Vitalik Buterin Flags Deep Design Flaws in Decentralized Stablecoins
Ethereum co-founder Vitalik Buterin highlights that the crypto industry still faces unresolved fundamental design issues concerning genuinely decentralized stablecoins. He contends that numerous current systems depend on precarious assumptions that may deteriorate as time progresses. In a recent post, Buterin outlined what he referred to as three fundamental challenges that continue to be unresolved. Instead of endorsing a particular project or suggesting a new stablecoin, he positioned the post as a critique of the existing designs of decentralized stablecoins and the potential shortcomings of those designs in the long run. Stablecoins, at their core, are cryptocurrencies crafted to uphold a consistent value, usually by being pegged to the U.S. dollar. Some stablecoins are issued by centralized companies that hold dollars or dollar-equivalent assets, while decentralized stablecoins strive to maintain stability through code, collateral, and market incentives, rather than depending on a single issuer.
Buterin’s primary concern was that the majority of decentralized stablecoins continue to rely on the U.S. dollar as their benchmark. He recognized that monitoring the dollar is logical in the short term, yet he contended that systems designed to withstand political or economic upheavals should not be permanently linked to one national currency. Over extended periods, he noted, even moderate inflation could diminish the effectiveness of a dollar peg. Buterin proposed that upcoming stablecoins could potentially align with wider price indexes or indicators of purchasing power, rather than being solely tied to the dollar. The second issue highlighted by Buterin involved oracles — the mechanisms that supply blockchains with real-world data such as asset prices. Due to the inability of blockchains to directly access external information, they depend on oracles to provide the price data utilized by smart contracts. Buterin stated that if an oracle can be manipulated by someone with sufficient capital, the whole system becomes susceptible.
He contended that in situations where oracles lack strength, protocols must resort to economic defenses instead of relying on technical solutions. In practice, this entails creating systems in which the expense of compromising the oracle surpasses the overall worth of the protocol. Buterin noted that this frequently necessitates deriving substantial value from users via fees, inflation, or governance control. He connected this dynamic to his enduring critique of “financialized governance,” asserting that systems primarily driven by token ownership lack inherent defensive strengths and instead depend on rendering attacks prohibitively costly to pursue. The third issue Buterin highlighted was staking yield, which he characterized as a concealed source of friction for decentralized stablecoins. Staking on Ethereum requires locking up ether to contribute to network security, with participants earning yield in return. However, when stablecoins are supported by staked ether, users encounter an implicit trade-off: the staking yield generated by the collateral competes with the returns that stablecoin users might otherwise receive. Buterin stated that this results in a scenario where stablecoin holders are essentially settling for diminished returns, which he characterized as a less than ideal outcome.
To highlight the challenges in finding a resolution, he presented three overarching theoretical approaches. One scenario would entail slashing staking returns to minimal levels. Another approach would entail developing a novel staking mechanism that provides yield while mitigating associated risks. A third option would entail transferring a portion of the staking risks directly onto stablecoin users. Buterin highlighted that these were not proposals, but rather illustrations of the constrained solution space. A significant concern that Buterin emphasized multiple times was slashing. Slashing denotes the penalties that are enforced on validators—those individuals who contribute to the security of the Ethereum network—when they act improperly or do not maintain an online presence. Buterin emphasized that the risks associated with slashing are frequently misinterpreted. He noted that this applies not only to intentional misconduct but also to scenarios where validators are offline for prolonged durations or find themselves on the losing end of a network-wide censorship dispute. These penalties have the potential to diminish the value of staked collateral, presenting a precarious underpinning for stablecoins. Ultimately, Buterin contended that decentralized stablecoins should not depend on static collateral levels. During times of significant market downturns, he noted, systems need to dynamically rebalance to ensure they stay solvent. In the absence of real-time collateral adjustment mechanisms, stablecoins face the danger of losing their pegs amid extreme volatility.
