The market cap of decentralized stablecoins grew 20 times in 2020. Mintages of decentralized stablecoin leading protocol Maker’s stablecoin DAI grew from 100 million to 4 billion in one year. Although the increase is huge, decentralized stablecoins currently have less than 10% market share in stablecoins, and the future growth will be even more impressive.
Decentralized stablecoin protocols can be divided into three categories: first, over-collateralized stablecoins (DAI, sUSD, etc.), second, algorithmic stablecoins (ESD, BAC, etc.), and third, partially collateralized stablecoins (FRAX, FEI, etc.). Each type of stablecoin protocol faces different trade-offs in multiple dimensions such as price stability, capital utilization efficiency, scalability and decentralization degree, and there is no single stablecoin protocol mechanism design that can satisfy all design goals.
The current mainstream mechanism design in the market ignores the fundamental issues common to decentralized stablecoin protocols. Without solving these fundamental problems, decentralized stablecoins cannot grow into a medium of exchange and store of value with the same volume as money in the real economy in general, and give up the broadest market space.
In this paper, we analyze the fundamental problems of decentralized stablecoin protocols and propose a new stablecoin paradigm Mars Ecosystem to solve these problems.
The logic of decentralized stablecoin protocols is fundamentally different from that of other DeFi protocols
The vast majority of DeFi protocols such as DEX and lending protocols have products that are a financial marketplace implemented by smart contracts to meet user-specific transaction needs. The financial market includes both the supply side and the demand side of capital, such as LPs and traders in AMM DEX, and depositors and lenders in lending agreements. The supply side of the capital provides the financial market with capital, which he deposits in the DeFi agreement. The demand side of capital acquires capital according to the rules of a particular financial market, and he uses Tokens to interact with the DeFi protocol in various ways. The supply side and the demand side of capital are aggregated and traded in the financial market provided by the DeFi protocol, i.e., the transactions take place in the DeFi protocol. The exact amount of value captured by the DeFi protocol depends on the amount of efficiency gains from the financial market created by the DeFi protocol, the degree of market competition, and other factors.
Unlike the vast majority of DeFi protocols, the product of a stablecoin protocol is a Token, a stable coin of some sort. The purpose of this Toke is to achieve functions that a currency can achieve such as a medium of exchange and a store of value. However, the implementation of these functions does not take place in the stablecoin protocol, but in the financial markets created by other DeFi protocols. For example, if a stablecoin wants to function as a medium of exchange, then there needs to be a large number of trading pairs composed of that stablecoin on DEX and users willing to use that stablecoin for trading.
Capturing the Value of Decentralized Stablecoin Protocols
The product of a decentralized stablecoin protocol is not a marketplace, but a Token, which determines that the value capture of a decentralized stablecoin protocol is different from that of other DeFi protocols. The value capture methods of decentralized stablecoin protocols that currently exist in the market can be divided into the following categories.
- charging a stablecoin transfer fee. Stablecoin transfers occur when it functions as a medium of exchange, and the value of the medium of exchange of stablecoin can be captured by charging a fee to the protocol governance coin holder at each transfer. For example, in Terra, a PoS public chain, miners pledge LUNA tokens to receive a transaction fee for the transfer of Terra stablecoins.
- minting tax. When the demand for stable coins grows so that the protocol can issue additional stable coins, the stable coins are given to the protocol token holders in preference. There are several models.
a) Rebase model. New coins are issued to all token holders, such as AMPL.
b) Locked stablecoin model. New stable coins are issued to the holders of locked stable coins, such as ESD.
c) Share Token model. New coins are issued to ShareToken holders of stablecoin protocols, such as Basis.
- Destroy governance coins when minting. Users must use the protocol’s governance coins when minting new stablecoins, which directly stimulates the demand for the protocol’s governance coins. There are several specific models as follows.
a) Partial minting with protocol governance coins. The assets needed to mint a stablecoin are partly the governance coins of the stablecoin protocol and partly other mainstream assets, such as the Frax protocol minting the stablecoin FRAX using the protocol governance coin FXS and the stablecoin USDC.
b) Minting entirely with protocol governance coins. The assets needed to mint a stablecoin are all the governance coins of the stablecoin protocol, such as LUNA for the Terra protocol minting stablecoin.
- Vault control value. The protocol governance coin holder can control the vault through the protocol governance, the greater this control, the greater the value of the protocol governance coin, such as Frax, Fei.
- capturing the value of the financial market. the Maker protocol creates a stable coin in a lending protocol, and its products include a lending market and a stable coin. Thus, although the value generated by the DAI generated by the Maker protocol when it flows in other DeFi protocols is not captured by the Maker protocol, the Maker protocol can capture the deposit-lending interest differential like other lending protocols.
