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Monetary Engineering

Stablecoins & Design

Cryptocurrencies are volatile; money must be stable. Stablecoins are the bridge that allows us to import the stability of fiat currencies into the trustless environment of a blockchain.

Stabilization Models

Fiat-Backed

Examples: USDC, USDT

Off-Chain Collateral. An issuer holds $1 USD in a bank account for every 1 token minted.

  • + 100% Capital Efficient
  • - Centralized (Censorship risk)

Crypto-Backed

Examples: DAI, LUSD

On-Chain Collateral. Users deposit ETH into a smart contract vault to borrow stablecoins against it.

  • + Trustless & Transparent
  • - Over-collateralized (Inefficient)

Algorithmic

Examples: FRAX, UST (Failed)

Endogenous Collateral. Relies on market incentives and seigniorage shares to maintain value.

  • + Infinite Scalability
  • - Death Spiral Risk

The Mechanism: Arbitrage

A stablecoin is not stable because of magic; it is stable because profit-seeking actors (Arbitrageurs) force it to be.

Scenario A: Price > $1.00

  1. Stablecoin trades at $1.02 on Uniswap.
  2. Trader mints 1 token for $1.00 collateral.
  3. Trader sells token on market for $1.02.
  4. Result: Supply increases, price dumps back to $1.

Scenario B: Price < $1.00

  1. Stablecoin trades at $0.98 on Uniswap.
  2. Trader buys token for $0.98.
  3. Trader redeems token for $1.00 collateral.
  4. Result: Supply decreases, price pumps back to $1.

The Stablecoin Trilemma

Generally, you can only optimize for two of the three following properties:

Peg Stability
Does it hold $1.00 during a market crash?
Decentralization
Can the issuer censor transactions or freeze funds?
Capital Efficiency
Can I scale the supply without locking up excessive capital?

Frequently Asked Questions

Why do stablecoins de-peg?▼

De-pegging occurs when the redemption mechanism fails or loses credibility. If users believe the collateral is missing (or frozen), they panic sell. If the selling pressure exceeds the available liquidity for redemption, the price crashes below $1.00.

What is the "Death Spiral"?▼

Specific to Algorithmic Stablecoins (like UST). If the backing asset (LUNA) falls in value, people mint more LUNA to redeem UST, which crashes LUNA further, causing more panic. It is a positive feedback loop that destroys both tokens.

Are USDC/USDT real money?▼

Legally, they are usually defined as "store of value" assets or IOUs. They represent a claim on a dollar in a bank account, but they are not FDIC insured like a bank deposit. If the issuer goes bankrupt, you could lose your funds.