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3.1 Types of Stablecoins
MOR is an overcollateralized stablecoin that is soft-pegged to the dollar. It resembles the collateralization mechanisms of DAI with the key difference of focusing heavily in supporting collaterals which are earning yield.
Throughout 2020 and 2021, many attempts have been made to create the most capital-efficient stablecoin. This has mainly been tried through different algorithmic stablecoins which back the peg either partially or totally by having different game mechanics/incentives to return the “stablecoin” to the peg when it has deviated too much. However, they all share one major obstacle: if a user doesn’t have the necessary collateral to fund token redemptions, a single black swan event (which resembles a bank run) can wipe out a borrower’s position.
The most popular example of this type of algorithmic stablecoin was IRON, which was a mismanaged version of FRAX. Users could mint IRON with BUSD (in the BSC version; USDC on Polygon) and redeem it for BUSD + some protocol tokens (STEEL in BSC, TITAN in Polygon). Whenever someone minted IRON, it used a portion of that BUSD to buyback the protocol’s token, which caused a pump in the price of the token, but left IRON only partially backed with collateral. The promise was that the remaining part of the stablecoin’s value relied on the protocol’s token marketcap to be able to redeem the full value of $1. In a bank run—which is what happened—many holders attempted to redeem their IRON, but the portion of reserves that the protocol token was supposed to cover quickly became worthless, leaving IRON holders with only the value in actual collateral (BUSD or USDC) for redemptions.
The king of decentralized stablecoins is and has been from the start DAI. It is by far the most liquid on DEXs and CEXs, has the largest outstanding supply, and different collaterals backing it—mainly ETH and USDC. The two most common criticisms of DAI are (1) having too much USDC in its Peg-Stability Module and (2) not being capital efficient, since a user must lock up a substantial amount of ETH or other tokens as collateral in order to mint it.
The first criticism is only temporary. One only has to read through Maker DAO’s forum page to realize that there are many proposals and possible solutions that will, over time, reduce the concentration of USDC as a percentage of the total DAI supply. The second criticism is a valid one. However, choosing to not even be 100% collateralized for a stablecoin can be extremely risky. Even if it is supposed to be more capital efficient, it often ends in disaster and is not worthwhile.
The MOR Solution
This is where MOR differs. Instead of trying to decrease how much collateral is backing each MOR, it focuses on earning a yield on the collaterals deposited in its vaults.
The first risk that needs to be addressed is the added smart contract risk that would somehow need to be priced/calculated. This is solved by adding yield to a user’s collateral, which means that stability fees can be higher, while the net borrow rate (stability fee − yield) for the user is much lower or even negative. (Yes, the user can earn more in yield than their interest payments.) This increase in stability fees is what makes up for smart contract risk. The protocol can accumulate a larger system surplus much faster, giving it a comfortable buffer to cover for these types of events.
Let’s take a brief look at the other category of stablecoin: those backed by cash/cash equivalents/other financial assets sitting in non-blockchain systems.
The top three issuers are Tether [USDT], Circle [USDC] and Paxos [BUSD and PAX]. When looking at their latest reserves compositions we can conclude that the ranking from most conservative to least conservative in terms of collateral management would be:
- 1.Paxos (BUSD and PAX)
- 2.Circle (USDC)
- 3.Tether (USDT)
Paxos is ranked first because they have the highest percentage of reserves in cash and treasury bills. This is why the Peg-Stability Module for MOR uses BUSD and it always treats BUSD as 1:1 to USD.
Note: There is no difference between holding BUSD or PAX, as Binance just provides the brand to BUSD. Binance uses a service from Paxos called “Stablecoin as a Service” which is used by some exchanges including Binance’s BUSD and Huobi’s HUSD. Paxos is actually the one holding the reserves.