The year of 2020 saw the market cap of decentralized stablecoins increase over 20x. That is an increase of over 2000%. From these decentralized platforms it is the stablecoin DAI that leads the way. The DAI ecosystem is from the Maker Protocol, increased from 100 million to 4 billion within a year. Although the increase is huge, the current market share of decentralized stablecoins is still less than 10% of the total stablecoin market. With the general move towards decentralization and mass exodus from intensive KYC/AML centralized exchanges – the potential market capitalization for truly decentralized stablecoins is a huge magnitude more than it currently possesses.
In order to be widely accepted and used by DeFi users, a decentralized stablecoin protocol must have at least the following properties:
High price stability: The price is contained to the $1 peg. The protocols in place to hold the value peg at $1 are crucial to the integrity and credibility of a stablecoin token.
High degree of decentralization: The operation of the protocol must not rely on a centralized infrastructure – a single point of failure. This includes centralized collateral, centralized protocol governance etc. Without this integral aspect, the concept of decentralization does not hold.
High scalability: The supply of stablecoins can grow without friction with the increase in demand for the stablecoin. If this property is not apparent the protocol cannot be widely used by users.
There is no decentralized stablecoin protocol that can satisfy all of the above properties at the same time. Specifically, the current decentralized stablecoin protocols can be roughly divided into the following three categories. Let's analyze their advantages and disadvantages by group:
The first category is over-collateralized stablecoins (DAI, sUSD, etc.). The advantage of this type of stablecoin is that the price has support and will not fall below $1. The disadvantages are as follows:
The capital utilization rate is low. It is always necessary to use more than $1 of assets to be over-collateralized to generate 1 stablecoin.
Scalability is low. Since the use of over-collateralization to generate stablecoins will expose the collateral to liquidation risks, the user's willingness to generate stablecoins is at most equal to the user's borrowing demand, so that the supply of stablecoins often cannot effectively expand with the growth of demand. As a result, the price of stablecoin will rise above $1.
The degree of decentralization is low. In order to solve the problem of low scalability, the Maker protocol has begun to accept real-world assets as collateral to generate DAI, which makes the Maker protocol more and more like a lending protocol rather than a decentralized stablecoin protocol.
The second category is algorithmic stablecoins (ESD, BAC, etc.). Algorithmic stablecoin generally refers to a stablecoin that does not have any collateral and purely relies on algorithm to ensure price stability. So far, all such protocols cannot guarantee the basic price stability and usually fall into a death spiral. “bank runs” (explained later) being the majority cause.
The third category is all other stablecoins except for the above two types of stablecoins. Common names include fractional-algorithmic stablecoin and fractional-collateralized stablecoin, which actually refer to this category of stablecoins. Representatives of this type of stablecoin include Frax, Fei, etc. We analyze the respective problems of these two protocols below.
When the Frax protocol is attacked by a short seller, a "Bank Run" will occur, resulting in a death spiral. The details are as follows: short sellers short the stablecoin FRAX and the governance token FXS, the price of FRAX drops below $1, users redeem FRAX in large quantities to get USDC and FXS, and users sell FXS, which causes the price of FXS to continue to fall. Although when FRAX price falls below $1, the system collateral ratio will increase, but since no user is willing to deposit USDC into the system at this time, the sooner users who redeem FRAX will get more USDC, and the later users who redeem FRAX will get less USDC. The users will rush to redeem FRAX and sell FXS, and the system will fall into a death spiral.
The direct incentive mechanism of the Fei protocol failed in reality. The underlying reason for the failure of this mechanism is that penalizing users who sell stablecoins when the price is lower than $1 is essentially artificially reducing the liquidity of stablecoins, and liquidity is a truly integral aspect of stability. The Fei protocol attracted a large number of short-term speculative users to mint FEI with ETH in its Genesis, and limited the liquidity of FEI afterwards. These short-term speculative users would rather suffer a penalty of 10% or even 100% to sell FEI, which led to the stablecoin FEI remaining below the $1 peg for an extended period of time.
At present, various stablecoin protocols face trade-offs in terms of price stability, degree of decentralization, and scalability. There are also two fundamental problems in common: one is the positive externality problem, and the other is the integration problem.
The positive externality problem of stablecoin protocols: The costs of producing and maintaining stablecoins are incurred by the protocol and its users (minters, share holders, bond holders). The majority of the value derived from the stablecoin protocols is within the transaction fees on other DeFi protocols. This capital is captured by these DeFi protocols and gives no financial benefit to the stablecoin protocol itself. In turn, this can mean to a supply shortage of said stablecoin when compared to the market demand on DeFi platforms.
The integration problem of stablecoin protocols: The demand for stablecoins created by any stablecoin protocol is highly dependent on the degree of integration of said stablecoin within other DeFi protocols besides the native stablecoin protocol. If the integration of stablecoins with other DeFi protocols is ignored, then supply growth and stability of stablecoins is affected.
Although it may seem there is a contradictory aspect in the two issues above – the problems are solved relatively simply. As with all things, moderation is key. Integration with other platforms is important even if it allows for an amount of positive externality – however, a thriving native ecosystem alongside this solves the issue of being too self reliant or too dependent.
Introducing Mars Ecosystem
Mars Ecosystem is a new decentralized stablecoin paradigm that brings a complete paradigm shift to the current stablecoin protocols. Its goal is to propose a stablecoin system that can solve the positive externality problem and the integration problem. The protocol ensures high price stability, a high degree of decentralization, and scalability.
Mars Ecosystem consists of three parts: Mars Treasury, Mars Stablecoin and Mars DeFi protocols. The native stablecoin is integrated within all three components of the Mars Ecosystem. The goal of Mars Ecosystem is to build the 'central bank' and reserve currency of the DeFi world.
Mars Ecosystem has the following unique innovations
- Treasury assets classification mechanism
- Mintage control mechanism
- Anti-"bank run" mechanism
- Integrated native stablecoin within the DeFi protocol