Preface
The demand for early stablecoins mainly came from solving the following two problems:
The problem of anchoring the value of virtual assets: At first, the value of virtual assets fluctuated greatly and was difficult to stabilize, which brought uncertainty and risk to the cryptocurrency market. Stablecoins solve this problem by anchoring a stable asset, such as the US dollar or gold, to stabilize its value.
Deposit and withdrawal issues under regulation: Due to the imperfect regulation of the cryptocurrency market, there are certain risks and uncertainties in the deposit and withdrawal of cryptocurrencies, which brings troubles to traders. Stablecoins avoid the deposit and withdrawal issues under regulation by providing a stable asset that allows traders to use an asset similar to legal currency in the cryptocurrency market.
The emergence of USDT provides an additional "storage" location for virtual assets, and currency-to-currency transactions have replaced fiat currency transactions as the mainstream, making stablecoins a means of payment and thus playing the role of a value scale. As an emerging and closed system, the early crypto market is in great need of external energy injection to increase market internal liquidity and value stability. Centralized stablecoins have become an important channel for traditional funds to enter the crypto market. Since centralized stablecoins rely on the issuance and management of central institutions, they are subject to financial and regulatory risks of the issuer. Since centralized stablecoins occupy an absolute dominant position in the stablecoin market, these risks may cause the value of centralized stablecoins to fall sharply or even collapse, thereby bringing unpredictable chaos and risks to the entire cryptocurrency market.
Recently, Binance partner Paxos was stopped by regulators and will stop issuing stablecoin BUSD, causing the market value of BUSD to decrease by nearly 50% in one month; the stablecoin USDC was temporarily de-anchored due to the security of some reserve assets affected by the Silicon Valley bank run, causing panic in the crypto market. Therefore, the cryptocurrency market needs more robust and decentralized stablecoins to ensure the healthy and stable development of the market. Although the process of replacing centralized stablecoins may be long, exploring and developing crypto-native stablecoins is becoming more and more a consensus.
Most of the known native stablecoins to be launched in 2023 are based on existing protocols, such as Curve's crvUSD, AAVE's GHO, Dopex's dpxUSDSD, etc. In addition, there are stablecoins that will track BTC and ETH prices and achieve excess reserves in stages, such as the stablecoin HOPE. The launch of these new native stablecoins shows that the stablecoin market is constantly developing and innovating. By leveraging existing protocols and technologies, they hope to achieve more efficient, safer, and more stable stablecoin issuance and management. The launch of these stablecoins is expected to further promote the development of the cryptocurrency market and provide investors with more choices and a better experience.
This article will summarize the models and development trends of native stablecoins, cold start strategies, and flywheel effect mechanisms, and compare the four native stablecoins that will be launched in 2023 from these three perspectives.
01 The model and development trend of crypto-native stablecoins
There are two types of crypto-native stablecoins:
Overcollateralized stablecoins: These stablecoins are backed by other cryptocurrencies (such as Bitcoin or Ethereum) as collateral and can be redeemed for the collateralized cryptocurrency, with parameters adjusted to balance supply and demand. Examples include Dai (DAI), sUSD (SUSD), and BitUSD (BITUSD).
Take DAI as an example. Its stability mechanism depends on its collateral and stability rate. Users deposit collateral such as BTC and ETH into smart contracts, and then lend DAI at a certain ratio. The contract balances the supply and demand of Dai by adjusting the risk parameter of the stability rate. DAI is different from centralized stablecoins. It is a truly created "new dollar", while MakerDAO plays the role of a decentralized central bank, managing the issuance and stability of the stablecoin system. Compared with centralized stablecoins, DAI is more decentralized and open, which makes it more resistant to risks and has the advantages of decentralization. However, this stablecoin model also has certain risks, such as fluctuations in the value of collateral and system security, which need to be continuously improved and strengthened.
