After multiple disasters and baptisms, is it the golden age for decentralized stablecoins?

Is it now the golden age for decentralized stablecoins after numerous disasters and tests?

Author: Ignas Translation: Luffy, Foresight News

Do you hold stablecoins? If so, which ones do you hold? What do you use them for? Do you put them into DeFi yield activities, or just hold them and wait for a dip to buy?

Perhaps you have converted stablecoins into fiat currency to avoid associated risks. This is understandable, especially when one of the major stablecoins, USDC, has experienced severe temporary deviations. Or maybe you have chosen fiat currency because it currently offers higher yields than blue-chip DeFi protocols.

In the bear market of the crypto market, the total market value of stablecoins has dropped from a historical high of $200 billion to the current $126 billion, which is not surprising.

But don’t be afraid. The stablecoin market is becoming more and more fascinating, and the founder of Synthetix said, “We are entering the golden age of decentralized stablecoins.”

Are you curious about what he meant by this statement? Let’s break it down in detail.

Which stablecoin is the safest?

This is the most important question because you don’t want to wake up one day and find your stablecoins have dropped by 50%.

Fortunately, the nonprofit organization Bluechip released an economic security rating for top stablecoins this week. The safety rating takes into account the overall performance of stablecoins and provides multidimensional information: stability (S), management (M), implementation (I), decentralization (D), governance (G), and externalities (E).

In the Bluechip evaluation model, the safest stablecoins are BUSD, LianGuaiXG, GUSD, and Liquity’s LUSD. This means that LUSD is the economically safest decentralized stablecoin, even safer than USDC.

This is not surprising. During the severe deviation event of USDC in March, LUSD played the role of a safe haven.

Interestingly, other DeFi stablecoins are also within the scope of evaluation, with DAI and RAI receiving a B+ rating, while USDD is rated F.

Tron’s USDD receives an F rating because its reserves are composed of TRX (69%), BTC (29%), and TUSD (2%). However, Bluechip does not consider the collateralization ratio of TRX. The collapse of Terra/Luna illustrates the huge hidden risks of native collateral.

If you are curious about the survey results, here is a brief summary of the selected stablecoin report:

  • Binance USD ERC-20 (Rating: A): This stablecoin is issued by LianGuaixos and is considered safe for public use. Although the issuance of BUSD was stopped by NYDFS in 2023, its support has not been affected.

  • Liquity USD (Rating: A): LUSD is part of the Liquity Protocol and is a highly decentralized stablecoin. It is controlled by code rather than a single entity, which is a testament to its security. However, please note that there are risks associated with smart contracts and oracles, so exercise caution when purchasing LUSD worth more than $1.

  • USD Coin (Rating: B+): USDC is one of the safest stablecoins, with reserves including short-term U.S. Treasury bonds and cash deposits. It has wide applicability and can improve its rating by proving its bankruptcy isolation reserves and incorporating a redemption schedule into its terms of service.

  • DAI (Rating: B+): DAI is the oldest on-chain stablecoin primarily backed by centralized assets. Nonetheless, it is considered safe and ideal for users seeking permissionless protocols.

  • Rai Reflex Index (Rating: B+): RAI is a decentralized stablecoin with a floating price not pegged to any fiat currency. Despite being an experimental stablecoin, it has proven to be a reliable low-volatility alternative to traditional stablecoins. It is backed by ETH collateral and is suitable for users who want decentralized and censorship-resistant stablecoins.

  • Tether (Rating: D): Although USDT is the oldest and largest stablecoin, it has transparency issues. It is suitable for institutional users, high-net-worth individuals, and advanced traders who have direct access to redemption mechanisms.

  • Frax (Rating: D): FRAX has a tight peg and performs well under market pressure, but concerns arise from its partial collateralization mechanism and reliance on centralized assets. It is suitable for risk-seeking yield farmers and liquidity providers who can handle protocol complexity.

  • USDD (Rating: F): USDD is managed by Tron DAO Reserve and is similar to the failed UST stablecoin. Due to concerns about its collateral, as only 50% of its supply is backed by non-TRX collateral (primarily Bitcoin), it is advised not to use it.

You may wonder, what does this security ranking have to do with the golden age of decentralized stablecoins?

Indeed, there is a connection because the subsequent content will include experimental DeFi stablecoins that either become the next big thing or collapse completely.

