Cracking the Stablecoin Trilemma

Transcript

[Music] foreign [Music] hey hello everybody I'm excited to be here and talk about the stablecoin trilemma and how to overcome it I'm Robert lauco founder and head of research at liquidy so first of all what is the stablecoin trilemma all about maybe you're familiar with the fact that stable coins usually have to pick two out of three desirable properties decentralization stability and scalability for example LUSD are unstable coin is very decentralized and

it's stable but it's not really scalable makers die used to be similar but they decided to integrate with centralized assets so they became a more scalable but less decentralized and then there are also other stable coins like the algorithmic ones which have tried to be scalable but they unfortunately failed ended up in downward spirals but let me first outline the issues with the current state of borrowing based or CDP based stable coins the problem there is a lack of scalability and that's due to the fact that the demand is kind of or or the way of minting the stablecoin

is constrained by the demand for loans against the collateral and this usually also leads to a softer Peg like the stable coin becomes less stable and also liquidity on the axis becomes a big issue because normally you would need to kind of pay out a lot of incentives to have liquid secondary markets now there is a novel a newer approach I call it a decentralized reserve Which is less well-known I would say the idea there is that instead of having individual positions you have a protocol owned Reserve which is still backed by some Reserve asset let's say ether like some native asset of the chain and there the idea is that you can always mint and redeem the stable coin basically at face

value like as if it was all always worth one dollar and this usually means that you can orbit whenever it's above or below pack so it means a stronger Peg and also you have solved the problem of liquidity because the protocol itself is now acting as a primary amm this also nice in theory but the problem here is that now the protocol takes on all the volatility um that comes from the volatile Reserve asset and that's why those existing exproaches have been um kind of struggling with the fact that they weren't really able to hedge their reserves against those price volatility risks so they turned out to be not so robust at least in difficult Market

situations there are two approaches by the way which I would say people have tried in this under this decentralized Reserve um idea one is a recapitalization by inflation where you have a reserve asset and the stable coin is allow liability of the system but you also have a third token which is a protocol a kind of native token which can be minted like inflated in Supply in order to um kind of let people deposit more Reserve assets like the system means the recapitalization token you can exchange for more of the reserve as let's say ether so the system tries to maintain like a surplus so that it can always buy back the stable coin

on the other hand you see another approach I call it delta neutral hedging which is more um let's say based upon traditional ideas where you try to hedge the reserve and its volatile asset against price Movement by issuing some derivatives like let's say Perpetual Futures where now people who buy those Futures they would normally go long or leverage long on the The Reserve asset and the protocol can then use this extra fund to kind of back its stable coin um so there have been a few protocols that have tried both of those ideas Unfortunately they all have their

challenges because with this recapitalization through inflation you have the problem that you normally need a very high collateral ratio because the risk is still very high so jet for example went for 400 to 800 percent they are pretty Capital efficient by Design on the other hand the delta neutral hedging approach has another issue like first of all some of them are not really decentralized because they are using centralized markets um to buy short or to open short positions and there are others like angle which try to incorporate the Futures Market in their own native protocol but it also turned out to be quite difficult in practice so both of those approaches basically yeah I have

proved like have failed like I would say like or at least some of them ended up in in that spirals and the most of the delta neutral protocols they ended up pivoting to some other designs because they they just realized that the hedging costs or the funding payments that they needed to pay to attract more Capital they just turned out to be not sustainable but I still think or V8 liquid is saying that we can solve this problem or we can take this idea of deltronutral hedging to the next level and here the challenge is really like under difficult Market situations there's just not enough demand for leverage which means a higher hedging costs in the end which is the

normally um kind of shoulder by the protocol which needs to pay out some form of incentives so the cost of the protocol can be very high we need to cut down on those costs how can we do that um we have looked at a few ideas like using protocol Revenue fees for example to finance the cost or even dilute existing users um to incentivize new like capital inflow but this is also not really sustainable but then kind of we came up with a new idea which is really about how to make this hedging product or this leveraged position more attractive in the first place yeah and here there are two innovations we kind of came up with on the users and the main idea is that we make the

product the leveraged product more attractive by adding principal protection so that your losses will be kept in a downturn and on the other hand the protocol can also reduce its costs by a very neat way of integrating a secondary Market into the prime system which means then less strain on the system overall and another um you know another idea here is that we make it so that this principle protected product is Perpetual which means you just create it it's set in forget there is no liquidation you can just become a header of the system and do not have to worry about it too much but what is it now really um in practice what is it about

