DeFi is gradually breaking free from the shackles of history and entering an era of rapid development.
Written by: Ignas
Compiled by: Luffy, Foresight News
Do you hold stablecoins? If so, which ones do you hold? What do you do with them? Do you put them to work in DeFi yield-generating activities, or do you just hold them and wait for a dip?
Maybe you have converted your stablecoins to fiat to avoid the risks associated with them. This is understandable, especially when one of the most important stablecoins, USDC, has had a short-term serious depegging. Or, maybe you chose fiat because it now offers higher yields than blue chip DeFi protocols.
It is not surprising that amid the crypto bear market, the total market capitalization of stablecoins has fallen from an all-time high of $200 billion to the current $126 billion.
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? 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 your stablecoin is down 50%.
Fortunately, the nonprofit Bluechip released an economic security rating of the top stablecoins this week. The security score considers the overall performance of the stablecoin and provides information on multiple dimensions: stability (S), management (M), implementation (I), decentralization (D), governance (G), and externalities (E).
In the Bluechip evaluation model, the safest stablecoins are BUSD, PAXG, GUSD, and Liquity's LUSD. This means that LUSD is the most economically secure decentralized stablecoin, even safer than USDC.
This is not surprising. During the severe USDC decoupling incident in March, LUSD acted as a safe haven.
Interestingly, other DeFi stablecoins were also included in the assessment, with DAI and RAI receiving a B+ and USDD being rated an F.
Tron's USDD score is F because its reserves are composed of TRX (69%), BTC (29%), and TUSD (2%). However, Bluechip does not consider TRX's collateral ratio. The collapse of Terra/Luna illustrates the huge risks hidden in the native collateral.
If you’re curious about the findings, here’s a quick summary of the report on selected stablecoins:
Binance USD ERC-20 (Rating: A): This stablecoin is issued by Paxos and is considered safe for public use. Although NYDFS stopped issuing it in 2023, BUSD’s support is not 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 thought, which is a reflection of its security. However, please note that smart contracts and oracles also have risks, so be cautious when buying LUSD worth more than $1.
USD Coin (Rating: B+): USDC is one of the safest stablecoins, with reserves consisting of short-term U.S. Treasuries and cash deposits. It has broad applicability and could improve its rating by demonstrating its bankruptcy isolation reserves and incorporating a redemption schedule into its terms of service.
DAI (Rating: B+): DAI is the oldest on-chain stablecoin and is primarily backed by centralized assets. Nonetheless, it is considered secure and ideal for users seeking a permissionless protocol.
Rai Reflex Index (Rating: B+): RAI is a decentralized stablecoin with a floating price that is 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 a decentralized, censorship-resistant stablecoin.
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 with direct access to redemption mechanisms.
Frax (Rating: D): FRAX has a tight peg and performs well under market stress, but its partial collateralization mechanism and reliance on centralized assets raise concerns. It is suitable for risk-seeking yield miners and liquidity providers who can handle the complexity of the protocol.
USDD (Rating: F): USDD is managed by the Tron DAO Reserve and is similar to the failed UST stablecoin. Since only 50% of its supply is backed by non-TRX collateral (primarily Bitcoin), it is not recommended to use it due to concerns about collateralization.
You might be wondering, what does this security ranking have to do with the golden age of decentralized stablecoins?
It is indeed relevant because the follow-up will include experimental DeFi stablecoins that will either become the next big thing or completely collapse.
For example, just a year ago, I wrote an article about the USDD, USDN, and CUSD algorithmic stablecoins. A few months later, USDN de-pegged and rebranded as another VOLATILE token.
Keeping in mind that the security of your funds is of utmost importance, let’s look at what makes DeFi stablecoins so exciting right now.
Lybra: LUSD’s Challenger
Here are the top 10 stablecoins by market cap, which one impressed you the most?
First, USDT has a staggering 66% market share, even though it is rated "D" by Bluechip for being unsafe. Second, only two stablecoins, USDT and LUSD, have seen an increase in market value this month. All other stablecoins have seen a decline in market value, some of which have seen a significant decline.
Rounding out the top 10 is eUSD, a stablecoin from Lybra Finance.
Interestingly, Lybra is a fork of Liquity that accepts stETH as collateral, while Liquity only accepts ETH collateral. Thanks to stETH, eUSD holders can earn an annualized interest rate of 7.2%.
The yield on eUSD is higher than that on stETH because eUSD can be generated using stETH with an over-collateralization ratio of 159%.
But this also brings up a potential problem: the decoupling of stETH, as Lybra uses Liquity’s ETH:USD price feed.
Another problem with eUSD is that the yield is distributed through rebase, which means that you can get more eUSD tokens at the APY rate. To solve these problems, Lybra has now launched v2 and another new stablecoin: peUSD.
The main upgrades of v2 are:
Full-chain functionality: peUSD is a full-chain version of eUSD (via LayerZero), allowing holders to use their stablecoins across different chains
Minting with multiple collaterals: peUSD can be minted directly using non-rebase LST, such as Rocket Pool's rETH, Binance's WBETH, or Swell's swETH. Yields 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 to earn interest on their eUSD collateral even if they spend their peUSD.