For example, just a year ago, I wrote an article about algorithmic stablecoins like USDD, USDN, and CUSD. A few months later, USDN unpegged and was rebranded as another VOLATILE token.

It is important to remember the importance of fund security. Let’s see what makes DeFi stablecoins so exciting.

Lybra: Challenger to LUSD

Below are the top 10 stablecoins ranked by market capitalization. Which one left the deepest impression on you?

First, USDT occupies an astonishing 66% of market share, even though it has been rated as “D” by Bluechip due to its lack of security. Second, this month only USDT and LUSD have seen an increase in market capitalization. All other stablecoins have experienced a decrease, with some experiencing a significant decline.

Ranked after the top 10 is eUSD, a stablecoin launched by Lybra Finance.

Interestingly, Lybra is a fork of Liquity and accepts stETH as collateral, while Liquity only accepts ETH as collateral. Thanks to stETH, eUSD holders can earn an annual interest rate of 7.2%.

The return rate of eUSD is higher than that of stETH because eUSD can be generated with a 159% over-collateralization rate using stETH.

But this also brings a potential issue: the decoupling of stETH, as Lybra uses the ETH:USD price feed from Liquity.

Another issue with eUSD is that the returns are distributed through rebase, which means you can earn more eUSD tokens based on the APY rate. To address these issues, Lybra has now launched v2 and another new stablecoin: peUSD.

The main upgrades of v2 include:

  • Full-chain functionality: peUSD is the full-chain version of eUSD (via LayerZero), allowing holders to use their stablecoin across different chains

  • Minting with multiple collateral: peUSD can be directly minted using non-rebase LSTs, such as Rocket Pool’s rETH, Binance’s WBETH, or Swell’s swETH. The returns accumulate through the underlying LST, and the value increases even if peUSD is spent.

  • Continuous earnings: When eUSD is converted to peUSD, users can continue earning interest from their eUSD collateral, even if they spend peUSD.

  • Usage in DeFi activities: peUSD is not a rebase token, so it can be used more widely in the crypto ecosystem.

You can experience v2 on the Arbitrum testnet.

Overall, eUSD poses the biggest threat to LUSD, but there are also other potential contenders, such as Raft and Gravita.

However, Liquity will not sit idly by and is organizing a counterattack.

Liquity v2: A Standalone New Product

The beauty of Liquity lies in its simplicity. You can use ETH as collateral to mint LUSD at 0% interest rate, with only a one-time borrowing fee of 0.5%.

Liquity was initially designed as an alternative to heavily governed DAI. LUSD has the lowest level of governance, and its smart contracts are immutable (not upgradeable) – which is useful for economic security but not for growth.

To keep up with competitors, Liquity has also launched v2 with support for LST. However, “condename v2” will be a completely new and different product rather than an upgrade of the original one.

Liquity v2 aims to solve the “stablecoin trilemma” of decentralization, stability, and scalability through a reserve-backed delta-neutral hedging model.

It is complex, but its workings can be simplified as follows:

Suppose Alice has 1 ETH worth $2000. She can deposit it into Liquity v2 and receive 2000 v2 LUSD. Now, Liquity holds her ETH, and Alice has 2000 v2 LUSD. If the price of ETH falls below $2000, Alice’s v2 LUSD will no longer be fully backed, exposing her to the risk of a downward price spiral.

To address this issue, Liquity v2 introduces:

Principal protection leverage: Users can hold leveraged positions (betting on future prices) and only bear the risk of the premium paid, not the principal.

Secondary market: Users can sell these protected positions to others. If a position is not purchased, Liquity will subsidize it to ensure that all positions are bought and the subsidy remains in the system.

If you are still confused, please refer to this Thread or blog post for a more detailed explanation.

Liquity v2 has multiple impacts, but the goal is to provide everything for DeFi users: principal protection leverage, mining revenue opportunities, and trading opportunities in the secondary market. v2 is expected to be launched in 2024.

Synthetix sUSD: Moving towards v3

As mentioned earlier, Synthetix founder Kain is bullish on decentralized stablecoins. Want to know why?

That’s because Synthetix v3 is being gradually rolled out. This is a great timing because despite the increasing trading volume of Kwenta, the market cap of sUSD has been declining, currently at $98 million.

And v3 might bring a turning point.

Synthetix is one of the most complex DeFi protocols currently. However, the core of the Synthetix ecosystem is the sUSD stablecoin, which is backed by SNX.

