Do efficient stablecoin solutions that won't "create trouble" really exist?

Source: Qianglie Forum

Not long ago, during some research, I was surprised by the roadmap of Shiba Inu coin: it turns out that they have been building a complete ecosystem around the Shiba brand, including their own Layer 2 (Shibarium), their own exchange (Shibaswap), their own DAO (Doggy DAO), NFTs, the metaverse… and of course, their own stablecoin ------ "SHI".

Seeing that meme coins are also planning to issue stablecoins, I realized that from public chains like NEAR, Tron, and Wave, to leading DeFi protocols like Aave and Curve ------ everyone is planning to issue their own stablecoins, and the collapse of Luna seems to have had no effect at all. In the current context of increasingly thin liquidity, centralized giants are acquiring everywhere, while leading decentralized DeFi protocols, besides squeezing liquidity space from other protocols, are also rushing to enter other tracks ------ especially stablecoins (*Protocol-owned-stablecoins, POSCs).

What kind of "new normal" will this be?

1. Why does everyone want to issue their own stablecoin?

At first glance, the reason seems obvious: who wouldn't want to "print money" themselves? Issuing a stablecoin means that from now on, your funding costs will disappear (although you have to follow some rules). Upon further analysis from the "dissipative structure" perspective of "Wenli," it becomes quite clear:

As an emerging and closed system, crypto must have energy injected for liquidity to increase. Energy can be injected from the outside, but it can also be generated internally ------ these two dimensions of "external energy" and "internal energy" help us categorize stablecoins:

So far, most of the liquidity in the circle is injected through USDC/USDT ------ shaking hands with the dollar, liquidity floods in like a star-absorbing technique, making it possible for the circle to expand ------ this is "external energy."

Can we rely solely on external injection? Of course, as long as you are willing to hand over all your "voice" to others, willing to be a "shadow" of the dollar in the crypto world, and willing to give up your liquidity decision-making power to the dollar world, you will float on the surface as long as others inject liquidity; if upstream is cut off, you will never grow up.

Of course, no one wants that.

So, the desire to seek "internal energy," explore internally generated stablecoins, and excavate liquidity creation mechanisms from within oneself ------ this desire must inherently exist. "Internal creation," or stablecoins that are natively generated within the crypto ecosystem, can be divided into two types: over-collateralized (MakerDAO) and under-collateralized (others). "Over-collateralization" has an inherent weakness: the speed of liquidity creation is too slow, which actually reduces the liquidity within the entire system ------ if you collateralize $1 million and withdraw $700,000, this "liquidity reduction" effect has always been a headache for the crypto circle.

This inherent deficiency has led to various "innovations" ------ all kinds of "under-collateralized" stablecoins. Everyone has been "inventing," trying to find ways to improve usage efficiency ------ until Terra/Luna was "killed," collapsing the entire crypto circle.

Up to this point, it seems like a "strange loop" ------ endogenous stablecoins can indeed bring liquidity to the system, but the safest "over-collateralization" leads to decreasing liquidity, while under-collateralization is prone to "chaos," dragging everyone into a death spiral. Is there a third possibility? Is there a solution that is more efficient than "over-collateralization" but won't lead to excessive "chaos"?

Aave's stablecoin (GHO) seems to be a recent effort in this "third path."

2. Based on pure credit creation of GHO: Will "facilitators" behave like Terra/Luna?

Aave adopts a "hundred flowers bloom" approach to stablecoin issuance design: "Aave over-collateralization," "delta neutral (market-neutral strategy)," "credit scoring," "pure algorithm," "RWA," "treasury backed" ------ it almost combines all the stablecoin issuance models seen in the market, such as Maker (RWA), FRAX, Luna, and so on.

Among them, there are identical models to others: for example, Aave over-collateralization. Depositors on Aave, who originally stored BTC or ETH to borrow USDC or USDT, can now directly borrow GHO, which is essentially doing the same thing as Maker ------ creating stablecoins through over-collateralization.

Since it is the same as Maker, it obviously does not solve any new problems or invent any new models. However, compared to MakerDAO, Aave still has advantages that only "lending platforms" possess.

