I’m increasingly skeptical of the economic viability of pegged asset protocols.
The issue is that decentralized custody - a requirement for such protocols - is an inherently low margin business and won’t provide enough returns to nodes to sufficiently incentivize security.
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The issue is that decentralized custody - a requirement for such protocols - is an inherently low margin business and won’t provide enough returns to nodes to sufficiently incentivize security.
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Fundamentally nodes securing pegged assets must have more at stake than the assets they’re custodying.
So if nodes custody $1 billion they must have more at stake than $1 billion otherwise they’d just steal the assets they’re custodying.
So if nodes custody $1 billion they must have more at stake than $1 billion otherwise they’d just steal the assets they’re custodying.
The above is why many of these protocols such as Ren and Keep have overcollateralizion requirements - it’s necessary for security in an environment where you can’t rely on trust.
The issue boils down to incentivizing those nodes to put up enough stake to secure assets custodied.
The issue boils down to incentivizing those nodes to put up enough stake to secure assets custodied.
As mentioned previously the economics of custody are poor.
Coinbase for example only receives 50bps annualized for custodying assets.
For traditional finance custodians like Bank of New York Mellon it’s more than an order of magnitude lower.
Coinbase for example only receives 50bps annualized for custodying assets.
For traditional finance custodians like Bank of New York Mellon it’s more than an order of magnitude lower.
The difference however is that clients of traditional custodians can rely on a legal system to keep their assets secure.
So we don’t need BNY Mellon to have $37 trillion at stake to properly secure their $37 trillion in assets under custody. That would be ridiculous.
So we don’t need BNY Mellon to have $37 trillion at stake to properly secure their $37 trillion in assets under custody. That would be ridiculous.
So with this in mind overcollateralized decentralized custodians face a serious challenge.
How can they attract enough capital when realistically they’re only returning <1% to nodes per year into perpetuity?
How can they attract enough capital when realistically they’re only returning <1% to nodes per year into perpetuity?
The model doesn’t scale easily, it’s just too capital inefficient.
You can’t just expect the staking token to be worth enough without requisite yield.
You can’t just expect the staking token to be worth enough without requisite yield.
We can turn to the centralized custodians once again for insight.
Even without the overcollaterallization requirements, centralized custodians recognize the unattractiveness of their business.
This leads them to enter new and adjacent markets and is why we see custody in crypto often paired with businesses such as exchange and staking.
This leads them to enter new and adjacent markets and is why we see custody in crypto often paired with businesses such as exchange and staking.
It is likely that doing the same may offer the only scalable model for decentralized custody under the constraints of the high capital requirements needed.
Cross-chain liquidity protocols like @THORChain have taken this path to decentralized custody by pairing custody with exchange, lending, and synthetic assets.
The idea is that the combination of those will provide sufficient returns to incentivize nodes to stake enough capital.
The idea is that the combination of those will provide sufficient returns to incentivize nodes to stake enough capital.
https://twitter.com/ryanwatkins_/status/1404795233997557770
So in short, cross-chain liquidity protocols are not only a superset of decentralized custodian protocols, but potentially may offer the only scalable way to do decentralized custody.
Perhaps pure play decentralized custodian protocols have some tricks up their sleeves that I‘m not seeing, so I won’t write them off as not working, but that’s just how I see the game today.
P.S - IBC works well as it can be established bidirectionally between chains without introducing new trust assumptions. But it doesn’t work for legacy chains like Bitcoin - the crown jewel asset people want to peg on other chains. messari.io/article/cosmos…
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