Upcoming CGP: Increase target level of stable holdings in the reserve

[Pinotio.com]

Author(s): Ronan McGovern (@Pinotio.com), Roman Croessman (@roman) + keen to welcome further collaborators/proposers

Summary

• The proposal increases reserve holdings of stablecoins, specifically DAI, in the short-to-medium term, and then phases stablecoins out as natural backed capital is introduced.
• This proposal increases the percentage of stable collateral in the reserve to better protect against cStable under-collateralization in the case of a crypto market crash.
• In the short term, this proposal has the effect of increasing the reserve target for stablecoins to 19.5%.
• In the medium to long term this proposal allows for stablecoin holdings to be reduced, and even eliminated, as natural backed capital is introduced in sufficient quantities

Importance of trust in cStables

As the CELO community grows, there are increasing numbers of dApps, merchants, creators and community members making use of cStables. It is critical for these users that cStables retain their value relative to their fiat currency pegs. This is particularly true for community members for which the underlying collateralisation and security mechanisms of Celo are not apparent.

All dApps and communities built on Celo have an interest in the strength of and trust in cStables.

Background on Reserve Collateralisation

As of April 14th 2022, Celo has approximately $120M in issued cStables (CeloReserve.org). This is currently collateralised by a reserve value of about $580 million of which:

• 97.2% are volatile crypto assets (Celo, Bitcoin or Ether)
• 2.8% are natural backed capital (MCO2) or stablecoins (DAI).

The price of volatile crypto assets including Celo, Bitcoin and Ether can swing wildly and this puts collateralisation of the reserve at risk. For example, were crypto prices to revert to the levels of the 2018 crypto winter, cStables could become undercollateralised.

In the case of a crypto market crash, there is a mechanism to slow undercollateralisation of the reserve and depegging of cStables. This is the “Tobin Tax”, whereby a transaction tax would be charged for swapping cStables for CELO. However, the Tobin Tax is a) currently turned off (set to zero) and b) it is unclear whether - in practice - this tax could slow reserve depletion or instead hamper liquidity in a detrimental way.

This proposal takes a more straightforward approach of increasing the amount of stable capital in the reserve.

Quite simply, in a crypto market crash the value of the reserve may plummet (with Bitcoin, Ether and Celo falling in price), but provided that the price of stablecoins in the reserve (or later natural capital, once introduced in larger amounts) remains stable, reserve overcollateralization is better preserved.

Current Reserve Allocation

CELO: 50%

BTC: 29.5%

ETH: 15%

Stable-value assets (currently DAI): 5%

cMCO2: 0.5%

Updated Reserve Allocation per this proposal

CELO: 50%

BTC: 15%

ETH: 15%

Stable-value assets (specifically DAI): 20% minus the target percentages of natural backed capital for the reserve

cMCO2: 0.5%

Note: With cMCO2 at a 0.5% target level in the reserve, this would put the short term stable-value assets target at 19.5%

Reserve Modelling in the Case of a Crypto Crash

The numbers in this model should be considered as illustrative of just one possible scenario. By nature, reserve asset price movements are coupled in complex ways.

This spreadsheet provides a model for the CELO reserve i) today and ii) after this CGP assuming:

• cStables outstanding remain constant in a crypto market crash.
• I vary the parameter x, which is the % fall in BTC, ETH and CELO prices in a crypto market crash.

Crudely, this chart shows that (following the assumptions above):

1. Today, the reserve could withstand about an 80% price drop in crypto (not an unprecedented fall, considering historical crypto data).
2. After the CGP, the reserve could withstand up to a 95% price drop in crypto.

The chart above likely overstates the security of the reserve, mostly because CELO is less established than BTC and ETH, so CELO is likely to fall further in a crash than BTC or ETH.

On the choice of DAI versus USDC as a stable-value asset

There are a number of factors to balance in choosing a stable-value asset:

1. Liquidity - can the stable-value asset be easily exchanged for other reserve assets with low slippage.
2. De-pegging risks
3. Regulatory risks - to what degree is it possible that funds could be confiscated or rendered immobile.

It is important to note that one bad scenario for the CELO reserve would be if the 20% stable-value allocation were to fully de-peg and be rendered worthless. However, there would still be the other 80% of the reserve. It is not just a matter of avoiding depegging risk, but balancing this risk against the overall risk of the reserve becoming undercollateralised, for example, the risk of undercollateralisation in a broad crypto market crash.