The first value capture method of charging for stablecoin transfers is very difficult to implement in practice, and in reality it is more common to see its opposite, namely subsidies for stablecoin transfers. stablecoin protocols such as Terra, Celo and others that focus on the payments market offer subsidies to users. Such subsidies are not just short-term expansionary behavior; they reflect the low-friction, highly competitive nature of the stablecoin market and make it difficult to justify a business model that charges fees for stablecoin transfers in the long run.
Both the second and third value capture approaches essentially capture the incremental demand for stablecoins. This value capture approach is effective during the stage of high growth of stablecoin demand, but when the stablecoin stock grows to a high level, the growth rate will slow down or even stagnate, and this value capture approach will fail.
The fourth value capture approach vault control value captures the value of the stablecoin stock. Compared to the second and third value capture approach to capture the incremental amount of stablecoin, the business model that captures the value of the stock has two advantages: first, it reduces the short-term volatility of the governance coin price, and second, it provides long-term support for the value of the governance coin. This business model is very similar to the value capture approach of centralized stablecoin protocols such as USDT and USDC.
The fifth value capture approach requires the stablecoin protocol to subordinate the stablecoin product to some financial market, and then capture the value of the financial market to the governing coin. This value capture approach is not universally applicable. Subordinating the stablecoin product to a financial market imposes constraints on the supply of stablecoins, such as the supply of DAIs in the Maker Protocol being constrained by lending demand.
Positive externality issues
There are significant differences in the way value is captured in decentralized stablecoin protocols compared to real-world central banks: real-world central banks do not conduct monetary policy to generate profits by printing money or generating interest from asset reserves, but rather to promote economic growth and maintain employment. Once a high rate of economic growth can be maintained, governments can generate revenue through taxation and other means.
By analogy to this model of central bank operation in the DeFi world, the primary starting point for a central bank in the DeFi world to conduct monetary policy would be to promote the growth of the DeFi economy and capture value in the growth of the DeFi economy, rather than capturing value through such means as minting taxes or controlling the vault. However, this ideal model for the operation of a DeFi central bank cannot be implemented in the DeFi world because there is no central government in the DeFi world that can collect taxes from other DeFi agreements, and the stablecoin agreement itself cannot collect taxes from other DeFi agreements.
By nature, the functional implementation of stablecoin, the product of stablecoin protocols, occurs in other DeFi protocols outside of the stablecoin protocol, and the value creation of stablecoin occurs in other DeFi protocols. This makes all stablecoin protocols face a fundamental problem: the positive externality problem.
Specifically, the positive externality problem of stablecoin protocols means that the cost of producing stablecoins and maintaining stable coin prices is borne by the stablecoin protocols and the users of stablecoin protocols (including minters, share token holders, bond token holders, etc.), but the value realization of the stablecoins created by stablecoin protocols occurs in and is captured by other DeFi protocols. Stablecoin protocols are unable to capture the value created by them in the same way as other DeFi protocols, so the supply of stablecoins by stablecoin protocols is always less than the real demand for it in the cryptocurrency economy.
The vast majority of DeFi protocols have a financial marketplace as their product, while stablecoin protocols have a stablecoin as their product, which dictates a different operational logic.
The operating logic of the vast majority of DeFi protocols such as DEX and lending agreements is to attract both the supply and demand side of capital to the financial market created by the DeFi protocol to trade. On the one hand, these DeFi agreements need to attract the capital supply side to provide capital for the agreement, such as LPs in DEX, and deposit side in lending agreements; on the other hand, these DeFi agreements need to attract the capital demand side to use capital for the agreement, such as traders in DEX, and lenders in lending agreements. In the process of matching the two parties, the agreement charges a transaction fee, and the DeFi protocol’s governance coin holds value by capturing this transaction fee. Combined with the incentive mechanism of liquidity mining, the value of the governance coin incentivizes more capital suppliers to provide capital for the DeFi protocol; the increase in capital for the DeFi protocol reduces the cost of using capital for capital demanders, thus attracting more capital demanders to trade the protocol. The increased trading volume of the protocol eventually brings more transaction fees, thus constituting a positive feedback loop.
And the operation of stablecoin protocols includes not only attracting capital to the stablecoin protocol to create stablecoins, but also promoting the acceptance of stablecoins by other DeFi protocols. This leaves all stablecoin protocols facing another fundamental problem: the problem of integration.
Specifically, the integration problem of stablecoin protocols refers to the fact that the demand for stablecoins, the product created by stablecoin protocols, is highly dependent on the degree of integration of stablecoins by other DeFi protocols outside of the stablecoin protocol, and if the integration of stablecoins by other DeFi protocols is ignored, the growth and even the stability of stablecoins will be affected.