For example, technically, lending platforms use a unified fund pool model, providing users with "deposit certificates," equivalent to a position. Creating stablecoins based on a unified fund pool and position model has technical advantages and lower costs (gas fees, liquidation costs, etc.), which gives it a natural advantage over Maker's vault-based solution, and the management model is much easier.

Even so, this is still a "model with inherent deficiencies that reduces system liquidity"; other solutions, such as RWA and Treasury-backed, only introduce "external energy" to varying degrees.

However, Aave has one concept that stands out and differs from other stablecoins: "facilitators" ------ can generate and destroy GHO without collateral. This is a completely "credit-based" stablecoin issuance scheme, i.e., "printing money."

So the question arises: what is the difference between this "facilitator" method of creating stablecoins based on pure credit and that of Terra/Luna?

Not only does it look very similar, but it even feels like it could be more chaotic than Luna. Terra/Luna relied on collateralizing its "stocks" to create currency, while Aave, if it is a completely "0 collateral" scheme, isn't it similar to the logic of "central banks directly creating currency"? It is exactly like pure credit borrowing, only that "zero credit borrowing" has been turned into "zero credit printing stablecoins," and then the printed stablecoins are used for borrowing.

This not only aligns with our conclusion in the "three questions of the soul of money" that "printing money out of thin air is the way to go," but also avoids concerns about a "death spiral" ------ what is there to spiral if there is no collateral?

Thinking this way, Aave has indeed created a groundbreaking new model for generating liquidity internally within the system.

3. Will a "stablecoin world war" occur?

The relationship between MakerDAO and leading DeFi protocols (Compound, Aave) is not precisely analogous, but somewhat similar to the relationship between "central banks and commercial banks" ------ MakerDAO prints DAI, while Aave/Compound, these "commercial banks," acquire DAI from MakerDAO at a fixed interest rate for use on their platforms.

Now, this "commercial bank" Aave wants to create currency itself, which is akin to the Bank of China telling the People's Bank of China: I want to print money myself and compete with you (well, this analogy isn't great; let's change it to JP Morgan and the Federal Reserve). What will happen next?

Let’s imagine: Aave launches GHO across all its lending markets, and borrowers can now borrow DAI issued by MakerDAO or GHO issued by Aave. If it were me, under equal conditions, would I choose GHO? It doesn't seem likely. Unless they offer me a significant incentive, like tips and discounts. Suppose Aave is generous enough, and everyone starts using GHO (the dollars printed by JP Morgan), then the circulation of DAI in the market will begin to decrease.

The question arises: after all, MakerDAO is not a central bank; won't it retaliate? In this case, wouldn't a world war in the stablecoin field be about to break out? Even if this kind of vicious competition doesn't burn money to create demand, but instead attracts more users to mint their stablecoins, does Aave have a real advantage?

Hayek envisioned a "free banking currency competition" in "The Denationalization of Money" ------ every bank can issue "trusted currency" based on its own assets. As long as market competition increases, there will definitely be more reliable currencies emerging. Competition among commercial banks already exists, and competition among stablecoins is also inevitable.

If it relies on competing over who has lower lending rates or who issues currency more prudently ------ such competition is also healthy competition. If there are flaws in MakerDAO, Aave might do better, why not?

Moreover, the logic of MakerDAO is inherently strange. Remember the famous dark web trading platform Silk Road? The founder Ross Ulbricht, who is still in a federal prison, wrote an article in 2020 criticizing the significant flaws of MakerDAO and proposed the idea ------ that a new generation of stablecoin platforms should compete.

(Article link: https://rossulbricht.medium.com/remaking-the-maker-protocol-4b29f879f11)

The collateral in MakerDAO is liquid; we hand it over to MakerDAO to create the stablecoin DAI, contributing to the MakerDAO ecosystem. But Maker wipes out our contribution in one fell swoop, not only reducing liquidity within the ecosystem through over-collateralization but also charging interest, which is very unreasonable.

In contrast, on lending platforms like Aave, the collateral we deposit can still earn interest (let's set aside whether this is a "gimmick"). If a direct battle with MakerDAO occurs, deposits can mine, borrowing costs are lower, and deposit interest rates are higher ------ isn't this healthy competition for users?

Even if "vicious competition" truly occurs, with rising deposit interest rates, there will still be the constraint of "maintaining currency value" ------ if one's stablecoin is severely over-issued due to vicious competition, there is certainly a risk of "decoupling" and being arbitraged, resulting in a ruined reputation and a loss that outweighs the gain.