The choice of percentage is a judgement that aims to balance these two opposing risks (depegging of reserve stablecoins; undercollateralisation of the reserve to to a crypto market crash).

On balance, we recommend that the regulatory risks of USDC outweigh the liquidity benefits, and therefore recommend the choice of DAI. Further, DAI is already a CELO reserve asset and does not involve introducing a new asset.

DAI

Liquidity - Dai liquidity would most likely be obtained via ETH/DAI or WETH/DAI pairs. Pairs involving USDT (Tether) would be avoided in any trades owning to a lack of transparency around the collateralisation of Tether. Daily volumes on DAI pairs are as follows:

Depegging risks - DAI is an overcollateralised stablecoin (data here):

• There is more than $1 worth of crypto collateral for each $1 of DAI
• Notably, about half of DAI is collateralised by USDC, while the other half is collateralised mostly by ETH and WBTC type assets.
• MakerDAO (the protocol behind DAI) has an automated liquidation mechanism that results in collateral being sold if there is a drop in crypto market prices and collateral ratios drop below set limits. This liquidation mechanism can, and has in the past, failed, but the system has been around for multiple years and one might argue is reasonably tested.

Regulatory Risks:

• DAI is, besides the fact that it is backed to large extent by USDC, relatively decentralised and there is no central entity that custodies DAI. Collateral is kept in decentralised smart contracts.
• Possibly the largest regulatory risk to DAI is if USDC were to be suddenly withdrawn from the market by its issuers. As mentioned about 50% of DAI comes from USDC.

USDC

Liquidity - USDC liquidity would most likely be obtained via ETH/USDC, BTC/USDC or WETH/USDC pairs. Daily volumes on such pairs are as follows:

Depegging risks - USDC is a 1:1 fiat-collateralised stablecoin run by Circle:

• Collateral is audited and published online.
• USDC is custodial, i.e. collateral is held by centralised agents. The reputation and performance of these agents (Circle) influences depegging risk.

Regulatory Risks:

• Were regulators to undermine the current approach taken by Circle - especially in a manner that is sudden or unexpected - it is possible that USDC could de-peg. For example, collateral backing USDC could be frozen in bank accounts, reducing its value as collateral for USDC tokens.
• Were USDC to be rendered illegal, wallet addresses with USDC could be blacklisted by public and private organisations. This is a risk for any token, but perhaps especially fiat-pegged stable tokens because these most directly influence a government’s control of their own currency.

On the medium term plan for increased natural capital in the reserve

This proposal specifies that stablecoins as collateral should be targeted only to the extent there is insufficient natural capital in the reserve to meet 20% of the reserve’s value

As governance proposals are introduced to increase natural capital in the reserve, the target for stablecoins is automatically reduced.

For clarity, the challenge of finding high quality (liquidity and stability) natural backed capital is not an easy one. It will require significant energy from the community to implement safely for the reserve.

Summary on the choice of stable-collateral

It is fundamentally a hard problem to provide safe collateralisation of one asset (here cStables) with other uncorrelated assets (here BTC, ETH and CELO).

MakerDAO (issuers of DAI) do this by invoking an overcollateralised approach plus a liquidation mechanism to provide protection of the peg during a crash in crypto prices. The investment and testing of such a liquidation mechanism is significant and not trivial to safely implement.

To date, CELO has in essence adopted an overcollateralised approach as well, but without a high-confidence mechanism to protect against undercollateralisation in a steep market crash. Thus, this proposal aims - in the short-to-medium term - to protect against this risk by adding stable-value assets to the reserve, i.e. assets that have a close correlation in value with the cStables issued by the Celo reserve.

All in all, DAI probably presents less regulatory risks than USDC (although DAI itself is 50% subject to USDC risks), whereas USDC provides easier reserve management owing to higher liquidity, plus more straightforward collateralisation, which likely reduces the risk of depegging. Either way, it will be important to move quickly to increase natural capital in the reserve (providing price movements with low correlation to BTC and ETH), in which case - under this proposal - stable-value assets would be automatically phased out.

