§ 03 REPORTS / DEFI / 2026-05-22

Stablecoins: From Pegged IOUs to Ungovernable Money

FILED UNDER DEFI § 2026-05-22

The design space, the graveyard, the fork-choice problem, and the flatcoin frontier — and why the most successful stablecoins gave up nearly everything crypto was for.

tl;dr

Contents

  1. The Design Space: What Were We Actually Trying to Build?
  2. The Graveyard: Failure Modes as a Taxonomy
  3. The Fork-Choice Problem: Who Decides Canonical Ethereum?
  4. The Failings of the Incumbents (USDC / Tether)
  5. The Flatcoin Frontier: Ungovernable Money That Actually Works
  6. Sources
  7. Data Notes & Caveats

1. The Design Space

What were we actually trying to build?

A stablecoin is an attempt to put a stable unit of account on a permissionless ledger. The disagreement — the entire history of the field — is over what you trust to keep it stable. That trust choice sorts every design into one of three families.

Crypto-overcollateralized (the immutable line). Lock volatile crypto worth more than the stable you mint; defend the peg with liquidations and redemption arbitrage. - BitUSD on BitShares — July 21, 2014, the first stablecoin (Larimer/Hoskinson). Behaved more like a volatile margin instrument and lost its peg in 2018. - MakerDAO Single-Collateral Dai (SAI) — whitepaper Dec 2017; ETH-only collateral. This is the genuine innovation in the lineage: a dollar you could mint against ETH with no issuer, no bank, no redemption desk. - Multi-Collateral Dai (MCD) — Nov 18, 2019; the original token renamed SAI.

Fiat-backed (the custodial line). Hold dollars (or T-bills) in a bank; issue a token that's a claim on them. - Tether (USDT) — launched as "Realcoin" July 2014 (renamed Tether Nov 2014). USDC (Circle/CENTRE) — announced May 2018, launched Sept 26, 2018. - These are the winners by size, and the point worth making bluntly: they are not a crypto innovation. They are a wrapper around the existing banking system. The interesting properties of crypto — bearer settlement, censorship resistance, permissionlessness — are exactly the ones they give up.

Undercollateralized / algorithmic (the seigniorage line). Back the coin with nothing exogenous — use a reflexive sister token and supply expansion/contraction to chase the peg. - Robert Sams' "Seigniorage Shares" paper (2014) is the intellectual root; Basis/Basecoin the famous early attempt (raised $133M, shut down Dec 13, 2018 over securities concerns); Empty Set Dollar, Frax (fractional) the DeFi-era descendants; UST the catastrophic apex.

The trilemma

You can have at most two of: decentralized, capital-efficient, robustly pegged. - Fiat-backed: capital-efficient + robustly pegged, not decentralized. - Overcollateralized CDPs: decentralized + robustly pegged, not capital-efficient (you must lock $150+ to mint $100). - Algorithmic: decentralized + capital-efficient, not robustly pegged (and the graveyard is the proof).

Haseeb Qureshi's foundational taxonomy essay frames the peg itself as a Schelling point — "if enough people believe the system will survive, that belief can lead to a virtuous cycle." That insight is the hinge of the whole analysis: pegs are confidence games, and the design question is whether the mechanism adds confidence under stress or consumes it.

The MakerDAO arc — the cautionary tale, not the victory lap

This is the most important thread in the history, because it shows decentralization decaying under economic gravity:

The lesson: capital efficiency is a one-way ratchet toward centralization unless you deliberately weld the door shut — which is exactly what LUSD does (§5).

Vitalik's two tests (the evaluation lens)

From "Two thought experiments to evaluate automated stablecoins" (May 25, 2022, written days after Terra): - Test 1 — graceful wind-down: "can the stablecoin, even in theory, safely 'wind down' to zero users?" - Test 2 — negative rates: "what happens if you try to peg the stablecoin to an index that goes up 20% per year?" — i.e., can the system express a negative interest rate honestly rather than papering it over with token printing?

He praised RAI as the "ideal type" — ETH-only, floating target — and, in "What in the Ethereum application ecosystem excites me" (Dec 5, 2022), planted the flatcoin seed: a governance-minimized coin could track "a global average CPI index" and advertise "abstract best-effort price stability," with lower regulatory risk because it isn't pretending to be a digital dollar.

2. The Graveyard

Failure modes as a taxonomy, not a list of disasters

Don't read these chronologically — sort them by failure category. There are five, laid out at the end.

