Why is it said that DeFi stablecoins are entering a golden age?
Why are DeFi stablecoins in a golden age?
DeFi stablecoins are gradually breaking free from the shackles of history and entering a booming era.
Translation: Luffy, Foresight News
Do you hold stablecoins? If so, which ones do you hold? What do you use them for? Do you invest them in DeFi yield activities, or do you just hold them waiting for a buying opportunity at a dip?
Perhaps you have converted stablecoins into fiat currency to avoid the associated risks. This is understandable, especially when one of the major stablecoins, USDC, has experienced significant short-term deviations from its peg. Or maybe you have chosen fiat currency because it currently offers higher yields than blue-chip DeFi protocols.
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In the bear market of the crypto market, the total market value of stablecoins has dropped from its 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 has stated, “We are entering the golden age of decentralized stablecoins.”
Are you curious about what he means 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 to find that your stablecoins have dropped by 50%.
Fortunately, the non-profit organization Bluechip has 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).
According to 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 the evaluation, with DAI and RAI receiving a B+ rating, while USDD is rated F.
Tron’s USDD received 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 enormous risk hidden in native collateral.
If you are curious about the survey results, here is a brief summary of the selected stablecoin reports:
Binance USD ERC-20 (Rating: A): This stablecoin is issued by LianGuaixos and is considered safe for public use. Although NYDFS stopped issuing it in 2023, the support for BUSD 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 individuals, which is a manifestation of its security. However, please note that smart contracts and oracles also carry risks, so be cautious when purchasing LUSD worth more than $1.
USD Coin (Rating: B+): USDC is one of the safest stablecoins, with reserves including short-term US Treasury bonds and cash deposits. It has broad applicability and can improve its rating by proving bankruptcy isolation reserves and incorporating redemption schedules into its terms of service.
DAI (Rating: B+): DAI is the oldest on-chain stablecoin primarily backed by centralized assets. Nevertheless, 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): Despite being the oldest and largest stablecoin, USDT has transparency issues. It is suitable for institutional users, high-net-worth individuals, and advanced traders who can directly utilize its redemption mechanism.
Frax (Rating: D): FRAX has a close tie and performs well under market pressures, but concerns have been raised about 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 the fact that only 50% of its supply is backed by non-TRX collateral (mainly Bitcoin), it is not recommended to use it due to concerns about collateral.
You might be wondering, what does this security ranking have to do with the golden age of decentralized stablecoins?
There is indeed a connection, as the following content will include experimental DeFi stablecoins that either become the next big thing or completely collapse.
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 renamed to another VOLATILE token.
Remember that fund security is crucial, so let’s take a look at what makes DeFi stablecoins so exciting right now.
Lybra: Challenger to LUSD
Here are the top 10 stablecoins ranked by market capitalization. Which one impresses you the most?
First, USDT holds an astonishing 66% market share, even though it is rated as “D” by Bluechip due to lack of security. Second, only USDT and LUSD have seen an increase in market capitalization this month. All other stablecoins have seen a decrease, some of which have seen a significant decrease.
After the top 10, there is eUSD, a stablecoin launched by Lybra Finance.
Interestingly, Lybra is a fork of Liquity, which accepts stETH as collateral, while Liquity only accepts ETH. Thanks to stETH, eUSD holders can earn an annualized interest rate of 7.2%.
eUSD has a higher yield than stETH because eUSD can be generated with a 159% overcollateralization rate using stETH.
But this also brings a potential problem: the decoupling of stETH because Lybra uses Liquity’s ETH:USD price feed.
Another issue with eUSD is that the yield is distributed through rebase, meaning you can earn more eUSD tokens at the rate of APY. To address these issues, Lybra is now launching v2 and another new stablecoin: peUSD.
The main upgrades in v2 are:
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 collaterals: peUSD can be minted directly using non-rebase LSTs, such as Rocket Pool’s rETH, Binance’s WBETH, or Swell’s swETH. Earnings accumulate through the underlying LST, and even if peUSD is spent, its value increases.
Continuous yield: 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 is the biggest threat to LUSD, but there are also other potential players, such as Raft and Gravita.
However, Liquity will not sit idly by, it is organizing a counterattack.