Algorithmic stablecoins: Algorithmic stablecoins are not backed by any assets or are not fully collateralized. The stability of their value depends on the operation of the algorithmic mechanism and the supply and demand relationship of market demand. Examples include UST, Ampleforth (AMPL), Terra (LUNA), and Reserve Rights (RSR). Decentralized non-full collateralization can be understood as the part without underlying asset collateral being managed by the algorithmic mechanism to adjust the demand side, which is the algorithmic stablecoin.
When the demand for algorithmic stablecoins increases (and thus the price increases), new stablecoins are created to reduce the price to the desired level. Conversely, when the demand is low (the price decreases), stablecoins are purchased from the market to reduce the circulating supply. The supply and demand relationship of algorithmic stablecoins is different from the logic of the traditional currency market. This logic seems unreasonable, but there are still many algorithmic stablecoin projects. The reason is that algorithmic stablecoins have extremely high seigniorage. Robert Sams wrote a paper in 2014 called "A Note on Cryptocurrency Stabilisation: Seigniorage Shares", which is also the source of the design framework of many stablecoins now. This design framework is achieved by issuing two tokens at the same time: one as a stablecoin and the other as a share token for regulating stability linked to it. In this case, algorithmic stablecoins can continuously absorb all funds flowing into the system as seigniorage, that is, create liquidity internally. The advantage of this stablecoin model is that it is more flexible and open, but there are also certain risks, such as insufficient market liquidity and failure of algorithmic mechanisms.
Native stablecoins do not rely on external assets as collateral. Native stablecoins can achieve self-regulation and self-reinforcement through mechanism design to improve stability. Due to the collapse of UST, the market's confidence in algorithmic stablecoins has been severely hit. Therefore, the main development direction of the stablecoin market is the over-collateralization model. There are four main development trends of the over-collateralization model:
Lowering the mortgage rate to release collateral liquidity
In the stablecoin market, Liquity has become a strong competitor to MakerDAO. Liquity uses an efficient liquidation mechanism, which only requires a collateral ratio of 110%. HOPE has also set the same target collateral ratio, which can release more liquidity compared to MakerDAO's 150%. The biggest innovation of Curve's stablecoin crvUSD is the use of AMM instead of traditional lending and liquidation processes. When the liquidation conditions are met, the liquidation process will be smoothed through continuous liquidation instead of a one-time occurrence. This mechanism can reduce liquidation risks and prevent losses caused by market fluctuations. The specific collateral ratio of crvUSD has not yet been announced.
Improving stablecoin liquidity
Newly listed stablecoins generally face the problem of lack of usage scenarios, so users who provide liquidity need to be incentivized directly or indirectly. The indirect way is generally to cooperate with other stablecoins to build sufficient liquidity to increase holder confidence and increase stablecoin demand. For example, FRAX was launched in December 2020. In February 2021, it built the FRAX-3Pool asset pool by providing FXS liquidity rewards on Curve, and increased the CRV incentives obtained by the FRAX pool through Curve Gauge. Subsequently, it cooperated with Convex to further increase the incentives and governance rights for the FRAX-3Pool asset pool, thereby building deep enough liquidity for FRAX. The direct incentive method uses tokens within the ecosystem to provide incentives for stablecoin liquidity staking. HOPE has adopted this method to provide incentives for governance tokens LT to users who pledge HOPE, thereby improving the liquidity of HOPE. In addition, the liquidity of HOPE is provided by dedicated market makers, which on the one hand ensures that HOPE has sufficient liquidity so that holders can exit at any time; on the other hand, it tracks the reserve pool price through arbitrage between minting and the market.
Fei Protocol uses a relatively special way to achieve this goal. It proposes a Protocol Controlled Value (PCV) model. The assets deposited by users in the contract will be directly owned by the protocol, and users cannot withdraw these assets. The protocol can use these assets more flexibly to maintain the liquidity of FEI and achieve the stability of FEI prices.
