Yield-Bearing Stablecoins: Dope or Nope?

In the buzzing world of crypto, stablecoins have firmly established their importance. These tokens, which remain relatively stable in price and are often pegged to the US dollar, come in various flavors. The likes of USDC and USDT, backed by tangible dollar reserves, remain vulnerable due to centralization risks.

MakerDAO’s DAI introduced us to the resilient decentralized model of over-collateralized stablecoins. The essence? Lock up, say $1000 of an asset, mint a fraction of that value in stablecoins, and if the collateral’s value drops below a set margin, external actors can liquidate it, often at a bargain.

But the latest chatter in crypto circles? APR-bearing stablecoins. These promise pro-rata yield distributions to stablecoin holders from yield-bearing collateral. Theoretically exciting, but some economic pointers suggest potential pitfalls.

Money’s Role & The Velocity Challenge

Money has always worn multiple hats:

• A unit to measure value (& to defer payments).
• An exchange medium.
• A storehouse for value (given its stability despite some inflation).

For a currency to earn its ‘sound money’ badge, stability is key. It measures value, aids in debt valuation, and facilitates exchange. But the velocity of money is equally crucial. If money isn’t circulating, economies stutter.

Here’s the catch with APR-bearing stablecoins: Their inherent growth-focused monetary policy, while intriguing, risks creating a currency that’s de facto deflationary if money velocity diminishes. Economic slowdowns often follow such trends.

🤔 Simplified: If your money might be worth more tomorrow, why spend today? And if everyone thinks this way, is the economy truly thriving?

The Nash Equilibrium: A Risky PvP Showdown ☠️

When delving into the realm of APR-bearing stablecoins, we’re stepping into a PvP (Player versus Player) arena. Just as gamers in a multiplayer video game might adopt strategies to outcompete others, participants in the APR-bearing stablecoin ecosystem are also vying for dominance.

The mechanism design of distributing collateral yield pro-rata to stablecoin holders creates a dynamic where more risk directly translates to higher rewards. In game-theory terms, this sets up a Nash Equilibrium where each participant’s optimal response to the actions of others is to increase their risk.

In layman terms, imagine you’re in a multiplayer game where the more risks you take, the more rewards you get. If every player realizes they can get maximum rewards by maximizing their risks, then the entire game strategy shifts. Every player starts taking maximum risks, aiming for those higher rewards.

However, in the case of APR-bearing stablecoins, this “game” can have real-world consequences. If everyone is operating at the minimum collateral ratio, it not only jeopardizes individual positions but can destabilize the entire system. It’s akin to every player in a game using a high-risk, high-reward strategy without considering the collective consequences.

The end result? A fragile system ready to topple at the slightest economic shake.

This shared strategy to maximize individual profit, where everyone is essentially competing against each other, makes the system’s Nash equilibrium a precarious ‘race to the bottom.’

Rethinking the Path Forward: A Stable Solution

In our journey through the volatile terrains of APR-bearing stablecoins, the path to stability might be closer than we think. Instead of having the collateral yield spread across all participants, what if we allowed it to accumulate organically within its original debt position?

By letting collateral yield accrue to itself, we advocate for a system that inherently increases the overall collateral ratio. This isn’t just a technical tweak; it’s a fundamental shift in approach. In this revised model, each debt position bearer holds the reins to their own destiny. They have the autonomy to manage the yield against their collateral without the looming shadow of the “race-to-the-bottom” syndrome seen in shared yield distribution systems.

In fact, this is exactly our design philosophy for BeefyBank, where in the future, you can collateralise liquid staked assets for stablecoins.

Conclusion

The world of crypto and DeFi is a dynamic landscape, rife with innovation but also challenges. As we probe into the intricacies of APR-bearing stablecoins, it becomes evident that while seeking rewards, it’s essential to maintain system stability and integrity. By reimagining how yield accrual works, we not only ensure individual empowerment but also foster a robust ecosystem where stability isn’t sacrificed at the altar of high returns.

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