A Comprehensive Thread on Stablecoins - Introducing Beanstalk

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A COMPREHENSIVE THREAD ✍🏻 on Stablecoins We dig into the design principles and understand the different types of #stablecoins Also, make sense of what @BeanstalkFarms is trying to achieve Let's dive right into it 🧵 👇

🧵/1 Welcome to Ch. 1 of the #Beanstalk Series $BEAN 🌱💵 is a credit-based stablecoin from @BeanstalkFarms Read Ch.0 👇 twitter.com/EverythingB0x/status/1578262881417560064?s=20&t=8NE_UL_8xawwMHb_y62sDQ

🧵/2 #Decentralized economy is ‣ Permissionless ‣ Programmable ‣ Highly Liquid ‣ Borderless ‣ Trustless

🧵/3 Economy ➡️ Decentralized When Crypto ➡️ Mass Adopted And Mass Adoption ➡️ Crypto as a Medium of exchange/ Global transfer of value

🧵/4 #Cryptocurrencies ‣ The wild west of the financial world ‣ Highly speculative ‣ Volatile, restricting the use for payments & trade (medium of exchange) 📈 $BTC price today (< $16500) - almost 1/4th of the price last October (>$61,000)

🧵/5 Importance of Stablecoins ‣ Provide price stability & steady valuation ‣ Eliminate volatility (no massive fluctuations) ‣ Pegged to the value of another stable asset/ #FIAT (US dollar) ‣ Make #crypto a medium of exchange

🧵/6 #Stablecoin Trilemma Design principle around which Stablecoins exist ‣ Price Stability ‣ Capital Efficiency ‣ #Decentralization

🧵/7 Stability Ability to remain at its peg (sans large variances) irrespective of market conditions 1 unit of #STABLECOIN = 1 unit of PEGGED ASSET (under all conditions) Affected by market expectations & trust

🧵/8 Efficiency Capital required to secure the stablecoin Locking up more than $1 of #collateral to create $1 of #stablecoin is deemed inefficient Efficiency = Low minting cost Can lead to stablecoin supply constraints due to higher capital requirement

🧵/9 #Decentralization The extent of dependence on centralized systems/entities Mitigates risks of single-point failure Makes the system #trustless

🧵/10 Achieving Stablecoin Trilemma = End State No #stablecoin has been able to embody all three characteristics Price stability (the most important design principle) Achieving it = Trade-off in either #decentralization or capital efficiency

🧵/11 Existing types of Stablecoins ‣ Fiat-backed coins ‣ Commodity-backed coins ‣ Crypto-backed coins ‣ Algorithmic coins

🧵/12 Fiat-backed coins (1:1 collateralization) Account for over 90% of the entire stablecoin supply Backed by a #FIAT currency A custodian/centralized organization/central issuer holds the fiat collateral/currency in proportion to the no of coins in circulation #CENTRALIZED

🧵/13 Simplest stablecoin category due to the structural advantage Most popular ones are backed by #USD 💵💵 Includes $USDT (#Tether), $USDC (#Circle), $BUSD (#Paxos)

🧵/14 Commodity-backed coins Collateralized with commodities like precious metals/oil/real estate instead of #FIAT (mostly #Gold) Rarely used in #DeFi Includes #Tether Gold and #Paxos Gold

🧵/15 🚩 Problems - FIAT/Commodity backed #Decentralization traded for capital efficiency/price stability Govt regulations & Intervention- Threat to #censorship Lack of Transparency & Accountability- Systemic risk for the industry Needs Trust on the part of users/investors

🧵/16 Examples 🔺 Censorship 😷 #Circle ($USDC) blacklisted wallets that interacted with #Tornado Cash after the #SEC added Tornado Cash smart contract addresses to the #OFAC list

🧵/17 No option but Trust 🫱🏿‍🫲🏻 With endless rumors about $USDT being partly backed/backed by volatile/riskier assets than cash/equivalents, there have been no efforts from #Tether to prove otherwise No audit reports/attestations No choice for users/investors but to trust

🧵/18 Systemic Risk 💣 (a ticking time bomb) Imagine the kind of chaos that will ensue over the entire industry if #Tether fails

🧵/19 Recommendations 🕵️ Transparency through regular #audits & attestations 🔍 Accountability for such actions to become an industry norm (how #CEXs have started the proof of reserves 📖) Need these #Centralized systems to be forthright

🧵/20 Crypto-backed coins (overcollateralized) • Similar to fiat-backed coins • Underlying collateral is another #cryptocurrency instead of #FIAT • No central entity/custodian (#Decentralized) • Coins issued on-chain employing smart contracts (#Trustless)