Innovation of price anchoring mechanism
When the price of an overcollateralized stablecoin deviates from the anchor value, its issuance can be expanded or contracted through an arbitrage mechanism to achieve the purpose of restoring the anchor. Different stablecoin mechanisms have different ways of expansion or contraction. Frax v2 introduces a new module based on the original AMO (Algorithmic Market Operations Controller). By automatically processing the assets of FRAX and its collateral in the DeFi ecosystem, increasing FRAX liquidity or increasing veFXS holder rewards, it regulates the supply of FRAX from more dimensions. For example, when FRAX's collateral (such as USDC) is insufficient, Curve AMO can convert a large amount of FRAX on hand into USDC, increase the USDC pledge of the FRAX protocol on Curve, and keep FRAX price anchored; while FRAX Lending AMO puts FRAX into lending markets such as Aave, allowing users to obtain FRAX by pledging assets (such as ETH) and paying interest, increasing the supply channel of FRAX.
Rich usage scenarios
Issuing stablecoins requires not only minting and issuance, but also creating usage scenarios for stablecoins. By building usage scenarios, the demand for stablecoins can be increased and their scale can be expanded. The main forms are lending, trading, and providing liquidity incentives for trading pairs. Terra provides a wide range of uses for its stablecoin UST, such as payment (CHAI), savings (ANCHOR), and investment (MIRROR). HOPE will also provide users with a rich set of usage scenarios by applying multiple protocols in its ecosystem. Among them, the HOPE Swap protocol supports trading; the HOPE Lend protocol supports lending business; and the HOPE Connect protocol is an on-chain custody and clearing and settlement tool that enables the connection between real assets and on-chain assets. Together, these protocols build a complete ecosystem that provides users with comprehensive blockchain services.
02 Analysis of the Cold Start Path of Native Stablecoins
Stablecoins have a self-reinforcing effect. The larger the scale, the higher the exchange rate stability, which attracts more users and capital to enter the market, further expanding the market scale and forming a virtuous circle. Taking the first native crypto stablecoin DAI as an example, the price volatility of DAI was very high in the early days, but as the scale grew, the volatility tended to stabilize. For native stablecoins, the cold start phase is crucial. If the scale cannot be established, they will face insufficient competitiveness in terms of holder confidence and risk resistance.
Summary of some native stablecoin cold start paths:
DAI is the first over-collateralized stablecoin, which initially only accepted ETH as collateral. Although the collateralization rate was 150%, in the sluggish market environment at the time, for long-term ETH holders, this was a very good way to increase the utilization of ETH, retaining the rights and interests of holding ETH while obtaining stablecoin cash flow.
As the issuance and management platform of UST, Terra public chain plays a vital role in the cold start phase of UST. As a public chain with the goal of commercial landing, Terra ecosystem has integrated various scenarios such as stablecoins, synthetic assets, machine gun pools, offline payments, etc. in the early stage, bringing rich application scenarios to UST. For example, it cooperated with Mirror Protocol to launch synthetic assets, and cooperated with Anchor Protocol to launch a lending agreement. Users can pledge their assets on Anchor to borrow UST. At the same time, Anchor also provides UST with 20% fixed deposit interest, etc. These collaborations have promoted the promotion and use of UST, quickly stimulated the demand for UST during the cold start period, and further increased the user group and usage scenarios of UST.
After the V2 version update, FRAX launched the algorithmic market making module - AMO, which can automatically transfer collateral or FRAX to a more capital-efficient place based on the collateral ratio, further promoting the growth of FRAX. The launch of AMO has rapidly increased the supply of FRAX from less than US$500 million to US$2.65 billion.
Analysis of cold start paths for potential native stablecoins in 2023
Cold start path of crvUSD
As a DEX platform focusing on stablecoins, Curve has the unique advantage that crvUSD can form trading pairs with various collaterals, forming a rich use scenario for exchanging assets. After Curve War, the Curve team obtained a large amount of veCRV, which will directly help crvUSD gain development advantages in terms of liquidity and incentives.