um so when somebody opens such a hedging position let's say a position of size 10 or 10 is then it means that whenever the East price goes up the protocol can take out money from its Reserve because it doesn't need all of its Reserve to back the stable coin so it can kind of increase the value of the hedging position so let's say here when ease price doubles maybe your hedging position now becomes verse 48. on the other hand when is plummets then there is a new principle protection here that makes it so that you can always get back tennis from the system so it's kind of asymmetric on the upside and that's very

nice because now if you think about it you have a position that can go up but not really go down at least in East terms then it means that it's kind of worth more than can eat it's fair price should be worth more than 10 Eve and this also means now that users should be willing to accept a premium in addition to the principle like they would pay more than this tennis maybe they would pay 12 or 14 E's to open such a position that's the price of this principle protection like an insurance a premium and the system itself can now collect those premiums in order to finance the protection later on when needed and when it is really needed that's interesting

because um normally when a position goes down like now it's in the red it still means that it's fair market value should be higher than the payoff like there is still maybe some downside priced in so only very rarely when the markets plummet really badly would you want to claim your principle otherwise you would rather sell it on the principal sell it on the secondary market for more than its principle but there is still a problem with this approach and that's the fact that now the system is like an insurance company it needs to protect a lot of principles or a lot of positions and if everybody comes and wants to claim their principle

at the same time this may lead to like a bank run situation so the problem here is that the liability is not constrained it can be higher than the collected premium so how can we solve this so here this next Innovation is about how to minimize this liability stemming from the principal protection and we do that by incorporating a secondary Market uh in a very special way and the idea here is that when somebody wants to kind of claim their principle yet then they would want to that they would try to sell their position on the secondary market and the system would kind of detect if the person who is selling a position for let's say tennis the

principal if this person is not able to sell it within a certain amount of time like there is a timeout period Then the system would step in and subsidize the sale it would do that by boosting kind of the inner value of this position gradually over time a bit like in an auction until somebody comes and buys the position for the principal like 10 years and this has very nice consequences or properties because it turns out the system only needs to subsidize a subset of all the positions like only uh those that are really deep in the red while um most other positions they don't need subsidies

because they can be sold on the secondary Market essays without extra boost and out of those that need to be subsidized they only need to be subsidized up to a certain level until they are both so it means in the end that the system only needs to pay out a fraction of a fraction of the total subsidy of the total principles from all positions this is a very nice property because now we can really reduce the total liability of the system another interesting fact is that the subsidies they are not really paid out um but they are just repurposed like it's like a value repurpose inside the system so the the protocol doesn't leak value so the value is kept in the system

just moved from this kind of collected premium pool to the position that needs a subsidy so can we crack the stablecoin trilemma I think we can by first building upon this idea of deltronutral hedging then adding principle protection as the main ingredient to make the positions more attractive in the first place and lastly by introducing the secondary Market as a mechanism that allows the system to reduce its liability from the principal protection it offers so um we are now in a phase where we want to open up our research we will put out some more information about our

project and we would love to get you involved I mean we'd love to hear your insights criticisms reactions about the new project and product and also see whether we can take it to a next level so please check out the latest information on Twitter or even better scan this QR code and then become a part of our Discord Channel there is also a community session sometime in August so watch out for an announcement have two minutes left so maybe if somebody has questions I'm happy to take them any there

hi can you hear me yeah cool so uh CRV USD recently really sorry I don't know it's my phone maybe so curve recently released CRV USD with this Dynamic CDP adjustments based on the you know market conditions of the of the collateral do you guys have any plans to do something similar with liquidity thank you that's a great question so first of all this implies some form of borrowing that was not part of my presentation here but that's also something we want to include in addition to this reserve-based uh kind of mechanism that means the

stablecoin we also want to offer borrowing and there we haven't been thinking about including something like this I guess there are other you know third-party apps for example D5 saver that can kind of deleverage your position when needed or leveraged up so I think you can reach a similar result in the end by using those third-party apps but it's something we can look into I mean to take also to make boring more more attractive at least for some users no more questions does V2 include governance to add new

stake teeth assets or is it similar to V1 ideally it should be similar to V1 no no um yeah I mean we want to stick to this uh yeah immutability uh but yeah let's see I mean we are open to discuss everything in the community thank you