Use 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 other potential players such as Raft and Gravita.
But Liquity is not going to sit still and wait for its fate to be extinguished. It is organizing a counterattack.
Liquity v2: A new standalone product
The beauty of Liquity is its simplicity. You can mint LUSD at 0% interest using ETH as collateral, with only a one-time borrowing fee of 0.5%.
Liquity was originally conceived as an alternative to the heavily governed DAI. LUSD has minimal governance and its smart contracts are immutable (non-upgradeable) — great for economic security, but not for growth.
To keep up with its competitors, Liquity has also launched v2, which supports LST. But “condename v2” will be a completely new and different product, not an upgrade of 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 complicated, but how it works can be simplified as follows:
Suppose Alice has 1 ETH, worth $2,000. She can deposit it into Liquity v2 and receive 2,000 v2 LUSD. Now, Liquity holds custody of her ETH, and Alice has 2,000 v2 LUSD. If the price of ETH falls below $2,000, Alice's v2 LUSD will no longer be fully backed, putting her at risk of a downward price spiral.
To solve this problem, Liquity v2 introduces:
Principal Protection Leverage: Users can hold a leveraged position (betting on future prices) where they only risk the premium they pay, not their principal.
Secondary Market: Users can sell these guaranteed positions to others. If a position is not bought, Liquity will subsidize it, ensuring that all positions are bought and the subsidy remains in the system.
If you are still confused, check out this Thread or this blog post for a more detailed explanation.
The impact of Liquity v2 is multifaceted, but the goal is to provide DeFi users with everything: principal protection leverage, mining income opportunities, and trading opportunities in the secondary market. v2 is expected to be launched in 2024.
Synthetix sUSD: Towards v3
As mentioned earlier, Synthetix founder Kain is optimistic about decentralized stablecoins. Do you want to know why?
This is because Synthetix v3 is being rolled out. This is very good timing because despite Kwenta’s growing trading volume, the sUSD market cap has been declining and currently stands at $98 million.
And v3 may bring a turning point.
Synthetix is one of the most complex DeFi protocols currently in existence. However, at 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 solving two key pain points for sUSD minters:
Multi-collateral: v3 no longer restricts collateral, allowing any collateral to back synthetic assets (v2 only allowed SNX). This will increase the liquidity of sUSD and the markets supported by Synthetix.
Synthetix Lending: Users can now provide collateral to the system to generate sUSD without being exposed to the debt pool and without incurring any interest or issuance fees.
If you’ve tried minting sUSD, you’ll know how significant these changes are! sUSD now has the potential to compete with other established stablecoins like FRAX, LUSD, or DAI.
MakerDAO: A Revenue Generating Machine
Maker is now in the final stages (check out my thread for more on this). A key point to remember is that Dai may even drop its peg to the USD if the regulatory environment changes.
Currently, Maker seems to be in a frenzy:
MKR is up 66% in 30 days, and Maker founders continue to buy MKR.
DAI has delivered a 3.49% return to its holders thanks to the reactivation of the DAI Savings Rate.
Spark Protocol is a fork of Aave that focuses on DAI and currently has a TVL of $75 million.
Maker has reduced its reliance on USDC from 65% in March to 17% today.
Maker currently ranks third in terms of revenue generation: above Lido, Synthetix, and Metamask.
Not all is rosy. A consumer electronics company defaulted on $2.1 million in debt to MakerDAO. However, with Bluechip’s B+ rating, a 3.49% DSR, and growing revenue, Maker’s DAI is experiencing a recovery after the disastrous USDC depegment a few months ago.
Frax v3: Abandoning USDC?
Frax received a D (unsafe) in the Bluechip assessment. The report said FRAX is risky because part of its collateral is the volatile FXS token, it relies heavily 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.
Like DAI, FRAX also lost its peg to the dollar during the USDC depeg and appears to have learned its lesson.
Frax founder Sam Kazemian shared in a Telegram chat that v3 is expected to be launched within 30 days.
Details about v3 are scarce, but DeFi Cheetah reports that v3 will be “an entirely different system that does not rely on fiat currencies, including USDC.”
If this is true, then v3 is a huge 180 degree shift from v2.
Sam has previously stated that their long-term goal is to obtain a Fed master account that will hold US dollars and trade directly with the Fed, making FRAX the closest stablecoin to a risk-free dollar. This will enable FRAX to get rid of USDC collateral and expand its market value to hundreds of billions of dollars.
I recommend following DeFi Cheetah for the latest details on Frax.
GHO: A new player with great potential
Despite the hype surrounding GHO’s launch, growth has been steady. While Aave has a whopping $5.8 billion in total value locked (TVL), GHO has a market cap of only $8 million.
This could be due to three reasons. First, GHO has only been launched for 11 days, so it is still too early. Second, it will take some time for GHO to be integrated into multiple DeFi protocols, but it will accelerate soon. Third, it is a bear market now.
Let’s take a look at how GHO works:
Use excess collateral to maintain the value of the stablecoin.