Cold start path of GHO
As a lending platform, Aave has a natural advantage in issuing stablecoins. Users' loans and collateral are centrally managed by a unified fund pool, which effectively reduces costs and improves efficiency, making the issuance of stablecoins more efficient and convenient. Therefore, creating a DAO-native stablecoin is a natural development direction, which should also reduce the cost of borrowers.
dpxUSD’s Cold Start Path
dpxUSD was created by combining rDPX with the USDC liquidity pool, incentivizing users to mint dpxUSD at a discount.
HOPE’s cold start path
The planning of the HOPE stablecoin is different from other stablecoins. In the early stages of development, the reserve price of HOPE will start at $0.5. The funds raised from the issuance will be converted into BTC and ETH and deposited into the HOPE Reserve Pool ("HRP"). Users can mint HOPE during the initial issuance period through the official protocol, or purchase HOPE thereafter through specific market makers or the HopeSwap protocol. As the cryptocurrency market recovers, the market value of HOPE will gradually reach $1 (reaching 100% of the face value, the "peg event").
HOPE's liquidity is provided by dedicated market makers, which ensure that HOPE has sufficient liquidity so that holders can exit at any time; on the other hand, they track the reserve pool price through arbitrage between minting and the market. If HOPE fails to reach the price anchor of $1, users who purchased HOPE in the first phase can redeem HOPE back to BTC and ETH. After HOPE fully transitions to HRP (stablecoin with excess reserves), other tokens (such as stablecoins) will be included. After that, the use scenarios of HOPE stablecoins will gradually expand to lending, derivatives trading, and synthetic assets.
By staking HOPE, holders can obtain the governance token LT (Light Token) of the HOPE ecosystem and enjoy other benefits in the future HOPE ecosystem, such as HopeSwap's transaction fee discounts, etc.
HOPE's cold start mode provides users with triple value:
A simple way to track the crypto market's two largest blue chip assets - BTC and ETH.
HOPE is an asset certificate composed of BTC and ETH. It can be traded and redeemed at any time and can be used as a high-quality collateral asset on DeFi, CeFi, and TradFi platforms.
Obtain platform governance token LT incentives.
03 The flywheel effect between governance tokens and stablecoins
Through mechanism design, governance tokens can incentivize the growth of stablecoins in the early stages and act as stabilizers for price anchoring in the later stages. There is usually a mutually reinforcing positive feedback effect between stablecoins and governance tokens, forming a flywheel effect.
MKR holders can control the management and decision-making of the MakerDAO system through voting, including governance and risk-sharing mechanisms, and receive fees and other rewards in the system. When DAI remains stable and increases in size, it means that the system is operating well, which increases confidence in MKR. In addition, more MKR is needed in the system to provide market guarantees, leading to an increase in the price of MKR. However, if extreme market conditions cause the liquidation of collateral in the MakerDAO system to fail, resulting in losses, these losses are usually borne by MKR holders to ensure the stability and security of the stablecoin DAI.
UST maintains a price of $1 through two-way destruction and minting with LUNA. When there is demand for UST in the market, people will buy and destroy LUNA, pushing up the price of LUNA. Terra uses the annualized interest rate of up to 20% provided by Anchor to continuously attract external funds into the system, thereby increasing the issuance of UST and pushing up the price of LUNA. Conversely, if the buyer liquidity of LUNA is not enough to support its price anchoring mechanism, it will cause UST and LUNA to spiral downward.
Frax is a stablecoin minted with USDC and FXS as collateral. As the demand for Frax increases, the demand for FXS will also increase, which will drive up the price of FXS, thereby generating returns for Frax reserve assets. In the future, Frax will transition to 100% USDC collateral, which will further enhance the stability and sustainability of Frax.
AAVE-GHO’s Flywheel
Holding and staking AAVE tokens can earn stAAVE, which can reduce the total cost of minting GHO (i.e. lower interest), which helps alleviate the secondary market sales pressure of AAVE and ensure the security of the AAVE protocol. All interest fees generated by GHO lending will be sent to the DAO treasury. If GHO reaches the market value of DAI, it can earn AaveDAO nearly $150,000 per day at an average interest rate of 3.5%, which is conducive to the price growth of AAVE, thereby making GHO safer.
rDPX - dpxUSD's Flywheel
rDPX V2 will introduce the ability to mint the pegged asset by burning rDPX (making it deflationary). The more demand there is for dpxUSD, the more deflationary rDPX will be, driving up its price, which in turn drives up demand for dpxUSD.