Liquity v2: An Independent New Product
The beauty of Liquity lies in its simplicity. You can mint LUSD with ETH as collateral at 0% interest rate, with only a one-time borrowing fee of 0.5%.
Liquity was initially created as an alternative to heavily-governed DAI. LUSD has the lowest degree of governance, and its smart contracts are immutable (non-upgradable) – which is useful for economic security but not for growth.
To keep up with competitors, Liquity has also launched v2 which supports LST. However, “condename v2” will be a completely new and different product, rather than an upgrade to the original product.
Liquity v2 aims to solve the “stablecoin trilemma” of decentralization, stability, and scalability through a reserve-backed delta-neutral hedging model.
It’s complex, but its working principle can be simplified as follows:
Let’s assume Alice has 1 ETH worth $2000. She can deposit it into Liquity v2 and receive 2000 v2 LUSD in return. Now, Liquity holds her ETH and Alice owns 2000 v2 LUSD. If the price of ETH falls below $2000, Alice’s v2 LUSD will no longer be fully backed and will face the risk of a 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 risk.
Secondary market: Users can sell these principal-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’re still confused, check out this thread or blog post for a more detailed explanation.
The impact of Liquity v2 is manifold, 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 gradually being rolled out. This is a great timing because despite the growing trading volume of Kwenta, the market cap of sUSD has been declining and currently stands at $98 million.
And v3 could 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:
Multi-collateral: v3 no longer restricts collateral and allows any collateral to support synthetic assets (v2 only allowed SNX). This will increase the liquidity of sUSD and the markets supported by Synthetix.
Synthetix loans: Users can now provide collateral to generate sUSD without facing debt pool risk or incurring any interest or issuance fees.
If you have tried minting sUSD, you will know how significant these changes are! sUSD now has the potential to compete with other established stablecoins like FRAX, LUSD, or DAI.
MakerDAO: The revenue-generating machine
Maker is currently in its final stage (check out my Thread for more details). One key point to remember is that if the regulatory environment changes, Dai may even abandon its peg to the US dollar.
Currently, Maker seems to be entering a frenzy:
MKR has increased by 66% in the past 30 days, and the founder of Maker keeps buying MKR.
Due to the reactivation of 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 a current TVL of $75 million.
Maker has reduced its dependency on USDC from 65% in March to 17% now.
Maker is currently ranked third in terms of revenue generation: higher than Lido, Synthetix, and Metamask.
Not everything is rosy though. A consumer electronics company owes MakerDAO $2.1 million in debt. However, with a B+ rating from Bluechip, a 3.49% DSR, and growing revenue, Maker’s DAI is experiencing a recovery after the catastrophic event of USDC detachment a few months ago.
Frax v3: Abandoning USDC?
Frax received a D (Unsafe) rating in the Bluechip evaluation. The report states that FRAX carries risks as some of its collateral consists of volatile FXS tokens and heavily relies on centralized assets (USDC), with the core team having control over voting rights and monetary policy.
It is suitable for yield farmers and liquidity providers pursuing risks who can handle the complexity of the protocol.
Like DAI, FRAX also lost its peg to the US dollar during the USDC detachment period and seems to have learned its lesson.
Frax founder Sam Kazemian shared in a Telegram chat that v3 is expected to be launched within 30 days.
There are few details about v3, but DeFi Cheetah reported that v3 will be “a completely different system that does not rely on fiat currency, including USDC.”
If this is true, then v3 has undergone a 180-degree shift 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 transact 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 recommend following DeFi Cheetah for the latest detailed information on Frax.
GHO: A New Player with Unlimited Potential
Despite the hype before the launch of GHO, its growth has been steady. While Aave has a total locked value (TVL) of up to $5.8 billion, GHO has a market value of only $8 million.
This may be due to three reasons. First, GHO has only been launched for 11 days, so it’s still early. Second, it will take some time to integrate GHO into multiple DeFi protocols, but its growth will accelerate soon. Third, it is currently a bear market.
Here’s how GHO works:
It maintains the value of the stablecoin through over-collateralization.
It is minted/burned only by approved coordinators (such as the Aave protocol itself, but possibly more), with each coordinator having a quota.
It generates interest when supplied to liquidity protocols, with the interest rate set by Aave governance (currently 1.51%).
It cannot be supplied to the Aave Ethereum market, which is important for security.