🧵/21 • A coin of higher value is locked in to issue a lesser-valued stablecoin • Over-collateralization serves as a buffer against the #collateral coin’s volatility • Popular example - $DAI (#Maker protocol) #DAI requires a collateral ratio of 150% for borrowing

🧵/22 🚩 Problems ‣ Capital Inefficiency ‣ Reliance on centralized stablecoins as collateral ($USDT & $USDC)

🧵/23 Capital Inefficiency • Capital efficiency is traded for #decentralization to achieve price stability • To reduce the required #collateralization ratio, some stablecoin protocols accept other stablecoins with deep liquidity ($USDC) as on-chain collateral

🧵/24 Reliance on #centralized stablecoins as #Collateral (this one is pretty baffling) • #Decentralized stablecoins are needed to mitigate the risks of Centralized stables • However, decentralized protocols mostly use centralized stablecoins as collateral

🧵/25 • Using centralized stablecoins exposes them to the same risks they are trying to mitigate Even though decentralized protocols are working on ways to increase the capital efficiency to mint/borrow stablecoins, we are still a long way from home

🧵/26 #Algorithmic coins (Undercollateralized) ‣ Promising solution to solve the #stablecoin trilemma ‣ Achieve capital efficiency ‣ Do not rely on traditional off-chain/on-chain collateral ‣ Maintain price stability using specialized #algorithms & smart contracts

🧵/27 ‣ Algo designed to #burn/remove, or mint/create coins to modulate the supply and maintain equilibrium and price stability ‣ Usually a two-token model with a #mint-&-burn mechanism for a second price-floating token ‣ Stablecoin is secured by the value of a second token

🧵/28 ‣ Protocol ensures that investors can always swap one stablecoin for $1 of the price-floating token ‣ Arbitrageurs are incentivized to buy/sell the stablecoin on the market and exchange it for the price-floating token if it's trading below/above the peg

🧵/29 🚩 Problems • Value created out of thin air • Can only survive as long as there is trust in its #algorithm • If the value of the corresponding risk-absorbing token isn't strong enough to manage the demand and supply, it won't survive

🧵/30 • In an attack of short duration, the algo will balance #supply/ #demand and bring the stablecoin back to its peg • But a well-capitalized attack by highly solvent market players on the pegging mechanism in times of market uncertainty can lead to disastrous consequences

🧵/31 Example 🔺 Proven by the events around the $UST collapse An attack coordinated in times of big market uncertainty Investors lost their trust in UST Resulted in a so-called death spiral

🧵/32 To support the #UST price, more and more Luna tokens had to be minted, heavily inflating the #Luna price As the UST price fell below the #peg, there was a huge loss of trust It led to more and more people exiting the coin The rest is a story

🧵/33 To SUM UP ❌CENTRALIZATION - FIAT-backed coins ❌OVER-COLLATERALIZATION - Crypto/Commodity-backed coins ❌INSTABILITY - Undercollateralized #Algorithmic coins

🧵/34 Challenges/ Opportunities Existing stablecoins can’t scale to meet the growing demand owing to the COLLATERAL REQUIREMENT Increased demand for stablecoins means an enormous amount of #collateral Insufficient collateral, both on-chain & off-chain, to meet this demand

🧵/35 Stablecoins are critical for the mass adoption of #DeFi & #Web3 The design space is highly innovative Many interesting approaches are being worked on (such as delta-neutral #derivative positions) While many designs have failed, some parts have been successfully adopted

🧵/36 Research and development are critical to bringing improvements to the existing designs, or Perhaps a need for a new design altogether @BeanstalkFarms is one such experiment

🧵/37 $BEAN is a credit-based stablecoin ‣ Relies on #credit as opposed to #collateral ‣ An experiment testing the scalability of an on-chain stablecoin protocol ‣ Based on an algorithm, $BEAN's design differs from other algorithmic stablecoins such as $UST

🧵/38 ‣ Doesn't use a two-token model or rely on a tradeable governance token (used for speculation and as a risk absorber) ‣ Aligns value creation and utility within the protocol ‣ Risks are held by the creditors of the system (Transparency in the docs)

🧵/39 #Beanstalk's story is one of success, a downfall through a brutal exploit, and then recovering & rising! On 6 Aug'22, Beanstalk relaunched the protocol after going offline for 4 months and 1 year after its initial deployment It has since completed 2 #security audits

🧵/40 The protocol continues to push in its quest to solve the existing stablecoin problems Stay tuned for what shall follow, and let's see how their unique approach fares in the future