Terra UST / LUNA — the canonical death spiral (May 2022)

OlympusDAO (OHM) — not a stablecoin (2021–2022)

Fantom fUSD — overcollateralized, yet depegged and stayed depegged

Iron Finance — IRON / TITAN: "DeFi's first large-scale bank run" (June 16, 2021)

The seigniorage wave — Basis Cash, ESD, DSD (late 2020 – 2021)

Honorable mentions (one-liners that expand the taxonomy)

Synthesis — the five failure categories

  1. Algorithmic reflexivity / death spiral — UST, IRON/TITAN, ESD/DSD/Basis, NuBits. The dominant killer.
  2. Collateral risk — fUSD (correlated, broken redemption), Frax↔SVB (off-system shock).
  3. Bank-run / coordination failure — IRON, the textbook case.
  4. Governance / oracle exploit — Beanstalk (flash-loan governance), IRON (lagging TWAP), Wonderland (treasury control).
  5. Yield-subsidy unsustainability — Anchor's 20%, OHM's rebase APY.

The through-line: durable pegs need (a) exogenous, uncorrelated collateral; (b) a redemption mechanism that closes the arbitrage under stress; (c) organic demand not propped by unsustainable yield. The algorithmic casualties were missing all three.

3. The Fork-Choice Problem

Who decides canonical Ethereum?

The actual source — and the correction

The canonical essay is Haseeb Qureshi & Leland Lee, "Ethereum is now unforkable, thanks to DeFi" (Oct 31, 2019). Two things to get right: 1. It's co-authored with Leland Lee. 2. It was written ~3 years before the Merge, framed around the then-active, hypothetical ProgPoW mining dispute — not ETHPoW. The argument is structural, and the Merge later became its real-world confirmation. That is the sharper framing: a 2019 prediction about a hypothetical fork, validated by a 2022 fork nobody was thinking about when he wrote it.

The argument, precisely

Thesis: "Ethereum will never again have a meaningful minority fork, in large part because of DeFi's inherent fragility." The mechanism is composability + centralized chokepoints, with USDC as the keystone: - CENTRE announces USDC will only be redeemable on one fork. - "All DeFi operators are forced to now follow USDC's lead. They cannot defy CENTRE… Composability both rules and constrains everything." - "DeFi operators would have no choice but to side with CENTRE and throw all of their weight behind the USDC-blessed fork, regardless of where community opinion came down." - Supporting cascade: oracles stop posting on the minority fork ("There are no more prices"), and Maker would "simply trigger global settlement" on it.

The issuer's redemption choice becomes the Schelling point. Coordination incentives do the rest.

Vitalik conceded the same point (Aug 2022)

At BUIDL Asia (Seoul, ~Aug 4–5, 2022), weeks before the Merge: you'll have "100 billion of USDT on one chain and 100 billion of USDT on the other chain… and so, they [Tether] need to stop respecting one of them." He called it a 5–10-year concern and suggested diversifying stablecoins (USDC and DAI) as mitigation. (Reported quotes from a conference talk, not a written primary.)

The live experiment — the Merge / ETHPoW (Sept 2022)

Why this is the deepest indictment

The sharpest framing: the canonicity of "real" Ethereum — the supposedly credibly-neutral, unstoppable settlement layer — was effectively ratified by the redemption policies of two private companies. This isn't a peg risk or a counterparty risk; it's a sovereignty risk at the base layer. It is the strongest argument for why decentralized stables aren't a nice-to-have but a precondition for Ethereum's neutrality. (Related: Lyn Alden, "Proof-of-Stake and Stablecoins: A Blockchain Centralization Dilemma.")

4. The Failings of the Incumbents

USDC and Tether — the price of winning

USDC and the SVB depeg (March 2023) — banking risk, imported wholesale

Tether — reserves, transparency, and the audit that never comes

Censorship / freeze power — the core CROPS failure

Counterparty / regulatory capture — structural, not incidental

Scale + regulatory status (early–mid 2026)

The irony

The most "successful" stablecoins are the most centralized — and regulation is entrenching that, not fixing it. GENIUS rewards the fiat/T-bill model and bans yield (protecting bank deposit franchises and Treasury demand), while effectively excluding algorithmic and disadvantaging decentralized designs that can't post fiat reserves through a licensed depository. The state is blessing a duopoly that gives up every CROPS property — Censorship-Resistant, Open-source, Private, Secure — that motivated crypto in the first place. CROPS is the rubric used to score the flatcoins in §5.

5. The Flatcoin Frontier

Ungovernable money that actually works

Definition first — two senses of "flatcoin"

LUSD, RAI, HAI, and ZAI are often grouped together — but the unifying property isn't the peg target, it's the trust model: decentralized, crypto-collateralized, minimal-governance, censorship-resistant. That is the real category — call it "ungovernable money" for the loose-sense umbrella.

