Decentralized Stablecoins: A Critical component of the cryptocurrency ecosystem 2/3

Part 2: New over-collateralized USD stablecoins in 2023

In a previous article on decentralized stablecoins, we introduced MakerDao’s Dai and Liquity’s LUSD, early stablecoin projects. In the second half of 2023, a new batch of stablecoin projects emerged, mostly related to LSD or issued by well-established DeFi protocols.

1. Curve crvUSD

crvUSD is a stablecoin issued by Curve, generated through over-collateralization of assets like wbtc, wstETH, and sfrxETH, and pegged to the US dollar. The core design of crvUSD is the Lending-Liquidating AMM (LLAMMA) algorithm, which liquidates by phasing collateral (e.g., ETH) and the stablecoin (crvUSD) into each other.

• Band Rage Adjustment: When users deposit ETH to mint crvUSD, they can adjust the so-called Band Rage, a price range for managing the automatic conversion of assets and potential liquidation. When loans are created, LLAMMA converts the user’s collateral into LP positions in the AMM, spreading the collateral across the band range.
• LLAMMA Liquidation Mechanism: Each band has a price range for the asset. If the price oracle is within this range, that particular band of collateral is likely to be liquidated. This mechanism allows ETH to remain as ETH when its price rises and converts to crvUSD when it falls to the lower limit of the Band Rage. In the middle price range, the assets are passively managed: partially converting to crvUSD as the ETH price drops, and vice versa when it rises.
• Continuous Liquidation: Unlike stablecoins like Dai, crvUSD’s liquidation is gradual, minimizing losses during market fluctuations and providing a more flexible liquidation window through the LLAMMA algorithm.
• Innovation in Liquidation Mechanism: The LLAMMA liquidation process is akin to a reverse mechanism of Uniswap V3. In Uniswap V3, the higher the ETH price, the more USD in the AMM pool. In LLAMMA, the lower the ETH price, the more USD in the pool, as ETH needs to be sold for liquidation.

The blue line represents the oracle price, and the red line represents the LLAMMA AMM price. The design of LLAMMA’s AMM is such that the AMM price (red) falls/rises faster than the price in Uniswap (blue). When the ETH price falls in Uniswap, the AMM price in AMM falls faster, creating opportunities for arbitrageurs to repay crvUSD and exchange ETH collateral.

The LLAMMA algorithm allows LPs to set their collateral liquidation price within a certain range. Additionally, liquidation is gradual, avoiding complete loss of collateral at a specific price point and gradually regaining collateral as the market rebounds, albeit at a cost.

crvUSD maintains its stablecoin price stability and liquidity through multi-strategy pool liquidity aggregation and collaboration with other DeFi projects. Moreover, crvUSD can generate returns through trading, lending, and liquidity mining, incentivizing more users to participate in its ecosystem.

Peg Mechanism

crvUSD employs a series of mechanisms to maintain its 1:1 peg to the US dollar, contributing to its stability and reliability.

1. Over-Collateralization
   The foundation of crvUSD is always maintaining over-collateralization, ensuring that the assets collateralized always exceed the value of minted crvUSD, providing ample safety buffer for the system.
2. Peg Keepers Role
   crvUSD relies on Peg Keepers to maintain its peg. These Keepers are authorized to mint or burn crvUSD in response to market conditions, keeping its value close to 1 dollar.
   Each Peg Keeper caters to specific Peg Keeper pools covering crvUSD paired with USDC, USDT, TUSD, USDP, etc. Their task is to maintain balance in these pools through trading while profiting.
   When crvUSD pool balances are low, Peg Keepers can mint new crvUSD and trade it into the relevant pools; when balances are high, they can buy back and destroy crvUSD.
   When crvUSD’s price is above 1 dollar, Peg Keepers release uncollateralized crvUSD to increase market supply. Conversely, when the price is below 1 dollar, they destroy minted crvUSD to reduce supply.
3. Automatic Borrowing Rate Adjustment
   The borrowing rate for crvUSD is influenced by its price and the proportion of PegKeeper debt. When the price is above 1 dollar, the rate is reduced to encourage borrowing and increase market supply; when below 1 dollar, the rate increases to encourage loan repayment and reduce supply. A higher proportion of PegKeeper debt indicates greater future adjustment capability, hence lower borrowing rates.

Upon its launch, crvUSD was widely promoted and utilized in the entire curve war ecosystem. Its unique liquidation algorithm is more LP-friendly, and its soft liquidation algorithm results in an actual average liquidation price lower than that of AAVE, Compound, or Spark under the same price movement conditions, enhancing LPs’ capital utilization rate. Curve itself, including protocols like Convex in the CRV ecosystem, based on crvUSD, launched attractive yield farming pathways, drawing substantial funds to mint crvUSD for various purposes. By mid-December 2023, the issuance of crvUSD had reached 120 million. The ultimate height crvUSD can achieve depends not only on more ecosystem protocols participating in yield farming to attract more funds to crvUSD but also on crvUSD’s expansion in value exchange.

2. Aave GHO

GHO is pegged to USD and represents a decentralized, multi-collateral stablecoin. Users or borrowers can mint GHO tokens using their collateral provided on the Aave protocol.

The interest rate model for GHO is straightforward, determined in a decentralized manner by the DAO. While this method may be less efficient, it retains the flexibility of the borrowing rate model, allowing for the implementation of any interest rate strategy deemed appropriate by the community in the future.