[Tobi]

Thank you @Pinotio.com for thinking about stability and bringing this up in such a thoughtful way. Stability can easily be taken for granted in good market environments. But in human engineered markets, the next crash is never far away.

I am torn with this proposal - between reducing stability risk, the value of decentralization, and the differentiation of cStables from other stablecoins.

I’ll try to summarize the arguments that I’m trying to weight:

Higher stablecoin allocation yes or no?

• Other stablecoins are probably the best shorter-term crypto crash protection that can be put into the reserve that is currently available on a blockchain
• Increasing the stablecoin allocation with DAI or USDC to 20% would push cStables further away from decentralization
• Short. vs. long-term stability. Stablecoins seem short-term stable, volatile assets more long-term to me. This proposal would subject the reserve increasingly to inflation.
• If a stablecoin is mainly backed by another stablecoin, why is it being used? Why not use the underlying stablecoin directly? I would rather use the underlying collateral directly.

If yes, by how much?

• It’s hard to quantitively come up with a reasonable number with wild crypto volatilities, but 20% of the reserve, around the current cStable market cap, seems reasonable to me. I don’t think 10% or 30% would make much of a difference. Probably in retrospect, but not with the current information set available.

If yes, DAI or USDC?

Assuming DAI and USDC have the same regulatory risk, as DAI mainly depends on USDC:

• What happens to DAI or USDC if ETH and BTC crash >> 50%, a scenario where the stable allocation would be needed and this proposal is meant to protect against?
  • USDC seems more likely to remain stable in my opinion, no liquidations and fewer market distortions.
  • DAI can be understood as a derivative on USDC, with additional collateral in the form of ETH, BTC, and several smaller tokens. As a source of stability, this seems riskier, as liquidation and market distortions adds complexity.
  • Liquidity now to get the asset is important, but even more important to me seems the liquidity in a crash. As DAI adds market complexity on top of USDC, I think USDC would be the better choice here.

Overall, I would personally probably vote no, as I think the current overcollaterization with a snapshot ratio of ~4 seems much more robust than other crypto backed & seignorage stablecoins, and in general fairly robust, to me. Or at least not fragile enough to introduce a significantly centralized stablecoin into the reserve that would make it hard for me to be as excited about cStables as I have been so far.

But I could be wrong, I will think more about this and I’m really curious to see the governance vote on this.

[0xLeo]

Hello @Tobi and @Pinotio.com - I wanted to add a couple of thoughts regarding this proposal.

One thing I think warrants discussion is that the spreadsheet assumes that DAI will hold its peg in a Crypto Crash scenario. I think it may be worth examining the assumptions behind this.

DAI and USDC will hold its value in a Crypto Crash - I think its important to think about the different causes of the potential crypto crash that we are worried about. If it is caused by a general risk-off sentiment that is triggered by equity sell-off and leveraged position liquidations, I think this assumption is likely to hold true.

However, I think the biggest risk that cStables need to guard against is a “bank-run” scenario on stablecoins caused by a loss of confidence. While it may never happen, if one of the larger stablecoins, such as USDT, were to experience a material depeg event, that would likely lead to a large crypto crash. In that scenario, I think it would be very important that the backing for cStables is simple and straightforward to understand.

Its not a given that USDC or DAI will be “fine” if USDT depegs. For example, while USDC is certainly considered to be safer than USDT, it is unclear what kind of liquidity risk Circle is taking with the reserve assets. Even if there was a 1:1 backing of reserve assets for USDC, a sudden demand for liquidity in of itself can cause USDC to depeg because these assets cannot be liquidated quickly enough. If Circle is keeping its assets in banks, even if the banks are FDIC insured, Circle is imposing credit risk of the bank on to USDC holders. Its the classic distinction between solvency vs liquidity.

In banks, there is extensive regulation to safe guard against both types of risk. Solvency requires the bank to hold certain types of assets. Liquidity regulations such as LCR requirements (Liquidity Coverage Ratio - ACT Wiki) ensure that banks can meet liquidity requirements even in extremely stressed scenarios. It seems like most of the debate surrounding centralised stablecoins has focused on the solvency part of the question but has largely ignored the liquidity part.

DAI inherits all of USDC’s risk and introduces additional complexity. Liquidations occur on a vault level and not on the overall collateralization level. Even if overall collateralization looks “safe”, a large account can trigger cascading liquidations.

