A major stablecoin issuer is formulating an intricate plan to ensure it always remains beyond the reach of centralised authority after US regulators froze USDC (USDC-USD) funds without warning.
In early August, OFAC swooped on the crypto "mixer" Tornado Cash after allegations that it was used for illicit transactions, such as those by Pyongyang's infamous hacking outfit, the Lazarus group.
Real world assets and MakerDao
The move by OFAC led to cries of indignation from crypto-proponents as the ability to function autonomously and beyond the reach of state authorities is a fundamental principle of the crypto gospel.
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The heightened threat of monetary censorship in the wake of the Tornado Cash affair has encouraged DAI (DAI-USD) stablecoin issuer MakerDao to try to become censorship resistant via collateralising their dollar peg with real-world assets as opposed to exposure to USDC.
MakerDAO founder Rune Christensen sees the OFAC crackdown as a sign that regulators are advancing towards “an eventual zero tolerance for anything that doesn’t give full control and surveillance powers to the state”.
He added that the stablecoin issuer needs to prepare for "a significant deterioration of regulatory security alongside a global economic and social decline".
So, MakerDAO has rolled out a high-risk "end-game" strategy where the DAI stablecoin could eventually unpeg from the dollar and become a free-floating asset backed by un-seizable real-world assets.
In a MakerDAO forum discussion entitled Endgame Plan timeline to free floating Dai Christensen said: "The Endgame Plan assumes that at a point in the future there will be a severe crackdown on the use of real-world assets in crypto, and anything that can be seized by global powers will be at serious risk of seizure through legal means."
Currently, the MakerDao-issued stablecoin DAI is backed by reserves that are made up of about 50% USDC, with the second half containing ethereum (ETH-USD) and other less centralised cryptos.
Incorporating real-world assets into the MakerDao reserves will open up access to a completely new and much larger market, that of traditional finance, and expand the DAI stablecoin's reach beyond the narrow corridors of decentralised finance (DeFi).
The current total cryptocurrency market capitalisation is hovering above $1tn (£860bn). This is dwarfed by traditional markets, such as the global fixed income at $199tn, global equities are $125tn, and global real estate at approximately $326tn.
MakerDao has estimated that onboarding real-world assets would reduce the protocol’s exposure to USDC by $3.4bn, or 20% of the total MakerDAO collateral that currently underpins DAI.
Allowing these real-world assets would give the stablecoin issuer a much larger balance sheet. But they would also make operations slower and less flexible as tokens deployed on the Ethereum blockchain are simpler and more liquid when compared to onboarding mortgages, renewable energy project loans, and carbon credits.
"When times are bad, crypto assets are liquidated seamlessly while real-world assets may enter a complicated process involving special servicing, courts, receivers and investment banks," said TJ Ragsdale, a member of the MakerDAO community.
He added: "Depending on the jurisdiction in which the asset is located, receivership and liquidation processes may look completely different. Whereas ETH, WBTC (BTC-USD), and LINK (LINK-USD) are all liquidated via the same, predictable mechanism, mortgages in Pennsylvania, consumer invoices in the Netherlands, and BNPL receivables in Indonesia behave drastically differently during a down market."
What is Tornado Cash?
Tornado Cash is a prominent cryptocurrency mixer, which disguises the senders and receivers of blockchain transactions.
Approximately 3.2 million ETH ($3.5bn) worth of clandestine transactions have been funnelled through Tornado Cash since its launch in August 2019.
The US Treasury blacklisted Tornado Cash in August, saying it was going after criminals who had used the service to launder more than $7bn worth of virtual currency since 2019.
What is MakerDao?
MakerDAO enables the generation of Dai stablecoin cryptocurrency. It has a market cap of around $6.5bn, and is ranked as the fourth most traded stablecoin in the world.
DAI has one-to-one parity with the greenback, which allows it to function within the crypto-sphere as a stablecoin.
Stablecoins are a stalwart of the crypto ecosystem, often used to park profits when bitcoin and ethereum are volatile.
The wider implications
The threat of censorship could spread to the very foundations of the Ethereum blockchain, the proof of stake consensus mechanism that will verify transactions after the upcoming Ethereum 'merge'.
James Key, CEO and founder of Autonomy Network told Yahoo Finance UK that the Tornado Cash blacklisting showed how the US government has a significant de facto influence on crypto, significantly reducing decentralisation.
He described the threat of censorship as creeping beyond the confines of centralised stablecoin issuers as it only takes a single ethereum miner or validator to include a Tornado Cash transaction in a block to become implicated in a sanctions violation.
Key said the implicit fear of regulatory action was enough to make Ethereum network miners or validators fall in line with the wishes of centralised authority.
"Even if OFAC never explicitly goes after a validator, the fear alone will cause validators to take action and block sanctioned transactions," he said.
OFAC will be looking to observe the NFT sector, which could become an avenue for money laundering that could overtake that which already exists in the traditional art world, according to Key.
He added that OFAC would now be scrutinising other mixing services and decentralised cryptocurrency exchanges or any place where there are pools of capital.
As the threat of sanctions threat escalates, stablecoin issuers are now at a crossroads as to which way they should progress.
Circle, the issuer of USDC, seems to be comfortable with working in close association with US regulators. However, this may cause alarm amongst the purists who seek full decentralisation and complete separation of the blockchain from any interference from a centralised authority.
The challenge for stablecoin issuers that choose to free themselves of these constraints is how to expand their market and introduce real-world assets that are overseen by real-world jurisdictions and legacy forms of governance and legal frameworks.