You can read Thor Hartvigsen’s article on how Synthetix v3 will impact DeFi. v3 is addressing two key pain points for sUSD minters:

  • Multiple Collaterals: v3 no longer restricts collateral and allows any collateral to support synthetic assets (v2 only allows SNX). This will increase the liquidity of sUSD and the markets supported by Synthetix.

  • Synthetix Loans: Users can now provide collateral to the system to generate sUSD without facing debt pool risks or incurring any interest or issuance fees.

If you have tried minting sUSD, you know how important these changes are! sUSD now has the potential to compete with other mature stablecoins like FRAX, LUSD, or DAI.

MakerDAO: A Revenue Generating Machine

Maker is now in its final stage (please check my Thread for more details). One key point to remember is that if the regulatory environment changes, Dai may even decouple from the US dollar.

Currently, Maker seems to be entering a frenzy:

  • MKR has increased by 66% in the past 30 days, with Maker’s founder continuously buying MKR.

  • Due to the reactivation of the DAI savings rate, DAI has brought a return of 3.49% to its holders.

  • SLianGuairk protocol is a fork of Aave, focusing on DAI, with TVL currently reaching $75 million.

  • Maker has reduced its dependence on USDC from 65% in March to the current 17%.

  • Maker is currently ranked third in terms of revenue generation: higher than Lido, Synthetix, and Metamask.

Not everything is rosy. A consumer electronics company owes MakerDAO $2.1 million in debt. However, with a Bluechip B+ rating, a 3.49% DSR, and growing revenue, Maker’s DAI is experiencing a recovery after the catastrophic event of USDC decoupling a few months ago.

Frax v3: Giving up on USDC?

Frax received a D (Unsafe) rating in the Bluechip assessment. The report states that FRAX carries risks because some of its collateral is the volatile FXS token, heavily relies on centralized assets (USDC), and the core team has control over voting rights and monetary policy.

It is suitable for risk-seeking yield farmers and liquidity providers who can handle the complexity of the protocol.

Similar to DAI, FRAX also lost its peg to the US dollar during the USDC decoupling period and seems to have learned its lesson.

Sam Kazemian, the founder of Frax, shared in a Telegram chat that v3 is expected to be launched within 30 days.

There are few details about v3, but according to DeFi Cheetah, v3 will be “a completely different system that does not rely on fiat currencies, including USDC.”

If this is true, then v3 has undergone a 180-degree transformation compared to v2.

Sam previously stated that their long-term goal is to obtain a primary account with the Federal Reserve, which will hold US dollars and directly trade with the Federal Reserve, making FRAX the stablecoin closest to risk-free dollars. This will allow FRAX to break free from USDC collateral and expand its market value to trillions of dollars.

I suggest following DeFi Cheetah for the latest details on Frax.

GHO: A New Player with Unlimited Potential

Despite the hype before the release of GHO, its growth has been steady. While Aave has a total locked value (TVL) of up to $5.8 billion, GHO’s market value is only $8 million.

This may be due to three reasons. First, GHO was just launched 11 days ago, so it’s still early. Second, integrating GHO into multiple DeFi protocols will take some time, but growth will accelerate soon. Third, it’s currently a bear market.

Let’s take a look at how GHO works:

  • Uses overcollateralization to maintain the value of the stablecoin.

  • Only minted/burned by approved coordinators (such as the Aave protocol itself, but potentially more), with each coordinator having a quota.

  • Generates interest when supplied to a liquidity protocol, with the interest rate set by Aave governance (currently 1.51%).

  • Cannot be supplied to the Aave Ethereum market, which is important for security.

  • Destroyed after repayment or liquidation, with the interest going to the Aave DAO treasury.

  • Interest rate determined by Aave governance rather than dynamically adjusted by supply and demand.

  • Provides a borrowing discount mode (30% interest discount) to stkAave holders.

  • Price stabilized at $1, set by the Aave protocol (without oracles), with arbitrageurs restoring the peg when the price deviates from $1.

GHO brings new revenue streams to the Aave DAO. With the current borrowing interest rate set at 1.5%, if it reaches a market value equivalent to LUSD, GHO could bring $4.4 million in revenue to the Aave DAO.

You can delve deeper into how it works in this post by Moonshot21. However, what truly sparked my interest in GHO is its potential for development.