In short, I think the risk of adding DAI or USDC is increased complexity. The current stablecoin landscape (and DeFI in general) is starting to look a bit like the CDO, CMO market in 2007, when products were being packaged together to create increasingly complex derivatives.

Of course there are benefits to adding stablecoins to the reserve as mentioned above, but I think it is worth examining the increased risk in worst-case scenarios.

[markbarendt]

My impression is that, at this point in history, this proposed switch of reserve assets would simply be trading one type of risk for another and not necessarily an improvement.

From a different conversation, it’s my impression that the reserve isn’t capable yet of buying RWA’s because of KYC and or other regulatory issues. If that’s true, addressing those issues could be a better use of effort and resources.

[Pinotio.com]

Thanks @Tobi , @0xLeo , @markbarendt - much appreciated on the input.

A few points to add:

1. Collateralisation Levels
@Tobi , earlier this year we had a time where reserve collateralisation dropped close to 2X.

2. I don’t see a basis for arguments of increased complexity
We already have 5% as a stables target (currently DAI) in the reserve. Increasing to 20% doesn’t substantially change operational complexity (provided there is sufficient liquidity in stables, see new new note below).

There is a tendency on this forum to use complexity as a reason against proposals. Indeed it is a good reason, and we should seek ways to simplify CELO. That said, arguments of increased complexity should be laid out clearly with the new approach versus the baseline. I think @Tobi and @0xLeo you did that well on DAI versus USDC, but I have a different view of how to compare baseline and new risks.

3. Evaluation of Risk
I agree that increasing stables in the reserve increases the exposure of the reserve to depegging of those stables. However, it is a matter of balancing new risk against the current risks.

Current Risks
The current risk is that we have a reserve that is ~97% crypto and 3% stable. That is a very crypto weighted portfolio. I know of very few people or organisations with such a one-sided weighting of their assets.

Being so heavy in crypto subjects the reserve to heavy drawdowns in crypto market crashes. Mathematically, this is highly punitive to long-run performance (see Spitznagel’s volatility tax: https://www.universa.net/UniversaResearch_SafeHavenPart4_VolatilityTax.pdf).

Side note: Such arguments are the reasoning behind 60:40 equity-bond portfolios. The complementarity of asset movements reduces drawdowns, which strongly pulls up average returns. Dampening drawdowns is even more critical to the Celo reserve because we are collateralising cStables.

New Risks
Under this proposal, we are putting 20% of our reserve subject to stable depegging risks. Yes, that is a risk, but it applies only to 20% of our portfolio.

BTW, DAI and USDC survived all previous market crashes. cStables would almost certainly be undercollateralised if we had a crash like 2018/19 today. So, even if we aren’t covering the most extreme scenario, we are covering a lot more scenarios than we are today.

All in all, this proposal brings the benefit of meaningful (but not complete) crash resilience via moving the reserve from an extreme 97:3 crypto:stable weighting to a target 80:20 crypto:stable weighting - and this is at the cost of putting 20% of our reserve at depegging risk in extreme scenarios (scenarios in which, btw, today’s Celo reserve would anyway certainly become undercollateralised).

Collateralising stables with other stables
@Tobi , I think this is an important question and there is a degree of truth. Some notes:
a. We are not collateralising stables with stables 1:1. Rather, we are collateralising with an 80:20 portfolio of crypto:stable assets. cStables will vary as a portion of the reserve.
b. While this may reduce decentralisation at the margin, we have to be realistic that a much bigger lever for decentralisation is to start putting the reserve directly under the control of governance (rather than a multisig). I plan to post shortly on a proposal for that (as you know, and thanks for the great feedback). I think this point is not apparent to the broader community and is under-appreciated.

USDC vs DAI
Good points are raised on this matter too. @roman and I are revisiting the choice of USDC vs DAI and plan to post shortly. There are meaningful liquidity benefits to using USDC over DAI (which means the reserve can be rebalanced faster with less slippage). Further, since the stable target is limited to 20%, we limit the portion of the reserve that is subject to depeg or regulatory risk - whether it is USDC or DAI.