The two critiques the category must answer

  1. Volatility of the underlying collateral. ETH is volatile, so you need some shock absorber: overcollateralization + liquidations (LUSD), or a floating redemption price that absorbs volatility into the peg target itself (RAI/HAI), or a soft-liquidation curve (crvUSD's LLAMMA).
  2. Capital efficiency / scalability. This is the unsolved one. Overcollateralized CDP supply is capped by demand for leverage — you only get stablecoins when someone wants to borrow against crypto. That's why DAI reached for USDC: to scale past the leverage ceiling, it had to centralize collateral. The honest statement: no decentralized stable has yet scaled to USDC-size without centralizing collateral. The trilemma is alive.

The protocols (sizes from DefiLlama/CoinGecko, 2026-05-22)

LUSD — Liquity v1 (the immutability gold standard). ETH-only, 0% interest, 110% minimum collateral ratio, Stability Pool + redemption arbitrage giving a ~$1.00–1.10 band. No admin keys, no governance, no upgradeability — it cannot be changed. The strongest CROPS score in the field and the cleanest counterexample to "decentralized stables inevitably centralize." Cost: capital inefficiency and a soft ceiling on size. ($28.6M mcap; $242M Liquity v1 TVL. Note its all-time low was $0.897 in Jan 2022, so the "$1.00–1.10 band" holds in normal conditions but isn't a hard floor.)

RAI — Reflexer (the non-pegged ideal type). ETH-only, non-pegged: an on-chain PID controller sets a floating redemption price via a redemption rate (price above target → negative rate nudges it down; below → positive). "Ungovernable money," governance minimized. Reflexer Labs has wound down; contracts are immutable and live but static and tiny ($1.7M mcap; $2.3M protocol TVL; redemption price now ~$3.06 — it never targeted $1). The point it proves: you can build stable-value money with no peg promise and no governance — Vitalik's "ideal type."

BOLD — Liquity v2. Adds user-set interest rates (redemptions hit the lowest-rate loans first, not the lowest-CR ones) and multi-collateral (WETH, wstETH, rETH in isolated branches); Earn yield now comes from real borrower interest, not token emissions. More flexible, governed (so a notch below v1 on immutability). ($33M BOLD circulating; $82M Liquity v2 TVL.)

HAI & Open Dollar (OD) — the RAI descendants. HAI ("Let's Get HAI") is a multi-collateral RAI fork on Optimism (Ameen Soleimani; mainnet Feb 2024) with a KITE governance token — so more governed than RAI. Alive but tiny (~$0.6M circulating). Open Dollar is a distinct project (not a HAI rebrand): GEB-framework, governance-minimized, LST-backed, ~$1.00-floating on Arbitrum, by Joseph Schiarizzi, whose twist is Non-Fungible Vaults (the CDP itself is a tradable NFT) — but it is effectively dormant now (~$6K TVL), so it reads as a design idea, not a live option.

ZAI on Zcash — the frontier exemplar. An oracle-free, ZEC-collateralized CDP "flatcoin": no Chainlink — an AMM TWAP is the only price input — and it's shielded-transaction native (depends on Zcash Shielded Assets / ZSAs). Posted to the Zcash forum Feb 2026 by pseudonymous dev lamb356 (repo lamb356/zai-sim); claims $0 bad debt in backtested replays of Black Thursday, FTX, and Luna.

Crucial caveat: ZAI is a simulation / research proposal — not deployed. No testnet, immutability not yet addressed. It is the most on-thesis design in the field — it pushes on the two hardest things at once (oracle dependence and privacy, the P in CROPS that almost nobody else even attempts) — but it belongs in any survey as a frontier direction, not a usable product.

Others worth a line each: - crvUSD (Curve): LLAMMA soft-liquidation (collateral is gradually swapped around the liquidation zone rather than dumped) — genuinely novel mechanism; governed. ($239M.) - GHO (Aave): overcollateralized, multi-collateral, governed by Aave. ($583M — the largest of the governed-decentralized set.) - frxUSD (Frax): moved to RWA/custodial backing — not censorship-resistant; the "decentralized brand, centralized reality" example. (FRAX ~$198M; frxUSD is the RWA/custodial successor.) - AMPL / SPOT (Ampleforth): AMPL targets a CPI-adjusted dollar via rebasing; SPOT is the non-rebasing low-volatility derivative — the most credible commodity-money / strict-flatcoin attempt, but both are now tiny/illiquid (AMPL ~$6M mcap; SPOT thinly traded). - Nuon (Laguna): the clearest explicit strict-sense flatcoin (Truflation goods basket) — but effectively dormant (~$9K TVL); a concept, not a going concern. - Ethena USDe: delta-neutral, CEX-hedged synthetic dollar ($4.44B circulating, down from a ~$14B peak — the unwind continued through early 2026). The foil: decentralized-flavored but CeFi-dependent — the contrast against LUSD that makes the "what counts as decentralized" point.

