How Maker and Frax Are The Diplomats of DeFi – The Defiant

Stablecoins Face Challenges In Wake Of Tornado Sanctions

Earlier this month, the crypto world was rocked by the Office of Foreign Asset Control’s move to sanction 44 addresses associated with Tornado Cash, putting the decentralized protocol on their Specially Designated Nationals and Blocked Persons list. 

With the announcement, it became outright illegal for US citizens to access the privacy-preserving protocol or otherwise face hefty fines and jail time. As a preemptive measure, Centre, the consortium behind USDC, froze $75,000 worth of USDC that were located in Tornado Cash’s smart contracts and nearly doubled the number of their banned addresses. The aftermath of the sanctions has resulted in intense discussions among crypto community members about censorship risks that exist throughout the ecosystem. 

In particular, stablecoins have been a flashpoint of this debate and for good reason. Stablecoins have proven to be one of the most utilized application areas of crypto. Today, there are over $150 billion worth of stablecoins in circulation and tens of billions of dollars in volume. Although the majority of activity comes from traders, stablecoins have been increasingly used for everyday activities such as salaries, remittances, payments, etc. Whatever the case, stablecoin use is growing and will continue to grow as more and more participants are onboarded to DeFi.

Yet, as the shadow of the USDC blacklisting looms, heated discourse online has fueled an array of emotional reactions. Decentralization purists have blasted DAI and FRAX for having USDC as collateral and have espoused alternatives that boast their anti-centralization prowess. Do they have a point though? What good is a stablecoin if it could be censored as simply as with an off switch? The answer is much more nuanced than what has proliferated. 

The Stablecoin Trilemma 

When it comes to designing a stablecoin, everyone is faced with the same three issues to tackle — decentralization, scalability, and peg. And right now, you can only choose two. 

USDC and USDT are fiat-backed centralized versions that have chosen the most extreme version of scalability by sacrificing decentralization completely. On the opposite end of the spectrum, stablecoins such as sUSD, LUSD, and RAI have prioritized decentralization above all else, yet are constrained in their growth by the amount of decentralized collateral available. 

Is there a middle ground that doesn’t sacrifice decentralization for scalability and yet can consistently maintain its peg? 

Currently, FRAX and DAI are leading the charge in this area. Both stablecoins have over $1 billion in market capitalization even after the bear market. One advantage that these stablecoins hold is that, unlike USDC and USDT, their custody does not lie in a central entity, but in permissionless smart contracts. By originating natively on-chain, their collateral can be transparently accounted for and allows them to adapt to the speed of…