Coupling
Worth bringing this proposal back to a bigger picture of what we are trying to do at CELO and how a lot of these proposals are coupled. Two specific points:

• Thinking about decentralising the reserve to governance is critical (proposal upcoming). If we were more decentralised with that, then regulatory issues (e.g. in considering DAI vs USDC here) would reduce.
• Over the next year we plan to bring forward many proposals such as a) expanding and/or launching cStables, b) finding credibly sustainable ways to give cStables more economic (and possibly voting) power. Right now the reserve is so crypto heavy (97-3 in crypto-stables) that in most new proposals, the forum asks the question: “But what if this proposal increases risks to cStable collateralisation?”. This will always be a good question to ask but, right now, by not having better stable collateralisation, we are slowing many of our other proposals. Adding a greater stable proportion to the reserve isn’t a complete solution, but I see it as a valuable step as we then move to ii) decentralise the reserve to government, and iii) add other forms of capital - especially natural capital - to the reserve asap.

[markbarendt]

Good morning,

@Pinotio.com

Current Risks
The current risk is that we have a reserve that is ~97% crypto and 3% stable. That is a very crypto weighted portfolio. I know of very few people or organisations with such a one-sided weighting of their assets.

I think using ‘crypto’ in the vernacular sense here in the crypto world is skewing the conversation about the real risks involved.

From my perspective stables are truly just as much ‘crypto’ as the Celo coin or ETH or BTC.

I think the idea you are trying to address is the ‘variable’ (risky) assets versus ‘stable’ (safe) portfolio balance. Colloquially put, it’s the stocks vs bonds vs cash idea from TradFi.

Within the crypto space, stable coins do open up different utility because of the peg to an external currency and they look good on a spreadsheet but IMO they face much more regulatory and political risks.

IMO stable coins simply don’t yet offer any better cover than variable value coins if there is a crash.

To truly mostly eliminate the crypto crash risk for the Celo ecosystem, the ecosystem needs to reach the point of being a truly profitable enterprise that interacts with the real world in a fully liquid manner.

In short people need to trust Celo even if they don’t trust BTC or ETH.

In the short term BTC and ETH are IMO as good or better than DAI.

In the medium term RWA’s like fiat and debt instruments could seriously reduce the crypto crash risks.

[John.Fletcher]

This is a very wise temporary measure, (pending more natural collateral being added to the reserve), and will reduce risk substantially.

[markbarendt]

Again I think language is getting in the way here.

I see how more stables may reduce volatility (a bit), but volatility and risk aren’t the same thing.

Volatility, within a normal range, isn’t really a risk to the system as a whole, it’s the norm not a threat.

So with that context, how will it reduce the real risks in a crypto crash?

IMO changing the allocation of which crypto is held appears to be more window dressing than substance.

[markbarendt]

An extraordinarily stable crypto market

[Pinotio.com]

Hi folks, @inlumino just posted a very interesting whitepaper on Near’s reserve design, that is very relevant here:

• Post over on the Proof of Deposit discussion.
• Near whitepaper: Decentral_Bank_Full_Whitepaper_v__1_0 (1).pdf - Google Drive

Remarks on the Near Reserve vs Celo Reserve

• The USN design and Near Reserve is very similar to what we have at CELO.
• One difference is that Near explicitly talk about stable capital in their reserve. Indeed the reserve has been seeded, at genesis, with $1 of USDT and $1 of NEAR for every $1 of USN (so they are starting from a ratio of having full stables backing, and then will move away from that thereafter, where USN is swappable with $1 of NEAR [same as cUSD being swappable with $1 of CELO).
• It’s very interesting that NEAR choose USDT given the widespread perception that USDT is the riskiest of backed stables because of low public disclosure of USDT reserves
• The USN whitepaper dedicates a full page to the topic of a “Death Spiral”. Note in particular this paragraph:
  
  
  
  My view is that claiming a death spiral won’t happen based on “simulations” and “historical data” is just naive. A similar narrative is present in Celo Reserve documentation. What ultimately matters for avoiding a death spiral is that there is collateral in the reserve that is closely correlated with the Stables. I recommend listening to Sam Bankman Fried (founder of FTX) on this week’s odd lots podcast. I don’t remember the timestamp but what he roughly says is that “If you have a basket of stables that are collateralised by a basket of volatiles, those stables will blow up”.