Comparison table

Name Collateral Peg type Governance / immutability Size (DefiLlama/CoinGecko, 2026-05-22) CROPS-ish read
LUSD (Liquity v1) ETH only Soft $1 (1.00–1.10 band) Immutable, no governance $28.6M mcap / $242M TVL Gold standard
RAI (Reflexer) ETH only Non-pegged, floating redemption price Governance-minimized, wound down $1.7M mcap / $2.3M TVL Ideal type, dormant
BOLD (Liquity v2) ETH + LSTs Soft $1, user-set rates Governed $33M circ / $82M TVL Strong, but governed
HAI ETH + LSTs + RAI RAI-style floating KITE governance ~$0.6M circ Alive but tiny
Open Dollar (OD) LSTs ~$1 floating Governance-minimized ~$6K TVL Novel (NFV vaults), dormant
crvUSD ETH/LSTs/BTC Soft $1 (LLAMMA) Curve governance $239M Novel liquidations
GHO Multi $1 Aave governance $583M Governed, largest
ZAI (Zcash) ZEC CDP "flatcoin", oracle-free Not yet built N/A — simulation Most on-thesis, vaporware-stage
frxUSD RWA/custodial $1 Governed ~$198M (FRAX) Not censorship-resistant
Ethena USDe CEX delta-neutral $1 Governed $4.44B The foil (CeFi-dependent)

The honest close

Score them on CROPS and only LUSD and RAI clear the censorship-resistant + immutable bar cleanly today. BOLD/crvUSD/GHO are decentralized-but-governed (a real category, not a dismissal). ZAI is the frontier — the only design even trying to add Privacy to the stack — but it's an idea, not a product. And the scaling question hangs over all of them: the immutable ones can't scale to USDC-size without centralizing, and the day they try, they become MakerDAO. That tension — not any single protocol — is the real subject.

Worth sitting with: outside GHO ($583M) and crvUSD ($239M), the immutable/censorship-resistant designs worth championing — LUSD ($28.6M), RAI ($1.7M) — are rounding errors against USDT's $189B. That scale gap is the argument.

6. Sources

Design space / history - Vitalik, Two thought experiments to evaluate automated stablecoins (2022-05-25) — https://vitalik.eth.limo/general/2022/05/25/stable.html - Vitalik, What in the Ethereum application ecosystem excites me (2022-12-05) — https://vitalik.eth.limo/general/2022/12/05/excited.html - Haseeb Qureshi, Stablecoins: designing a price-stable cryptocurrency — https://haseebq.com/stablecoins-designing-a-price-stable-cryptocurrency/ - MakerDAO MIP29 (PSM) — https://mips.makerdao.com/mips/details/MIP29 - Deribit Insights, DAI is now 60% backed by centralized assets (2020-09-26) — https://insights.deribit.com/market-research/dai-is-now-60-backed-by-centralized-assets-what-does-that-mean/ - Messari, State of Maker Q2 2022 — https://messari.io/report/state-of-maker-q2-2022 - CoinDesk, MakerDAO votes to retain USDC after depeg (2023-03-23) — https://www.coindesk.com/business/2023/03/23/stablecoin-issuer-makerdao-votes-to-retain-usdc-as-primary-reserve-even-after-depeg - Maker Dec-2017 whitepaper — https://makerdao.com/whitepaper/Dai-Whitepaper-Dec17-en.pdf - BitUSD background — https://medium.com/the-ledger-by-spark/what-is-bitusd-everything-you-need-to-know-about-the-first-stablecoin-ever-created-72337c53fdfa - CoinDesk, Basis shutdown (2018-12-13) — https://www.coindesk.com/markets/2018/12/13/basis-stablecoin-confirms-shutdown-blaming-regulatory-constraints

