State of Decentralized Stablecoins in 2022: Analysis of 25+ Projects
Stablecoins make up 14.2% of the total $1.07 trillion crypto market.
Yet 90% ($140.9B) of the total stablecoin market is dominated by 3 fiat backed centralized projects: USDT, USDC and BUSD.
In contrast, 63 smart-contract based DeFi stablecoins together amount to a mere 8.3% ($11.72B) of the total stablecoin market cap.
In April 2022 UST algorithmic stablecoin’s market cap was higher than DAI, but UST collapsed due to design flaws. Terra’s UST collapse wiped out half of the decentralized stablecoin MC.
So what’s next for DeFi stablecoins?
With Aave and Curve about to launch their own stablecoins, I ventured to analyze 25+ decentralized stablecoin protocols to find out:
- How do they function?
- How do they keep their peg?
- What are their major use cases and major risk factors?
- How do they expand the supply?
And most importantly, what makes them different from each other?
The full database and stablecoins analyzed is available at ignasdefi.notion.site
I analyzed the protocols by type, market cap, functioning mechanism, major use cases, governance token utility and major risks.
Stable, decentralized and capital efficient?
Stablecoins provide a refuge from crypto volatility by keeping the value stable.
Yet a decentralized stablecoin has to have a transparent functioning mechanism and contingencies to avoid censorship. Decentralization is a key selling point for DeFi stablecoins.
The third key feature is capital efficiency: how to meet growing demand and scale effectively? In other words, how to create money cheaply?
The Holy Grail is achieving all 3, but every project has to compromise on one.
Maker’s DAI is decentralized and peg stability ensured by over-collateralization, so it cannot mint DAI cheaply.
Terra’s UST compromised on peg stability and everyone who trusted its algorithmic mechanism paid the price. Literally.
There are at least 3 more algorithmic stablecoins you should know about.
Algorithmic stablecoins: maximize capital efficiency at your own risk.
In a nutshell, algorithmic stablecoins are created by depositing $1 USD worth of a volatile asset to issue $1 USD stablecoin. In case of UST, $1 USD worth of LUNA exchanged for 1 UST.
If UST price falls below $1, anyone can buy and burn UST to mint LUNA at 1 USD, then sell LUNA at a profit. This way stabilizing the price.
Capital efficiency is achieved simply: as demand for UST increases, it boosts demand & price for LUNA. When the price of LUNA goes up, less of it is needed to mint 1 UST.
On the way down, the process is reversed, which finally led to UST’s death spiral.
Currently 3 major projects are still using the algorithmic model: Tron’s USDD, Waves’ Neutrino USD and Celo’s cUSD.
They have some peculiarities:
- All three are minted by $1 worth of governance token to mint 1 stablecoin, but Tron limits minting to the 9 Tron DAO members, including Alameda Research, Wintermute etc. Tron also doesn’t have a clear redeem policy.
- Tron and Celo claim that their stables are over-collateralized by DAO Reserves (like BTC, USDT & USDC and ETH). But minting isn’t available with the reserve assets. “Collateral’ here is similar to Terra’s acquired BTC buffer to be used in case of a depeg. The reserves didn’t save UST.
- Wave’s USDN is currently only backed by 10.89% of WAVES. Just a week ago it was 16%. USDN lost its peg a few times with contagion expanding to vires.finance lending protocol, losing investors $500M USD.
To remedy situation, WAVES issued SURF token used to buy WAVES at a discount, but it’s locked until USDN backing ratio goes back to 115%.
Near’s USN was initially designed to be algorithmic, but due to UST collapse, USN is moving away from the algorithmic design. The team announced USN V2 which is now backed by USDT and will eventually support wider collateral.
Shiba Inu (SHI) and Thorchain (TOR) planned to issue algorithmic models, but both projects are looking ways “to avoid the issues found in other moonshots.”
Overall, purely algorithmic model is in crisis. USDD is the largest one by market cap but it is plagued by lack of transparency, and is centralized as its minting process is limited to a few entities.
Over-collateralization: sacrifice capital efficiency for peg stability
Popularized by Maker’s DAI, 12 out of 28 covered stablecoin projects use over-collateralization to ensure the peg.
Maker requires more than $1 USD worth of collateral a to open a Collateral Debt Position (CDP) to mint 1 DAI. Maker launched in 2017 and initially only ETH collateral was supported to mint DAI.
As demand for DAI grew, limiting itself to ETH prevented growth. More collateral assets were added. It now accepts wBTC, Lido’s stETH, Curve and Uniswap LP tokens, real world assets and, most controversially, USDC.
Maker DAO added USDC to keep DAI price stable, since DAI was continuously trading above $1 USD.
After Tornado Cash sanctions to freeze USDC addresses, USDC is becoming a liability to Maker. At the time of writing, 55% of collateral is USDC. To avoid potential peg collapse and censorship, Maker’s founder Rune suggests moving away from USDC.
“I think we should seriously consider preparing to depeg from USD… it is almost inevitable it will happen and it is only realistic to do with huge amounts of preparation.” — Rune Christensen
Still, over the years Maker’s model proved successful to keep the dollar peg.
A few projects, though, dared to challenge Maker in two areas: capital efficiency and/or governance model
Abracadabra’s MIM
Abracadabra’s MIM uses a wide range and complex collateral, including interest-bearing tokens, such as Stargate’s USDC.