In short, I think the Near reserve will face parallel issues to the Celo reserve with respect to ensuring safety (avoiding a death spiral) when there are strong drops in Celo/Near prices. I can’t publicly find the Near reserve dashboard yet, but I think Near will have the advantage of higher stables backing in their reserve (although of course it’s possible that USDT might depeg in the worst of crashes).

[markbarendt]

Good morning Pinotio,

I read that paper yesterday and agree that USN will face the same technical challenges as CUSD.

My thought though is that the particular type of crypto asset in the reserve isn’t the biggest factor that will matter in the case of a crypto crash.

Instead simply it’s trust.

I think it will be a matter of which particular crypto projects people trust and are most invested in themselves. Today those projects are BTC and ETH without question.

I’d suggest that if any single large cap stable coin de-pegged the likely outcome would be akin to a magnitude 9 earthquake in the stable coin market and that any stable coin, backed by other stable coins, would be in serious jeopardy even if that coin was not held directly.

In that situation I think it is likely that there would be a huge shakeout and that stable coin collateralized projects may disappear.

The only downside the Near white paper suggests for over collateralized projects that use other assets is what they called inefficient use of capital.

I think it would be wise not to follow the herd here and build the reserve on a different foundation.

In real world terms the “fiat USD” is backed by the USA’s reputation for paying it’s bills. For Nicaragua using the USD as a peg becomes a big risk, hence their motivation to use BTC instead.

[Pinotio.com]

Thanks Mark,

Is it that you’re not worried about undercollateralisation of cStables? If so, why are you not worried? By definition, if the reserve is undercollateralised, it is not possible for all cStable holders to redeem their stables from Mento at par value.

This isn’t about the catastrophic (but possible) case where USDT or USDC fail - in which case it’s possible - or likely - that everything gets crushed. This is about the more mild scenario that fluctuations in crypto prices can result in cStables being undercollateralised (because our reserve has basically no assets that are correlated to stables).

[markbarendt]

There are certain risks inherent in any start up.

Being under collateralized for a moment or two is a “so what” moment in my mind. IMO the only reason it seems important to anyone today is a matter of marketing. The competition and Nay-sayers are driving that narrative.

Fiat isn’t over collateralized, it never has been, it does though have incredible utility.

The wild card here is trust that the system will work when I need it to buy my groceries.

For example, if CELO went “all in” and did “whatever it took” to fix the on/off ramp issue once and for all, it would create more trust than any other crypto currency simply because people like my wife could move money out when she needed it with a few clicks.

Fix that utility issue and the status of the CELO reserve on hour by hour basis will matter very little to the user.

The feds might require more backing, but if CELO fixed the on/off ramp issue I’d bet the influx of fiat would fix that and that CELO’s value would pump in concert.

[Pinotio.com]

@markbarendt

Being under collateralized for a moment or two is a “so what” moment in my mind. IMO the only reason it seems important to anyone today is a matter of marketing. The competition and Nay-sayers are driving that narrative.

Yeah, I think the key questions are:

1. Is it ok if it’s for more than a moment? (It’s definitely possible there is undercollateralisation for weeks, months, who knows)
2. How do we know it’s ok for a moment?

And btw, I’m open to you being right. It’s just there’s a chance you aren’t right, and I think adding a small percentage of stables (20%) is worth any associated downsides to hedge against you being wrong.

[markbarendt]

Yes, a distinct possibility that I’m wrong is always there.

My hope is that we can find and fix the real problems rather than take an aspirin to mask the symptoms.

[VirtualHive]

We followed the discussion and want to give some input:
Tldr: Timing markets rarely works, BTC should be a decent collateral long term

Since the proposal aims to reduce BTC for another stablecoin we quickly look at BTC and its behavior in the last cycle. From its peak end of 2017 till November 2018 BTC fell ~80%. This was after a so called “blow off top” in December 2017 where BTC went down ~50% within 1 week.

Currently BTC trades ~44% down from its top back in November 2021. Therefore even if we see a draw down as bad as in 2017-18 more than half already happened. We would rather argue that the drawdown won’t be as bad due to eg. no “blow off top”, more demand via TradFi.
Overall we see the proposal to adjust the reserve here as “timing the market” in order to front run a real crash. But even in the scenario of a real crash BTC will be the asset that drops the least compared to ETH and CELO.
Looking at current numbers the reserve could drop ~78% before cUSD gets undercollateralized. Furthermore we think that a draw down of ~78% in CELO / a long lasting bear market itself will result in less adoption of the eco system and therefore demand for cUSD.

