Centralized stablecoins, such as USDC and USDT, have become dominant players in the cryptocurrency market, particularly in decentralized finance (DeFi). While they provide liquidity and stability, Michael Egorov, the founder of Curve Finance, has expressed growing concerns about their inherent risks and limitations in a decentralized ecosystem.
The risks of centralized stablecoins
In a recent interview, Egorov emphasized the geopolitical and regulatory vulnerabilities associated with centralized stablecoins, which he believes could undermine the very principles of decentralization.
Egorov explained that centralized stablecoins are backed by real-world assets, such as cash reserves and U.S. Treasury bills, which are held in traditional financial institutions. While this backing offers stability, it also exposes these assets to government intervention, including freezes or seizures.
The founder of one of the leading crypto lending and borrowing protocols highlighted that this regulatory risk is a critical weakness of centralized stablecoins. As stated by him, governments can exert control over these assets at any time.
“For [the US dollar], keys are never yours. So, that’s a problem,” Egorov stated. This comment reiterates the lack of full user control in centralized stablecoins, as the custody of assets ultimately lies with financial intermediaries.
Read also: Coinbase delists multiple stablecoins in EU markets
The case for decentralized stablecoins
To mitigate these risks, Egorov advocates for the development and adoption of decentralized, algorithmic stablecoins. Unlike their centralized counterparts, these stablecoins operate autonomously on blockchain networks without reliance on physical cash reserves.
Decentralized stablecoins, according to Egorov, offer “algorithmic assurance” to investors, ensuring that their funds cannot be seized or frozen by external parties. “If you have something totally decentralized, then it is just software running on-chain autonomously, so you cannot really do anything to it,” he remarked. This model aligns with the core values of DeFi, promoting transparency, autonomy, and resilience against external interference, he implied.
Read also: Introduction to Stablecoins: USDT, USDC, and BUSD
However, decentralized stablecoins come with their challenges, including susceptibility to smart contract vulnerabilities and market instability. One typical example of the flaws of algorithm-based stablecoins is the case of TerraClassicUSD (USTC), formerly known as TerraUSD (UST).
Recall that UST depegged in May 2022, following a series of problems in its design, including the dependency on a volatile sister token, LUNC (formerly LUNA), no collateral backing and large-scale withdrawals from Anchor Protocol. This terrible incident resulted in over $40 billion being wiped out from the crypto market.
Overall, the collapse of UST revealed the inherent risks of algorithmic stablecoins, particularly those without collateral backing. It highlighted vulnerabilities in relying on a volatile asset and unsustainable yield mechanisms to maintain stability. The event not only led to significant, permanent financial losses to users but also sparked regulatory scrutiny in the crypto industry.
However, Egorov believes that these challenges are more manageable than the geopolitical risks associated with centralized models.
Read also: Tether (USDT) Stablecoin: Use Cases and Pros and Cons You Should Know
Finding a balance
The debate over centralized versus decentralized stablecoins is not new, but it has gained urgency as governments worldwide increase regulatory scrutiny on crypto assets.
Centralized stablecoins, like USDC, have faced criticism for complying with government requests to freeze funds, raising questions about their role in a decentralized ecosystem. Likewise, USDT has faced concerns regarding its reserves in the past.
Putting these into perspective, Egorov’s comments highlight the need for DeFi platforms to carefully consider their reliance on centralized stablecoins. While they currently provide the liquidity necessary for DeFi protocols to thrive, their regulatory vulnerabilities could pose risks to the industry, according to him.
Therefore, for DeFi to achieve its full potential, he believes the ecosystem must prioritize decentralization, even when it comes to stablecoins. This would not only protect users from asset seizures or freezing but also preserve the integrity of DeFi as a whole.
Read also: Refuge from the Naira: Why Nigerians are Turning to Stablecoins in an Unstable Economy
Ndianabasi Tom A Petroleum Engineering degree holder, Ndianabasi’s interest since 2018 has been studying the ever-growing field of blockchain and cryptocurrency, keenly evaluating the innovation, exploration, and expansion of this field locally and globally. The founder of Nitadel a media platform, Ndianabasi has been a Writer at Crypto Asset Buyer (CAB) since 2021. When he is not drilling resources in the blockchain and cryptocurrency field, Ndianabasi is singing, reading, watching crime movies, or playing football.