Failure modes - LFG reserves drained — https://www.coindesk.com/business/2022/05/16/luna-foundation-guard-left-with-313-bitcoin-after-ust-crash - Harvard, Anatomy of a Run: Terra-Luna — https://corpgov.law.harvard.edu/2023/05/22/anatomy-of-a-run-the-terra-luna-crash/ - Anchor yield — https://www.coindesk.com/markets/2022/01/28/anchor-protocol-reserves-slide-as-money-markets-founder-talks-down-concerns - Olympus bonding primer — https://olympusdao.medium.com/a-primer-on-oly-bonds-9763f125c124 ; CoinGecko OHM — https://www.coingecko.com/en/coins/olympus - fUSD relaunch / depeg — https://cointelegraph.com/news/fusd-stablecoin-launch-and-rumors-of-cronje-s-return-send-fantom-ftm-price-higher ; https://decrypt.co/120530/ftm-soars-week-fantom-preps-stablecoin-relaunch - Iron Finance post-mortem — https://ironfinance.medium.com/iron-finance-post-mortem-17-june-2021-6a4e9ccf23f5 ; Fed note — https://www.federalreserve.gov/econres/notes/feds-notes/runs-on-algorithmic-stablecoins-evidence-from-iron-titan-and-steel-20220602.html - Seigniorage algos (ESD/DSD figures) — https://aws.okx.com/learn/algorithmic-stablecoins-performance-suggests-they-have-yet-to-justify-their-models ; https://dailydefi.org/articles/what-are-seigniorage-stablecoins/ - Beanstalk — https://www.coindesk.com/tech/2022/04/17/attacker-drains-182m-from-beanstalk-stablecoin-protocol ; https://medium.com/immunefi/hack-analysis-beanstalk-governance-attack-april-2022-f42788fc821e - Wonderland/Sifu — https://www.coindesk.com/tech/2022/01/27/how-did-a-former-quadriga-exec-end-up-running-a-defi-protocol - Frax/SVB — https://www.coingecko.com/research/publications/stablecoins-supply-svb-impact - NuBits — https://medium.com/reserve-currency/the-end-of-a-stablecoin-the-case-of-nubits-dd1f0fb427a9

Fork-choice problem - Qureshi & Lee, Ethereum is now unforkable, thanks to DeFi (2019-10-31) — https://haseebq.com/ethereum-is-now-unforkable-thanks-to-defi/ - Circle, USDC and Ethereum's Upcoming Merge (Aug 2022) — https://www.circle.com/blog/usdc-and-ethereums-upcoming-merge - Fortune, Circle and Tether support PoS Ethereum (2022-08-09) — https://fortune.com/crypto/2022/08/09/stablecoins-circle-tether-support-ethereum-merge-proof-of-stake/ - Vitalik @ BUIDL Asia (reported) — https://cointelegraph.com/news/vitalik-centralized-usdc-could-decide-the-future-of-contentious-eth-hard-forks - Lyn Alden, Proof-of-Stake and Stablecoins — https://www.lynalden.com/proof-of-stake/

Incumbent failings - USDC SVB — https://www.coindesk.com/business/2023/03/11/circle-confirms-33b-of-usdcs-cash-reserves-stuck-at-failed-silicon-valley-bank ; Fed FEDS note — https://www.federalreserve.gov/econres/notes/feds-notes/in-the-shadow-of-bank-run-lessons-from-the-silicon-valley-bank-failure-and-its-impact-on-stablecoins-20251217.html - NYAG settlement — https://ag.ny.gov/press-release/2021/attorney-general-james-ends-virtual-currency-trading-platform-bitfinexs-illegal - CFTC settlement — https://www.cftc.gov/PressRoom/PressReleases/8450-21 - Tether Q4'25 attestation — https://tether.io/news/tether-delivers-10b-profits-in-2025-6-3b-in-excess-reserves-and-record-141-billion-exposure-in-u-s-treasury-holdings/ - Tornado Cash sanction — https://home.treasury.gov/news/press-releases/jy0916 ; delisting — https://home.treasury.gov/news/press-releases/sb0057 - Circle freeze (Dune-cited) — https://www.theblock.co/post/162172/circle-freezes-usdc-funds-in-tornado-cashs-us-treasury-sanctioned-wallets - GENIUS Act — https://www.whitehouse.gov/fact-sheets/2025/07/fact-sheet-president-donald-j-trump-signs-genius-act-into-law/ ; https://www.cov.com/news-and-insights/insights/2025/07/the-genius-act-becomes-law-key-provisions-from-the-federal-stablecoin-regulatory-framework - DefiLlama stablecoins (live data) — https://defillama.com/stablecoins

Flatcoins / decentralized stables - Liquity docs (LUSD/BOLD), Reflexer/GEB docs (RAI), HAI / Open Dollar docs, Ampleforth (AMPL/SPOT), Nuon (Laguna), Ethena — primary protocol docs; current sizes from DefiLlama/CoinGecko. - ZAI on Zcash — Zcash forum thread (Feb 2026) + repo lamb356/zai-sim.

7. Data Notes & Caveats