Commenting on the last few points discussed in this thread:
According to the metrics used UST is constantly undercollateralized and it’s no problem so far. Like stated the main point depends on the trust people have in the stablecoin itself. The far bigger problem in the reserve is CELO since if really everyone would try to get out of cUSD at the same time and then swap the CELO to USD they will get a haircut anyway.

All of this is of course a lot of speculation but we don’t think this is the best time to reduce the least volatile asset (out of the 3 volatile ones) in the reserve into another stable coin.

[markbarendt]

Been chewing on this today and one other thing that stands out to me in favor of keeping BTC and ETH rather than adding DAI, is the question of liquidity.

To me it seems that BTC and ETH are arguably going to be the most liquid assets if things go really sour.

I would even hazard a guess that that is part of why Terra is loading up on BTC.

[Pinotio.com]

Hi folks, and many thanks for the comprehensive input: @markbarendt , @VirtualHive , @0xLeo , @Tobi .

In short, @roman and I have decided not to proceed with submitting a CGP on this topic. Instead, I will shortly post with a proposal on reserve decentralisation.

Rationale
While I remain concerned about undercollateralisation of the reserve in the case of a crypto crash, two reasons emerged to stop pursuing the addition of stables to the reserve in favour of focusing instead on reserve decentralisation and adding natural capital to the reserve, as well as other Mento 2.0 efforts.

1. Regulatory Risks
At present, the Celo Reserve is managed by a multi-sig of trustees. If USDC or DAI is to become regulated (e.g. as a security or eMoney), it is possible that this treatment could flow through to crypto that is backed (or backed-in-part) by USDC/DAI. This is speculation at this stage. We do not yet know fully how USDC or DAI or cStables will be treated from a regulatory standpoint in different jurisdictions. Increasing the exposure of the reserve to these assets may increase risks of multi-sigs/trustees (or cStables backed by these currencies) of falling into regulated territory where compliance would be difficult.

Obviously, this point emphasises the importance of further decentralising the Celo Reserve.

2. Rationale for one stable backed by another
Why would make sense to have one stable-coin backed by another? Why not just use the first (e.g. replicate USDC natively on Celo OR bridge it from Ethereum (which is already possible)?

The answer, under this proposal, is that the backing is only temporary - to protect the reserve in a crypto downmarket - and to be phased out as natural capital is to be phased in.

Still, adding USDC and DAI would be a detour from Celo’s mission points of decentralisation and of natural backed assets and I think this concern comes to the fore from the community both in a real sense and in the sense of “what will outsiders think if we add USDC or more DAI”.

Where from here #1: Decentralising the Reserve
Ideally, we keep Celo in a lane of regulatory compliance where the protocol and cStables are afforded differentiated treatment as decentralised items. Decentralisation of reserve management helps with this. I will post shortly with a proposal on that matter.

Where from here #2: Getting natural backed capital into the reserve"
This is critical for the Celo mission. Further, hopefully natural capital assets are less volatile (relative to fiat) than BTC or ETH, and so this would improve reserve collateral quality. This will be a challenge but I’m hopeful the Climate Collective CGP will make good progress.

Where from here #3: Fundamentally, how do we safely collateralise fiat denominated cStables with volatile assets?"
This requires continued thought (including ideas in Mento 2.0), but might include:
a. Having a black-start procedure (i.e. some guidelines around what would happen if the reserve does become undercollateralised).
b. Potentially having a deposit guarantee scheme up to some amount (e.g. each phone-verified wallet) is guaranteed by the reserve up to a certain value.
c. Limiting minting of stables if the reserve collateralisation ratio goes below a certain limit.

[John.Fletcher]

So what happens if crypto falls 80+ % before those natural assets are in place? Also, these natural assets which are less volatile… which ones are you thinking of specifically? I would like to see a chart so see how volatile they are exactly.

[John.Fletcher]

@Pinotio.com

“what will outsiders think if we add USDC or more DAI”

What do you reckon outsiders think of Celo betting the savings of vulnerable people in developing countries on the value of bitcoin and other massively volatile crypto assets?