Why stablecoins don’t need a separate value capture coin

May 13 · 4 min read

Separation of concerns is the process of splitting up a complex system such that each part is as isolated as possible. This (hopefully) reduces the overall complexity as the engineer can think about each individual piece on their own.

A question that will logically come up is, “What concerns should be separated?”. The answer to that question is sometimes easy and sometimes quite hard.

Let’s say you are tasked with sorting out jelly beans of various sizes and colors. You could sort them all into piles based on their size or you could group them based on color. You could even group them by color then sub group them by size. The point being that there are multiple ways you could go about grouping them.

The correct way to group them comes down to exactly what your end goals are. If you are trying to sell packets of jelly beans where each packet only contains beans of the same size then it makes little sense to group by color.

That is for a simple task. Imagine though, that the jelly beans are instead parts of a complex crypto project like an algorithmic stablecoin. Deciding exactly what your concerns are is hard. Then deciding how to separate them out is even harder.

Stablecoin concerns?

Let’s take a look at a common way of thinking about this problem in algorithmic stablecoins. One of the most common “concerns” that get separated is the need for stability and the need for value accrual and speculation vehicles.

This is usually done by issuing 2 tokens:

  1. The stablecoin
  2. The value accruing token

This seems like a great idea, so what’s wrong with it?

On the surface this is a very logical separation — of course you can’t speculate on a coin that is stable, so it makes sense to have another non stablecoin for that purpose.

We think this is the wrong way to go about it as it brings up a whole lot of other subtle issues.

What is the problem? In our opinion, the problem is that by separating out the coins you end up separating out the incentives as well. We want incentives to be aligned on all fronts, all working towards stability. If a speculator can just buy the value accruing token do they provide any value to the ecosystem? Do the people actually contributing value to the stability of the coin get rewarded by capturing that value?

This issue can be observed with Maker’s DAI. The people actually locking money up in vaults are the ones that are helping to provide value to the ecosystem. Sadly, they are not necessarily capturing any of the value they create.

Holders of MKR also don’t necessarily capture all the value, and a speculator can hold MKR without really contributing any value to the stability of DAI.

Misaligned incentives everywhere.

But do single coin stablecoin projects work?

There is indeed a problem with most existing stablecoins which don’t have a separate value accrual coin. The problem is that without a value accrual coin they are forced to capture value in another way. The way is usually to use the native token itself. That is, someone bonds their tokens and gets paid additional tokens.

This method has its own set of misaligned incentives. In this case the speculators are providing value by providing liquidity, or something similar, but they often don’t care for the protocol itself and will just dump their rewards to realise profits. So by removing the value accrual coin you have just introduced volatility to the stablecoin.

Is there a better way?

The question we asked ourselves was, “What are the first principal concerns which actually NEED to be separated and how do we do that?”.

We decided what really needs to be done is separating speculative usage of the coin from the usage as an actual stablecoin. This is really what projects want to achieve when they separate the stablecoin from the value accrual coin.

Now the question is — Is there a way to do that without misaligning incentives with a separate value accruing coin?

Our solution is:

  1. Make farming LP the core speculative action in the protocol
  2. Reward our speculators directly with the token they would otherwise purchase with their farmed protocol rewards

For example, farm the Malt/DAI LP and get paid rewards in DAI. No need for speculators to sell Malt for DAI to realise profits. No speculators accumulating a lot of the native token. No additional volatility introduced from speculators exiting.

Malt treats speculators like allies, not like challengers. Speculators are providing real value to the ecosystem in the form of LP, and are rewarded in a sustainable way — no need to sell Malt to realise their profits, less cause for undue price volatility. All done without adding complexity in the form of other coins or misaligning incentives.

This is a powerful separation of concerns with a strong alignment of incentives. Speculators must provide liquidity, and more liquidity makes the protocol stronger.

More speculation equals more liquidity which benefits users who want to use the coin purely as a stablecoin. However, that is achieved without unintentionally adding volatility.

In short, speculators are now a strength, not a weakness. Speculators make the coin more stable.