Kopalnie Krypto Team - Thursday 21 September 2023
Stablecoins on Chia Network: the fall of USDS and a lesson on centralization
This is the second installment in our article series where we aim to understand the operation of stablecoins within the Chia Network ecosystem. In the first part, we familiarized ourselves with the lending system in decentralized finance, using the AAVE protocol and Ethereum blockchain as examples. This time, we will deviate almost entirely from that topic. Instead, we will focus on the definition of a stablecoin. We will also touch upon some history, as it turns out that the Chia ecosystem was blessed with the introduction of stablecoins. However, this did not last long. Why? We will find out in this article!
What is a stablecoin?
In the first article of this series, we often used the word "stablecoin", but we didn't really delve into the specifics of its operation. It's time to rectify that.
A stablecoin is a type of cryptocurrency or digital asset whose value is tightly linked to another stable asset. This can be, for example, a fiat currency. In simpler terms, the value of stablecoins is close to the value of the currency we use daily. The value of most stablecoins is close to the current price of the US dollar (USD). The primary goal of stablecoins is to provide price stability. This means their value doesn't undergo rapid fluctuations, as is the case with traditional cryptocurrencies like Bitcoin or Ethereum.
An example of a popular stablecoin is Tether (USDT). It exists on many blockchains, including the Ethereum blockchain. We discussed the operation principle of the AAVE lending protocol using this stablecoin as an example. One of the many stablecoins available on the cryptocurrency market is also USDS, once issued by the Stably platform. This coin will be the subject of our considerations. It turns out that stablecoins had already made their debut on the Chia blockchain, all thanks to Stably. However, Chia ecosystem users didn't enjoy USDS for long. Time for a history lesson.
Prime Trust and Stably - some mistakes cost too much
We mentioned earlier that stablecoins had already premiered in the Chia ecosystem. This happened on October 25 2022, when the Stably platform announced on its blog the support for another blockchain, which was, of course, the Chia blockchain. This sparked considerable excitement among the community as this event marked the beginning of USDS trading in their favorite ecosystem.
Not long after, on December 16 2022, a partnership with Stably was announced by one of the largest decentralized exchanges operating on the Chia blockchain - dexie. As part of this collaboration, dexie started introducing offers enabling the purchase of, among other things, XCH, NFTs, and CAT tokens using USDS stablecoins. However, the idyll didn't last too long.
We'll start our darker part of the story by discussing how Stably stored its USDS tokens. Well, it didn't really store them at all. The custodian, Prime Trust, was responsible for this. They managed a wallet where clients' assets were stored. They served as collateral for the USDS stablecoin, ensuring its value. This means that USDS was a so-called centralized stablecoin because its value was upheld by a single entity. Ultimately, this was why things went very wrong.
On June 21 2023, Stably announced the suspension of its services. This happened because their custodian, the aforementioned Prime Trust, blocked any deposits or withdrawals of assets they were storing. What directly influenced this? We still don't know everything, but supposedly in 2021, Prime Trust lost access to the wallet where they stored their clients' assets. These assets also served as collateral for the USDS stablecoin. To fill the gap, the company began using the resources of other clients, which was, of course, a significant mistake. Ultimately, on August 14 2023, Prime Trust declared bankruptcy.
Without delving too deeply into the details, we can certainly deduce one thing: Prime Trust can be considered history. The problem is that the USDS stablecoin simultaneously became history. Due to a lack of coverage, its value fell, making it unrelated to the US dollar's price. The Chia ecosystem then lost access to the stablecoin.
In this article, we learned what a stablecoin is. We also learned how the history of stablecoins on the Chia blockchain has looked so far. We also realized the adverse effects centralization can have in the world of cryptocurrencies. Prime Trust is a perfect example of a centralized "big player" that, despite its significant reputation, operated in a less than desirable manner behind the scenes. The Chia ecosystem currently lacks a proper stablecoin implementation. However, there is a glimmer of hope, as a decentralized stablecoin protocol, reminiscent of AAVE in its operation principle, emerges on the horizon. We'll talk about it soon in the final part of the saga!