It is burned after repayment or liquidation, with the interest going to the Aave DAO treasury.
The interest rate is determined by Aave governance rather than dynamically adjusted by supply and demand.
It offers a lending discount mode to stkAave holders (30% interest discount).
It aims to stabilize the price at $1, set by the Aave protocol (without an oracle), and arbitrageurs restore the peg when the price deviates from $1.
GHO brings new revenue streams to the Aave DAO. The current borrowing interest rate is set at 1.5%, and 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 its workings in this post by Moonshot21. However, what really sparked my interest in GHO is its development potential.
Aave DAO can choose to use real-world assets, government bonds, and other collateral to mint GHO, or even adopt partial algorithmic methods similar to the current FRAX model.
The potential of GHO is huge, but its actual execution remains to be observed.
crvUSD: The Stablecoin for True DeFi Professionals
I believe crvUSD is the most difficult stablecoin to understand.
The unique features of crvUSD include LLAMA, soft liquidation, and “de-liquidation”. Here’s a brief summary for you:
The uniqueness of crvUSD lies in its use of a special AMM algorithm called the Loan Liquidation AMM algorithm (LLAMA) to implement 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, which can result in significant losses for the borrower.
On the other hand, LLAMA gradually converts depreciating collateral into crvUSD, thereby conducting soft liquidation, which helps maintain the peg of crvUSD and protects borrowers from losing all their collateral during severe market downturns.
However, if the price of the collateral continues to fall significantly and soft liquidation cannot cover the losses, forced liquidation will occur.
If the price of the collateral recovers, LLAMA will reverse this action by converting crvUSD back to the original collateral, a process known as “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 way to handle collateral liquidation events, offering a new and interesting top-selling method that makes crvUSD unique in DeFi.
The operation of this game is as follows:
Borrow crvUSD using ETH or LST.
ETH price increase: If the value of ETH increases, your collateral will increase, potentially allowing for more crvUSD borrowing.
ETH price decrease: If the ETH price decreases, LLAMA will gradually convert your ETH collateral into crvUSD to maintain a safe collateral ratio.
Forced liquidation: If the ETH price drops significantly, forced liquidation will occur.
Lower liquidation fees: Compared to other protocols, the soft liquidation mechanism of crvUSD may provide lower liquidation fees.
Due to its low fees and gradual liquidation, this is a more efficient way to top-sell compared to borrowing through other lending protocols. Hopefully, the pegged exchange rate of crvUSD can be maintained.
Final Thoughts: The Golden Age of Decentralized Stablecoins?
Innovation goes beyond the aforementioned stablecoins, as some lower-market cap projects offer many innovative approaches:
Beanstalk: A unique stablecoin that maintains a peg of 1 USD using credit instead of collateral. It dynamically adjusts its Bean supply, Soil supply (loan amount), and maximum interest rate through its proprietary Sun, Silo, and Field mechanisms. Learn more here.
Reserve Protocol: Allows for permissionless creation of asset-backed stablecoins that generate yield and have over-collateralization. Anyone can create stablecoins backed by a basket of ERC20 tokens, including eUSD backed by stablecoins held in Aave and Compound v2.
Reflexer’s RAI: Rated B+ by Bluechip. The value of RAI is determined by supply and demand and continuously adjusted based on its issuance protocol. Unlike traditional stablecoins, RAI’s target exchange rate varies based on market conditions, establishing a balance between RAI minters and holders.
Will the recent changes usher in a new golden age for DeFi stablecoins?
The reputation of DeFi stablecoins took a hit with the collapse of UST, followed by the decoupling of USDC, exposing the reliance of DAI, FRAX, and all DeFi on USDC.
However, the recent shift by Maker towards more censorship-resistant stablecoins and the possibility of Frax v3 moving away from USDC towards more decentralized collateral can be seen as steps in the right direction.
In addition, Liquity v2 offers a solution to the trilemma of blockchain scalability, providing a way to expand 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 collaterals, and sUSD minters will no longer be exposed to the debt pool.
Finally, the launch of crvUSD and GHO presents a new strategy to maximize DeFi yield and surpass traditional financial yields, potentially helping DeFi enthusiasts sell at the top during the next bull market.
Individually, these changes may seem minor, but when considering the broader DeFi landscape, they do inspire hope for a true golden age of decentralized stablecoins.