HOPE-LT Flywheel
HOPE's value manifestation: HOPE was initially issued at a reserve price of 50 cents. The protocol is expected to end with a $1 anchor price and a reserve rate slightly higher than 100% (e.g. 105%-112% in Hong Kong dollars). Before HOPE reaches a $1 anchor, holders will be similar to ETFs holding ETH and BTC, while also receiving additional LT rewards. After HOPE stabilizes at $1, the protocol's excess profits will flow into LT tokens.
LT's value: LT is the governance token of the protocol, which can be obtained by providing liquidity in the protocol, participating in various protocol services, or staking HOPE. LT can be staked to obtain veLT, which can increase the yield of LT. In addition, veLT can also be used to vote to increase the liquidity rewards of holders and obtain additional handling fee sharing.
This brings the following flywheel to HOPE-LT:
Users holding HOPE tokens can stake to obtain LT tokens to increase their holdings of governance and ecological incentive tokens while reducing the circulation of HOPE.
Users holding LT can use veLT for boosting, improve the efficiency of obtaining LT rewards, and increase liquidity rewards and obtain additional handling fee sharing by voting Gauge, thereby further increasing their holdings of LT. DeFi projects in the HOPE ecosystem can obtain LT through transaction mining, and the emission of each protocol is determined by voting, which also gives veLT the value of vote-buying.
When the reserve price of HOPE reaches $1, its value will be reflected in LT, which will further promote the demand for LT.
The rise of BTC and ETH will cause LT to appreciate. The appreciation of LT will increase the total amount of ecological incentives, stimulate the increase in the usage of HOPE, and thus stimulate the increase in the issuance of HOPE.
The improvement of ecological construction will promote the increase in demand for veLT, thereby reducing the circulation of LT and increasing the value of LT.
In short, the reserve rate and price of HOPE are affected by the market. If the market rises, the reserve price of HOPE will increase, thereby promoting the demand and holding of LT. Conversely, if the market falls, the reserve price of HOPE will decrease, thereby reducing the cost of LT and reducing the demand and holding of LT. The HOPE project will be launched on April 19.
Conclusion
In the stablecoin market, algorithmic stablecoins were once considered a very promising narrative. However, with the development of the market and the rapid expansion and collapse of UST, people gradually realized the fragility of this algorithmic stablecoin model without external asset support. This made market participants realize that the over-collateralization model is a more reliable way to keep the stablecoin price.
Today, native stablecoin projects with overcollateralization as the core are still exploring more efficient stabilization mechanisms, liquidation mechanisms, and more abundant types of collateral assets. They are committed to improving capital utilization to cope with market volatility and risks. The development of these projects not only provides the market with higher capital efficiency and more capital arbitrage opportunities, but also provides more investment options for more investors, and ultimately promotes the development of the overall DeFi ecosystem.
Among the over-collateralized native stablecoin projects, some are based on existing protocols, such as GHO, crvUSD, and dpxUSD. They can guarantee the stability of their prices to a large extent through the over-collateralization model based on existing liquidity. At the same time, some over-collateralized stablecoin projects achieve cold start through model innovation, such as HOPE, which uses the method of locking reserve assets and DeFi ecosystem to maintain the price stability of stablecoins by establishing reserve pools and usage scenarios.
At present, European and American banks frequently go bankrupt, and the stability of centralized stablecoins is questioned, so the status of transparent native stablecoins on the chain will become more important. The transparency and decentralization of native stablecoins can bring greater trust and security to the market, while also providing more arbitrage opportunities and liquidity.
About Snapfingers Research
Snapfingers Research is a research platform under Snapfingers, focusing on DeFi and TradeFi research on various public chains.
