusted stablecoins in the space.

Dai from MakerDAO

Dai is a tiny bit more advanced. Dai is a decentralized stablecoin minted through MakerDAO, and each Dai is over-collateralized by a mix of USDC and other strong crypto assets.

However, this over-collateralization means that Dai is not very capital efficient. More than $1 worth of assets backs each Dai, which is only worth $1. This excess collateral makes Dai safe, but sacrifices capital efficiency in return.

The mechanism for bringing DAI back to peg is two-fold. Let’s say Dai is trading above peg at $1.10, then you can swap 1 Dai for 1.10 of USDC, which you can use to mint more DAI to sell for more USDC.

When Dai is below peg, borrowers are incentivized to take advantage of the cheap Dai to repay their loans. If your debt is 100 Dai and Dai falls to $0.80, then you can buy 100 Dai for 80 USDC and close your loan at a 20% discount.

Hence, repaying debt is the use-case (and demand) for Dai.

Magic Internet Money from Abracadabra.money

MIM is quite similar to Dai. MIM is issued against an over-collateralized crypto position. Burrowers will either repay their MIM debt and receive their collateral back, or their collateral falls to debt value and Abracadabra liquidates the collateral to cover the debt.

An interesting food for thought is that for all MIM out there, there is a corresponding amount of debt that is slowly increasing in size. If everyone tries to repay their loan all at once, would there be a squeeze on MIM?

MIM also has a separate token, Spell. Spell can be locked and staked, allowing users to vote on governance and earn 75% of the interest fees generated by MIM.

Because MIM only allows stronger assets with larger market caps to be provided as collateral,  the chances of liquidation are significantly lower and MIM is quite safe. A riskier version of MIM exists in Mai.finance, which more or less works the same way that MIM does, except Mai allows users to borrow using riskier assets that MIM does not accept.

Similar to Dai, repaying debt is the use-case (and demand) for MIM and MAI.

Thus concludes the first release of Fluff and Air. We will begin fudding your stablecoins in the next release of Fluff and Air. Meow.