Stablecoin Models from a Self-Sovereignty Perspective
Stablecoins are a vibrant space attracting both media attention and capital. We will look to place them into technological and economic contexts, review the types of protocols currently in the public domain and examine them through the prism of self-sovereignty.
I. A Piece of the Decentralised Money Puzzle
The classical requirement for effective money is that it must function well as a medium of exchange, store of value and unit of account. The first generation of cryptocurrency protocols went a long way towards fulfilling these requirements, but a number of critical shortcomings have caused their role in the real economy to be limited. The next generation of solutions is looking to change that.
Medium of exchange — a key failure of existing cryptocurrencies in this dimension stems from their limited transaction handling capacity. This issue lies in the domain of fundamental blockchain protocols, and is being actively addressed by a number of projects.
Store of value — existing technology already allows cryptographically secure storage and retrieval of crypto assets. Some usability improvements would be beneficial, but the fundamental functionality is already in place.
Unit of account — directly related to the question of price stability, it is an area where the current crop of cryptocurrencies is evidently failing. Fulfilling this function requires a sophisticated monetary policy, which is the focus of stablecoins. An unavoidable pre-requisite for almost any such policy is being able to rely on a blockchain with a sufficiently powerful smart contract capability, a number of which already exist. In future, however, computational capacity may become the critical enabler of sophistication and effectiveness in algorithmic monetary policy design.
II. Role of the Stablecoin in the Real Economy
Having a stable unit of value is critical in the widest range of transactional contexts — from vendors not having to switch price tags every day to the ability to form long-term contractual relationships without fear of a price swing turning them from profitable to loss-making overnight.
Price stability is equally critical for the whole of the decentralised financial industry. Whether in a simple lending contract or a sophisticated financial derivative, no one wants to contend with a large amount of risk that can arbitrarily redistribute value among counterparties.
Ultimately, stablecoins are aiming to become the monetary base of the decentralised economy, underpinning its every sector. The global fiat equivalent of this role is estimated at over $40 trillion and, while the stablecoin space is not expected to see this kind of valuations in the foreseeable future, the size of opportunity is still impressive.
III. Stablecoins and Self-Sovereignty
Generally defined as having full control over oneself, self-sovereignty in the stablecoin context is a property attributable to mechanisms that are both decentralised and self-sufficient. While merits of decentralisation are well-known, self-sufficiency has so far received less attention. A self-sufficient stabilisation protocol is one that does not rely on any external assets or information, particularly on collateral or price signals.
Why is self-sufficiency important? Using an external asset means relying on an object that is outside of the stabilisation mechanism’s control. That object may misbehave beyond acceptable bounds, become fundamentally compromised or cease to exist altogether. While such issues may be somewhat mitigated through diversification, the mechanism would still import many of the vulnerabilities of the external objects it relies on.
Using external price signals also carries a number of issues. Whatever assets are used as reference for stability, they will inevitably have their own volatility profile and will be governed by a distinct set of economic priorities and goals, which will not be consistently aligned with those of the decentralised economy. Only by discarding such proxies can a stablecoin relate directly to the real economy that it aspires to service, and enact a truly unencumbered monetary policy of its own.
IV. Existing Stablecoin Models — A Brief Review
a. Mechanisms with Fiat Collateral
Fiat currency is placed as collateral with a conventional financial institution and an equivalent amount of stablecoins is issued. A fixed stablecoin-to-collateral exchange ratio is instituted, allowing anyone to exchange one for the other. Stability is ensured through potential arbitrage between market price and exchange ratio.
While this may be the most direct and effective way to deliver price stability, the mechanism is entirely hostage to the institution that holds the collateral — reliant on its creditworthiness, its goodwill and that of regulators. In effect, such stablecoins are little more than a technological extension of fiat money, much like a debit card. As such, this model is neither decentralised, nor self-sufficient to any material degree.
b. Mechanisms with Crypto Collateral
Similarly to fiat-collateralised mechanisms, this approach relies on potential arbitrage between stablecoin price and its exchange ratio vs. collateral. In this case, collateral is held in a smart contract-like structure, which also plays the role of exchange counterparty.
The key difference, however, is that collateral is no longer the same as the reference asset against which the coin is stabilised. Instead, we are dealing with assets that have their own price parameters, and the exchange ratio needs to take these parameters into account. As a result, this mechanism needs a price feed.
Price feeds can be either oracle-based or decentralised. The former is essentially a centralised mechanism that delivers information from a trusted external source into the blockchain. The latter is a scheme where a group of users is economically incentivised to periodically submit truthful information about what they observe the price parameters to be.