4. The First Principle of "Risk Sharing": Who is the real loser?

At first glance, Aave's "hundred flowers bloom" issuance design seems to combine all the stablecoin issuance models seen in the market, which would make those with a financial background feel extremely comfortable, as it appears to perfectly utilize the "Financial 101" asset portfolio management essential course ------ the diversification method of "not putting all your eggs in one basket," thus achieving the possibility of a "third correct solution that is more efficient than over-collateralization and won't lead to chaos."

Well, the devil is still in the details. For Aave itself, it indeed "diversifies." But don't forget the "first principle of risk sharing" ------ "sharing" can only be achieved when "high risk" is borne by "low risk."

Suppose Xiao Pao issues a GHO today without collateral ------ using his own credit, he creates a stablecoin out of thin air. Then he borrows one USDC from Will, who has deposited it in Aave, at a "1:1 exchange rate" ------ at this moment, the USDC is in hand, and since it is not collateralized elsewhere, it means Xiao Pao has already freed himself and can run away freely.

Thus, the risk created by Xiao Pao is successfully "100% shared" with the person who deposited USDC (Will).

If Xiao Pao does not run away, but the next day the price of GHO drops to $0.9 (decoupling), Will's original $1 USDC equity would only be worth $0.9.

Of course, if Aave's pool is large enough, and there are many other people's USDC deposited in the pool, after sharing, perhaps Will can get back $0.96, but in any case, Will has still been "shared" the risk created by Xiao Pao for no reason.

Even worse, if Will is over-collateralized and has deposited his BTC, when the price of BTC drops significantly, Xiao Pao only needs to wait for Will to be liquidated, then use the GHO he created at zero cost to liquidate Will's collateral, thus obtaining Will's hard-earned BTC collateral. This is simply the definition of "taking advantage of someone else's misfortune": obtaining collateral at zero cost without any responsibility.

Before the appearance of Aave's credit GHO, the liquidation process on existing lending platforms was: when Will's BTC price drops, Xiao Pao deposits a small amount of USDC, and takes Will's collateral BTC at a low price ------ in this process, USDC returns to the fund pool. However, Aave's GHO will be destroyed, disappearing forever from this world ------

Thus, the final outcome will be: Will (the depositor) suffers a net loss, Xiao Pao (the one printing GHO based on credit) gains a net profit, and the platform Aave simply says "sorry." The end. Don't forget that Aave's responsibility is to maintain GHO's value at $1 and ensure it does not decouple, but it has no obligation to guarantee that BTC does not drop in price.

Next time you see the phrase "risk sharing," don't forget its translated version: the low-risk party suffers losses while the high-risk party benefits ------ this is just like the CDO tranches in the subprime mortgage crisis in the real world.

5. Conclusion

At this point, we seem to have reached a conclusion: a lending platform with deposits wanting to create stablecoins is a simple and natural logic. When a lending platform has funds deposited, it inherently possesses the ability to issue stablecoins.

Aave's stablecoin meets several important conditions:

First: There is a strong demand; the crypto ecosystem needs "internal energy" to enhance internal liquidity.

Second: Issuing stablecoins from a lending platform has advantages over MakerDAO's purely collateral-based stablecoin generation.

Third: The platform is large enough, making it easy for the market to accept.

However, this still does not guarantee that it will succeed, nor can it ensure there will be enough "trust" and "demand" ------ why should it? Can leading protocols just print money? MakerDAO is a pioneer, and the market has already developed a real demand for DAI, which is recognized as "money." Of course, Aave's "portal" setting acts like a "demand-side anchor," directly providing scenarios for stablecoin demand; at the very least, it can also pledge its stablecoins internally to borrow other assets ------ this is already the greatest demand for a "stablecoin."

However, for a stablecoin to succeed, it requires tremendous momentum. In any case, a stablecoin is just a symbol; if there are no other economies and projects using it, it is of no use. And to get the market to accept your stablecoin, you need to manage the costs of inflation and deflation, liquidity incentive costs, competition costs with other currencies, maintenance costs, and so on ------

Printing money out of thin air is indeed the way to go, but it is also very expensive.