Minted/burned only by approved coordinators (like the Aave protocol itself, but potentially more), but with a limit per coordinator.
Interest is generated when provided to liquidity protocols, with the interest rate set by Aave governance (currently 1.51%).
Unable to supply to the Aave Ethereum market, which is quite important for security.
After repayment or liquidation, it will be destroyed and the interest will be included in the Aave DAO treasury.
Interest rates are determined by Aave governance rather than adjusted dynamically by supply and demand.
Provide a lending discount model (30% interest discount) to stkAave holders.
The price is stabilized at $1, set by the Aave protocol (no oracle), and restored to the peg by arbitrageurs when the price deviates from $1.
GHO brings a new source of income to Aave DAO. The current borrowing rate is set at 1.5%, and if it reaches a market value comparable to LUSD, GHO could bring Aave DAO $4.4 million in revenue.
You can take a deeper dive into how it works in this post by Moonshot21 However, what really piqued my interest in GHO was its potential for growth.
Aave DAO could choose to mint GHO using collateral such as real-world assets, treasuries, or even a partially algorithmic approach similar to the current FRAX model.
The potential of GHO is huge, but its actual execution remains to be seen.
crvUSD: A Stablecoin for True DeFi Professionals
I think crvUSD is the most difficult stablecoin to understand.
The unique features of crvUSD include LLAMA, soft liquidation, and “de-liquidation”. Here is a brief summary for you:
What is unique about crvUSD is that it uses a special AMM algorithm called the Lending and Liquidation AMM Algorithm (LLAMA) to implement a soft liquidation mechanism.
In a typical DeFi lending protocol, if the value of a borrower’s collateral falls below a certain threshold, it will be forcibly liquidated, which may cause the borrower to suffer significant losses.
On the other hand, LLAMA gradually converts depreciating collateral into crvUSD, thereby performing soft liquidations, which helps maintain the crvUSD peg and protects borrowers from losing all their collateral during severe market downturns.
However, if the price of the collateral continues to fall sharply and soft liquidation cannot make up for the losses, forced liquidation will occur.
If the price of the collateral recovers, LLAMA reverses this action by converting crvUSD back to the original collateral, a process called “de-liquidation.”
To maintain crvUSD’s peg, Curve uses the PegKeeper contract, which is able to mint and destroy crvUSD tokens as needed, ensuring the price remains around $1.
The above mechanism makes crvUSD unique in DeFi by providing a more resilient method to handle collateral liquidation events, thus providing a new and interesting way to sell on the top.
Here’s how the game works:
Borrow crvUSD with ETH or LST
ETH price increases: If the value of ETH increases, your collateral increases, potentially allowing more crvUSD to be borrowed.
ETH price drops: If the ETH price drops, LLAMA will gradually convert your ETH collateral into crvUSD to maintain a safe collateral ratio.
Forced liquidation: If the price of ETH drops significantly, forced liquidation will occur.
Lower liquidation fees: crvUSD’s soft liquidation mechanism may provide lower liquidation fees compared to other protocols.
Due to lower fees and gradual liquidation, this is a more efficient way to top out than borrowing through other lending protocols. Just hope the crvUSD peg holds.
Final Thoughts: A Golden Age for Decentralized Stablecoins?
Innovation does not stop at the above stablecoins. Some projects with lower market capitalization have provided many innovative methods:
Beanstalk: A unique stablecoin that uses credit rather than collateral to maintain its $1 peg, dynamically adjusting its Bean supply, Soil supply (loan amount), and maximum interest rate through its proprietary Sun, Silo, and Field mechanism. Learn more here.
Reserve Protocol: Allows permissionless creation of asset-backed, yield-generating, and over-collateralized stablecoins. Anyone can create a stablecoin backed by a basket of ERC20 tokens, including eUSD backed by stablecoins deposited on Aave and Compound v2.
Reflexer's RAI: Received a B+ rating from Bluechip. RAI's value is determined by supply and demand and is constantly adjusted according to its issuance protocol. Unlike traditional stablecoins, RAI's target exchange rate changes according to market conditions, creating a balance between those who generate RAI and those who hold RAI.
Will the recent changes usher in a new golden age for DeFi stablecoins?
When UST collapsed, the reputation of DeFi stablecoins was hit first, followed by the decoupling of USDC, which exposed the dependence of DAI, FRAX and all DeFi on USDC.
However, Maker’s recent gradual shift away from USDC to more censorship-resistant stablecoins, and Frax’s v3’s potential shift away from USDC to more decentralized collateral, can be seen as steps in the right direction.
Additionally, Liquity’s v2 could provide a solution for scaling stablecoins by solving the blockchain trilemma, as the current LUSD design compromises on scalability.
The Synthetix sUSD v3 upgrade 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 debt pools.
Finally, the launch of crvUSD and GHO proposes new strategies for maximizing DeFi yields to surpass traditional financial yields, and may even help DeFi enthusiasts sell at the top during the next bull run.
Individually, these changes may seem minor, but when considered in the broader DeFi context, they do inspire hope for a true golden age for decentralized stablecoins.