Oracles, while potentially accurate, are an obvious vulnerability and a vector of attack. If compromised, they will cause the mechanism to collapse entirely. Decentralised feeds, on the other hand, constitute a deceptively complex game-theoretic problem. As of the time of writing, we are not aware of any successful implementations or of strong evidence that a robust truth-telling equilibrium can indeed be induced.
Using volatile collateral has two further implications. Firstly, the mechanism requires significant over-collateralisation in order to compensate for the possibility of a decline in collateral value. This over-collateralisation is a material cost to users, who have to lock up significantly more value than they get back in form of stablecoins. Secondly, no matter how high the level of over-collateralisation, the mechanism still faces the risk that its collateral breaches acceptable volatility thresholds, or ceases to exist altogether. To manage such situations, mechanisms tend to resort to internal governance layers — another potential source of centralisation.
From a self-sovereignty perspective, such models are a mixed bag. Decentralisation can theoretically be achieved if the chosen collateral and any associated governance layer are in themselves decentralised (which may be a challenge in case of the latter), and a decentralised price feed is successfully implemented. On the self-sufficiency front, however, such models are fundamentally compromised, as they rely on both external assets and external price signals.
c. Schelling Point Mechanisms
The concept of Schelling point, or focal point, can be demonstrated with the following example. Suppose two people are placed in separate rooms and given identical pieces of paper with two intersecting lines drawn on them. Then, they are given the task of selecting, without communication, the same point on that sheet of paper. The Schelling point theory says that they will likely both select the point where lines intersect, by virtue of that point’s uniqueness. Mechanisms in this category rely on price stability being that focal point.
Construction of such mechanisms begins with the hypothesis that a change in coin price can be neutralised by a corresponding proportional change in coin supply. In other words, if price falls by 10% and money supply is shrunk by the same 10%, then price will revert to original level. Implementation of this principle takes form of two (or more) internally generated coins, one of which is the stablecoin and the other a “volatile coin”. They are combined with a smart contract that receives information from a price feed (which brings with it the same complications as described above) and varies stablecoin supply by offering users to exchange stablecoins for volatile coins, or vice versa, in amounts that should theoretically neutralise the change in price as reported by the feed.
Critically, users would only be prepared to hold/swap these coins as required for stabilisation if they believe everyone else is also willing to do so, i.e. if everyone’s willingness to engage in stabilising behaviour is common knowledge, and that this behaviour will in fact result in reversion of price to target level within a certain timeframe. These are some very strong assumptions, and they are undermined from the off by lack of a strong transmission mechanism between money supply variations and market price — decision on whether to sell newly minted coins rests entirely with individual users. This construct is also susceptible to exogenous shocks. If an external event occurs which causes a sufficiently large group of users to modify their behaviour, it may lead to a knock-on effect across the rest of the user base and cause the mechanism to collapse.
On the self-sovereignty scale, Schelling point models rank a step above mechanisms with crypto collateral. Provided successful implementation of a decentralised price feed, such models may have the capacity to be fully decentralised. In terms of self-sufficiency, these mechanisms eschew external assets, which is the significant step up. The remaining vulnerability that separates them from full self-sovereignty is reliance on external price signals.
d. Feron Stabilisation Mechanism
Feron is a mechanism with a single native coin that requires neither collateral, nor information about price. It originates from the idea that demand for money can be split into two parts — transactional and speculative. The former refers to coins used on a regular basis for their primary purpose, while the latter are the coins held in expectation of an investment return and they are the main driver of price volatility. Feron introduces into the usual blockchain context a central bank that offers all users a range of riskless deposits of various maturities. This creates a situation where, unless a speculative holder is actively selling their coins, there is no reason not to place the coins on deposit. In effect, the central bank uses the incentive of riskless interest to absorb access liquidity from the system.
Concentrating excess liquidity in the central bank means that when a user wants to sell their coins, they first have to withdraw them from deposit. In other words, the user will signal the central bank that they are willing to forego a riskless return in order to use their coins for another purpose. When such signals occur in relation to a significant portion of money supply, they almost invariably indicate a change in price expectations. By aggregating and interpreting such signals, the central bank is able to detect and measure changes in price expectations without needing to observe the parameter directly.
To counteract falling price expectations, the central bank will dramatically raise interest rates for a short period of time, enticing users to keep coins on deposit rather than offer them for sale at an exchange, thus alleviating the price pressure. Once outflows cease, central bank rates revert to much lower steady state levels. The mechanism effectively pays users not to sell their coins and, by doing so at the right time and in the right amount, it keeps long term money supply growth at an acceptable level. Looking at it from another perspective, the mechanism turns price volatility into the much less harmful interest rate volatility.
As of the time of writing, Feron remains the only self-sovereign model in the stablecoin space, relying neither on external assets nor information in any form. As such, we believe that combining it with the next generation of fundamental blockchain protocols may allow us to deliver on the promise of truly effective self-sovereign money.

