Why Decentralized Stablecoins Matter (Part 2)

So, DeFi could be more decentralized; however, fiat-backed, centrally-issued stablecoins are not helping move the needle on this issue, and it's not just the crypto community that has noticed.

Key Takeaways

  • Decentralization is a spectrum, not a binary.
  • Fiat-backed stablecoins face centralized risks.
  • More decentralization means more censorship-resistance.

Most people reading this will agree that decentralization is more favorable than centralization, especially when it comes to participation in DeFi.

On the other hand, it has been argued (1, 2) that DeFi isn't that decentralized after all. Even MakerDAO, a foundation that has fully dissolved all rights to the protocol, has taken the position that decentralization is a spectrum rather than a binary.

So, DeFi could be more decentralized; however, fiat-backed, centrally-issued stablecoins are not helping move the needle on this issue, and it's not just the crypto community that has noticed.

United States Legislators Aim Their Sights at Stablecoins

The United States Senate Committee on Banking, Housing, and Urban Affairs hammered home the points against fiat-backed stablecoins in DeFi during a December 2021 hearing titled, "Stablecoins: How Do They Work, How Are They Used, and What Are Their Risks?

In a prepared statement, law professor Hilary J. Allen described the current situation by saying, “DeFi relies heavily on centralized crypto services (including stablecoins), which in turn rely on traditional financial services (like banks and fiat currencies). DeFi is therefore not particularly decentralized.”

Chairman Sherrod Brown's statement during the December Senate hearing spelled out some further troubles facing DeFi and its entanglement with fiat-backed stablecoins:

“It’s not decentralized when one company controls when people can access their own money. It’s certainly not transparent when critical information about stablecoins, and the companies that issue them, isn’t available to people who have their money tied up in these assets.”

How Centralized Stablecoins Can Negatively Affect DeFi

There's some truth to Chairman Brown's statement that companies in DeFi are controlling when people can access their own money. Both Circle (USDC) and Tether (USDT) have blacklisted accounts or frozen stablecoins held in accounts on multiple occasions.

It's estimated that these blacklists make it 40% more expensive to transfer USDC than it does to transfer a decentralized stablecoin like DAI. What could end up being even more costly than blacklists is demanding KYC (Know Your Customer) for holding fiat-backed stablecoins, and the idea has already been floated.

A CoinDesk article pointed out the implications of requiring KYC for centrally issued stablecoins: “Under the strictest scenario, stablecoin issuers could be required to cut off any entity that can't provide a verified name or address," which would include cutting off DeFi smart contracts, as they can't pass KYC.  

The demand for KYC on fiat-backed stablecoins would most likely affect billions of dollars worth of tokens locked in DeFi. As a result, according to CoinDesk, "Given the ecosystem’s (DeFi's) reliance on stablecoins, this would come close to breaking it.”  

How Decentralized Stablecoins Extend DeFi's Horizon

This might sound incredibly simple, but: Decentralized stablecoins matter because they are decentralized. They're more censorship-resistant than fiat-backed options, and that matters for a decentralized system like DeFi.

Additionally, decentralized stablecoins are more transparent than fiat-backed stablecoins, since they operate 100% on-chain. Legislators don't need to pass laws to enforce transparency for USDH collateral, because all this information is publicly available and accessible from anywhere in the world.

One must ask, "Why host thousands of validator nodes around the world? Why try coding smart contracts so they're impervious to hacks and exploits? And why build a community around decentralization just to get rugged on centralized assets that lack the same censorship-resistant qualities as the rest of the system?"

Bitcoin first illuminated the transparency and censorship-resistant properties of blockchain technology in 2009. It would be a shame to ignore the merits of decentralization at this stage in the game.

With the launch of our decentralized and censorship-resistant stablecoin, USDH, Hubble Protocol hopes to contribute to the longevity DeFi for years to come.

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