GHO introduces the concept of Facilitators. These entities (protocols, organizations, etc.) have the ability to generate (and destroy) GHO trustlessly. Facilitators are foundational to the system, which can be other protocols or entities whitelisted. Facilitators are appointed through Aave’s governance voting. Each Facilitator is allocated to a Bucket, representing the maximum amount of currency they can mint. Theoretically, each Facilitator can be entirely distinct, having its own risk profile, liquidity, and technical characteristics. Aave protocol itself is actually the first Facilitator of GHO.

GHO also includes a discount strategy mechanism not found in other protocols. The initial discount strategy allows participants in the safety module (stkAAVE holders) to receive a discount on GHO borrowing rates. The rate of discount is set per stkAAVE provided, ranging from 0% (no discount) to 100% (full discount). Since stkAAVE holders can mint GHO at a discounted rate, this means they will pay a lower interest rate for the GHO they borrow. This borrowing discount mechanism incentivizes borrowers to stake AAVE, ultimately reducing the cost for AAVE stakers to mint GHO.

The interest generated from borrowing GHO is sent 100% to the DAO treasury, bringing additional revenue to Aave DAO. The development of GHO can be seen as an additional revenue-generating function for the protocol, operating independently in the backdrop of the protocol’s core business. All revenue generated is directly captured by the protocol and flows back to its financial department.

Since GHO currently has no practical use and there are no Yield Farming paths to provide additional income, its issuance is quite limited. As of mid-December 2023, it’s less than 35 million. Additionally, since its issuance, GHO has been significantly off its peg point. Although currently increasing the GHO borrowing rate has brought the price closer to its anchor point, using interest rates alone to regulate its peg mechanism may need to be proven over a longer-term timeframe.

3. Lybra eUSD

eUSD, launched by Lybra, is a fully decentralized, yield-generating stablecoin. It’s backed by Ethereum (ETH) and staked ETH (stETH), allowing users to mint eUSD by depositing ETH or stETH as collateral, with a minimum collateralization ratio of 150%.

eUSD can be redeemed at any time for $1 worth of any collateral. When minting eUSD, users can choose to become Redemption Providers. If they do, any eUSD redemption might be fulfilled from their collateral, and their debt decreases accordingly. Redemption Providers earn a 0.5% redemption fee paid by redeemers. Additionally, if they also participate in LBR (the governance token of Lybra) staking, they can earn an extra 10% yield.

eUSD’s yield includes minting yield, holding yield, and mining yield. Holding yield is realized through the reBase mechanism. When users mint eUSD, they lose their claim to stETH income, replaced by reBased eUSD income, with a portion taken as protocol fees.

When eUSD’s price deviates from its pegged rate, users can arbitrage in two ways:

• Mint more eUSD as collateral and sell it to increase market supply.
• Buy eUSD from the market to exchange for $1 worth of collateral.

Lybra V1, after launch, revealed certain mechanism flaws, primarily that eUSD inherently tends to de-peg upwards due to its yield-generating nature, attracting arbitrageurs to buy eUSD. Therefore, Lybra released V2, introducing eUSD price equilibrium mechanisms. This includes introducing Curve’s 3pool, rewarding USDC instead of eUSD when eUSD is at a premium. Moreover, to participate in eUSD mining, one must hold LBR-ETH LP; otherwise, the yield decreases. Lybra V2 further introduced the concept of peUSD to resolve the contradiction between eUSD being both an interest-bearing and circulating asset. Users use Rebase LST to mint the interest-bearing asset eUSD, while Non-Rebase LST is used to mint zero-interest peUSD, exchangeable 1:1 with eUSD. Thus, peUSD replaces eUSD’s circulation attribute, allowing eUSD to create specific scenarios with its interest-bearing attribute, such as DAO treasuries, idle fund management, etc. The collateral expanded from stETH to other LST assets.

eUSD currently has a circulation of around 130 million, while peUSD’s issuance is less than 30 million, totaling about 160 million (as of mid-December 2023), with the overall protocol TVL just over 300 million. However, since minting eUSD users forfeit staking income, which is counterintuitive to depositing stETH as collateral (depositing stETH is long ETH, while forfeiting staking income is short ETH), there’s an inherent contradiction, raising questions about its long-term incentives beyond farming income.

4. Prisma mkUSD

In Prisma, users can deposit LSTs like wstETH, rETH, sfrxETH as collateral and mint mkUSD at a 4% interest rate plus a 0.5% minting fee similar to LUSD, under the condition of maintaining a minimum collateralization ratio of 110%-120%. The current rate is decided by community voting.

mkUSD is pegged 1:1 to the US dollar and can be redeemed at any time for $1 worth of collateral. The collateral in the vault with the lowest collateralization ratio becomes the subject of redemption, reducing the vault owner’s debt post-redemption.

Prisma Finance, originating from Liquity’s source code, retains the concept of a stability pool. mkUSD holders can deposit mkUSD into the stability pool, which is used to liquidate vaults reaching the minimum collateralization ratio during a price drop in collateral, with the acquired LST distributed proportionally to stability pool LPs.

Prisma also adopts Curve’s veTokenomics, boosting the reward income of the stability pool or other LPs by locking governance tokens Prisma to obtain vePRISMA.

Currently, Prisma’s borrowing rate is the lowest in the mid to long term compared to others mentioned (mkUSD 4%+0.5% liquidation fee, Spark 5.53%, GHO 6.42% with dynamic adjustments, crvUSD’s lowest mint rate with ETH is 12.34% with dynamic adjustments). Additionally, its farming yield surpasses the interest on the issued stablecoin. This has led to mkUSD’s issuance rapidly reaching around 176 million dollars, outperforming crvUSD, GHO, and eUSD mentioned in this article.

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