Mars Ecosystem’s solution to the positive externality problem and integration problem
Mars Ecosystem is an innovative decentralized stablecoin paradigm that solves the positive externality and integration problems that make current decentralized stablecoin protocols unsustainable.Mars Ecosystem consists of three parts: Mars Vault, Mars Stablecoin and Mars DeFi Protocol. It integrates the creation and use of stable coins into the same system, which together form a positive feedback loop. mars stable coins are price stable, efficient in capital utilization, scalable and decentralized. mars vault has the potential to become a DeFi world central bank.
Mars Ecosystem uses a mechanism of minting/redeeming stable coins using $1 equivalent assets to maintain the stability of Mars Stable Coin (USDM). This mechanism has proven to be one of the most stable stable coin mechanisms: stable coins for Terra, Frax and other protocols are generated using this mechanism. However, unlike Terra, Frax and other protocols, Mars Ecosystem uses an asset hierarchy mechanism when minting stablecoins, which incorporates multiple assets into the Mars vault.
When users mint USDM in Mars Ecosystem, they need to hand over $1 worth of Mars Vault accepted whitelist assets to Mars Vault, and Mars Vault will give users a USDM. Mars Vault accepted whitelist assets are divided into the following tiers: 1) stablecoin, 2) BTC, 3) ETH, BNB and other Layer 1 faucets tokens, 4) DeFi faucet tokens such as UNI and AAVE, and 5) Mars Ecosystem governance coins (XMS). The volatility of assets gradually increases from Level 1 to Level 5, and the Mars Vault determines the maximum acceptable percentage of each asset in the vault based on its volatility, with the more volatile the asset, the lower the maximum acceptable percentage in the vault.
The design of Mars Vault to accept diverse assets is a solution to the problem of integration of stablecoin protocols. By accepting tokens from mainstream DeFi protocols into the vault to mint USDM, Mars Vault can accumulate mainstream DeFi protocol governance tokens. mars Ecosystem achieves the goal of working with and participating in the governance of mainstream DeFi protocols by holding mainstream DeFi protocol governance tokens, specifically by facilitating USDM integration in the corresponding DeFi protocols into proposals of these DeFi protocols.
In contrast to other stablecoin protocols, Mars Ecosystem includes multiple DeFi protocols in addition to the stablecoin module. transaction fees generated by USDM flowing on these MarsDeFi protocols can be captured by the Mars ecosystem and provide value to support the Mars Ecosystem governance coin XMS. Take Mars Swap as an example, it is an AMM DEX similar to Uniswap. mars Swap will provide mining incentives for USDM LPs and transactions, thus incentivizing users to use USDM on Mars Swap. this design helps to provide early usage scenarios and demand for stablecoins and alleviate the integration problem of stablecoin protocols. On the other hand, users can pledge XMS at Mars Swap to receive transaction fees from MarsSwap, and this design is a solution to the externality problem of the stablecoin protocol.
Capturing the value of USDM flows through transaction fees in the Mars DeFi protocol is not all there is to the XMS value capture model. marsEcosystem proposes a new value capture model for stablecoin protocols: minting control. The minting control mechanism captures the value by capturing the demand for additional stablecoins, but unlike the two mechanisms of minting tax and destroying the governed coins at minting, it guarantees that the market value of XMS is always several times the number of USDMs in terms of quantity. The specific implementation mechanism of minting control is as follows: every once in a while, the system calculates the average market value of XMS over the past period (e.g. $300 million), divides this average market value by a parameter known as the XMS support multiple determined by the protocol through governance (e.g. 3 times), and the resulting number is defined as the USDM supply limit (e.g. 100 million), and in the following period, users can only mint USDM up to this USDM supply limit (e.g., if the current total USDM supply is 50 million, the user can only mint up to another 50 million to bring the total supply to 100 million). If the XMS support multiple is 3x, then the market value of XMS is always 3x the USDM minted. Unlike the traditional minting tax and the model of destroying governance coins when minting, this minting control not only captures the demand for additional stablecoins, but also guarantees that the market cap of governance coins is sufficient to support the stable price of stablecoins when the demand for stablecoins decreases and users redeem them as governance coins and sell them in the market. Intuitively, 1 stablecoin is backed by at least $3 of governance coins.
Overall, Mars Ecosystem provides a new solution for the stablecoin protocol to solve the integration problem by opening the Mars vault to accept other DeFi protocol tokens for minting USDM, while providing an application scenario for USDM by building the Mars DeFi protocol to solve the positive externality problem of the stablecoin protocol. The unique minting control mechanism of Mars Ecosystem makes it possible to open the Mars vault to accept tokens from other DeFi protocols to mint USDM without reducing the value capture of XMS, on the other hand, it enables the market value of XMS to always provide quantifiable support for the stability of USDM at a level several times higher than its minting volume.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/an-article-exploring-the-fundamental-problems-of-decentralized-stablecoin-protocols-and-the-solution-of-mars-ecosystem/
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