Aave DAO has the option to use real-world assets, government bonds, or other collateral to mint GHO, or even adopt a partially algorithmic approach similar to the current FRAX model.

The potential of GHO is enormous, but its actual execution still remains to be observed.

crvUSD: The Stablecoin for True DeFi Professionals

I believe crvUSD is the most difficult stablecoin to understand.

crvUSD’s unique features include LLAMA, Soft Liquidation, and “De-Liquidation”. Here’s a brief summary for you:

  • crvUSD’s uniqueness lies in its use of a special AMM algorithm called Loan Liquidation AMM (LLAMA) to achieve a soft liquidation mechanism.

  • In typical DeFi lending protocols, if the value of the borrower’s collateral falls below a certain threshold, it will be forcibly liquidated, potentially causing significant losses for the borrower.

  • On the other hand, LLAMA gradually converts depreciating collateral into crvUSD, enabling soft liquidation that helps maintain the peg of crvUSD and protects borrowers from losing all of their collateral during severe market downturns.

  • However, if the price of the collateral continues to plummet and soft liquidation cannot cover the losses, a forced liquidation will occur.

  • If the price of the collateral rebounds, LLAMA reverses this process by converting crvUSD back into the original collateral, in a process called “De-Liquidation”.

  • To maintain the peg of crvUSD, Curve uses the PegKeeper contract, which can mint and burn crvUSD tokens as needed to ensure the price remains around $1.

The above mechanism provides a more flexible approach to handling collateral liquidation events, offering a new and interesting way to exit positions, making crvUSD unique in DeFi.

The operation of this game is as follows:

  • Borrow crvUSD using ETH or LST

  • ETH price increases: If the value of ETH rises, your collateral will increase, potentially allowing for more crvUSD borrowing.

  • ETH price decreases: If the price of ETH drops, LLAMA will gradually convert your ETH collateral into crvUSD, maintaining a safe collateral ratio.

  • Forced liquidation: If the price of ETH drops significantly, a forced liquidation will occur.

  • Lower liquidation fees: Compared to other protocols, the soft liquidation mechanism of crvUSD may provide lower liquidation fees.

Due to lower fees and gradual liquidation, this is a more efficient way to exit positions compared to borrowing from other lending protocols. Let’s hope the pegged exchange rate of crvUSD can be maintained.

Final Thoughts: The Golden Age of Decentralized Stablecoins?

Innovation goes beyond the aforementioned stablecoins, and some lower market value projects offer many innovative methods:

  • Beanstalk: a unique stablecoin that uses credit instead of collateral to maintain a peg of $1. It dynamically adjusts its Bean supply, Soil supply (loan amount), and maximum interest rate through its proprietary Sun, Silo, and Field mechanisms. Learn more about it here.

  • Reserve Protocol: allows the creation of asset-backed stablecoins, generating income and overcollateralization without permission. Anyone can create a stablecoin backed by a basket of ERC20 tokens, including eUSD backed by stablecoins deposited in Aave and Compound v2.

  • Reflexer’s RAI: has received a B+ rating from Bluechip. The value of RAI is determined by supply and demand and continuously adjusted according to its issuance protocol. Unlike traditional stablecoins, the target exchange rate of RAI varies based on market conditions, establishing a balance between RAI generators and holders.

Will recent changes usher in a new golden age for DeFi stablecoins?

During the UST collapse, the reputation of DeFi stablecoins was first affected, followed by the decoupling of USDC, exposing the reliance of DAI, FRAX, and all DeFi on USDC.

However, Maker’s recent shift away from USDC towards more censorship-resistant stablecoins, as well as the possibility of Frax v3 transitioning from USDC to more decentralized collateral, can be seen as steps in the right direction.

In addition, Liquity v2 offers a solution to the blockchain trilemma, providing a way to scale stablecoins, as the current LUSD design compromises on scalability.

The upgrade of Synthetix sUSD v3 will also enhance the utility of sUSD outside the Synthetix ecosystem, as it will be minted with multiple collateral types, and sUSD minters will no longer be exposed to the debt pool.

Lastly, the launch of crvUSD and GHO presents a new strategy to maximize DeFi yields beyond traditional financial yields, and can even help DeFi enthusiasts sell at the top during the next bull market.

Individually, these changes may seem small, but when considering the broader DeFi landscape, they indeed inspire hope for a true golden age of decentralized stablecoins.