Accepting different collateral assets is more capital efficient, but is riskier. MIM had previously supported UST, but while it managed to keep the peg, its market cap dropped from $4.6B to the current $220M.
Nevertheless, MIM is still 5th largest DeFi stablecoin thanks to a diverse collateral, liquidity mining and attractive SPELL staking mechanism that accrues protocol fees to the token holders.
Liquity’s USD
Liquity’s LUSD is like Maker Lite.
ETH is the sole collateral accepted. It shuns cumbersome Maker governance model, offers 0% interest rate borrowing and collateral rate is only 110%.
Smart-contracts are immutable (cannot be upgraded or changed) and minting fees are algorithmically adjusted.
LUSD features a Stability Pool to act as source of liquidity to repay debt from liquidated positions. Liquity even offers rewards in LQTY to run front-end websites to avoid censorship.
LUST is probably the most decentralized stablecoin in the market. It won’t scale to become the number 1 stablecoin by market cap as only ETH collateral is accepted, but it has a clear Product Market Fit for a specific group of DeFi users.
What’s special about Tron’s JUST, Kava’s USDX and Mai Finance MAI?
Tron DeFi ecosystem has two stablecoins: USDD and JUST.
JUST launched first. It uses Maker’s CDP model, yet JUST accepts one and only TRX as collateral.
For Tron it makes sense to support USDD as it doesn’t need to be over- collateralized. Tron can mint a lot more USDD than JUST with the same amount of TRX.
Kava’s USDX supports BUSD, BNB, BTCB, XRP Collateral and previously accepted UST. Following Terra’s collapse, USDX tumbled to $0.65. High yield on BUSD is USDX’s main selling point right now.
MAI pushes the limits with the widest array of collateral tokens: 60 assets on 10 chains supported to mint MAI at 0% borrowing rate.
Innovation in over-collateralization beyond Maker
Quite a few stablecoins bring innovation with the focus on capital efficiency or rewards:
- Synthetix’s sUSD minted when SNX holders stake their SNX as collateral with 400% collateralization ratio. SNX stakers earn weekly staking rewards in exchange for managing their Collateralization Ratio and debt.
- Yeti Finance’s YUSD accepts borrowing against not one, but several yield- generating assets. Users can mint YUSD against all of his portfolio assets, which should reduce liquidation risks.
- Inverse Finance’s DOLA is borrowed against a wide range of collateral in their lending money market. The collateral lending and borrowing increases capital efficiency by earning yield on let out assets.
- Venus is a lending and borrowing market, that allows to mint VAI on lent collateral.
It seems like Aave’s GHO will fall to this category, with the focus on capital efficiency. GHO will be minted on supplied collateral, yet Aave eventually plans to support Real World Assets and Delta-Neutra positions (see UXD below).
Algorithmic stablecoins are more capital efficient, but proved to be unstable. On the other side, over-collateralized stables have hard peg mechanism, but issuing money is expensive ($1 USD of stablecoin demands more than 1$ in collateral).
There are a few stablecoins that are trying to find the perfect middle.
Frax
Frax is a fractional-algorithmic stablecoin: partially backed by collateral and partially stabilized algorithmically.
It started 100% collateralized by USDC, but as the protocol moves into the fractional state, some of the value that enters into the system during minting becomes FXS (which is then burned). At the time of writing, 9.5% of the FRAX supply is algorithmic.
For example, in a 90% collateral ratio, every FRAX minted requires $0.9 of collateral and burning $0.1 of FXS. In a 95% collateral ratio, every FRAX minted requires $0.95 of collateral and burning $0.05 of FXS, and so on.
When FRAX is $1.01 the CR lowers. The if the price of FRAX drops to $0.99 the CR increases.
Frax is the 2nd largest DeFi stablecoin after DAI. Like DAI, FRAX is heavily exposed to the USDC censorship risk, although the team is planning to support more diverse collateral and issue other asset-pegged assets such as frxETH.
Frax’s economy currently is composed of two stablecoins (FRAX and FPI, which is pegged to inflation index), a native AMM (Fraxswap), and a lending facility (Fraxlend).
The model is much more capital efficient and allows flexible increase of FRAX supply. Yet the most interesting innovation to increase supply and capital efficiency of Frax is Automated Market Operations, which I’ll cover later below.
UXD
Few have heard about UXD Stablecoin (UXD)as the market cap is only $21M. Still, it uses a simple and interesting model to achieve decentralization, capital efficiency and stability.
The only DeFi stablecoin native to Solana, UXD is pegged to the USD using delta-neutral position derivatives.
Users can issue 1 UXD with $1 USD worth of SOL, without a requiring over-collateralization.
Depositing SOL collateral is hedged by opening a corresponding short position on Mango markets. So, the long exposure of spot SOL is hedged by a short-position, thus price movement of SOL balance each other out. This is called a delta-neutral position.
The funding rate on the short position of the delta-neutral position is generated and automatically distributed to the stakeholders of UXD protocol.
Interestingly, ‘Delta-neutral’ position appears in Aave’s GHO proposal. Will it use something similar to UXD? We’ll have to wait and see.
Hedge-fund stablecoins
Thanks to yield farming, stablecoin holders can earn higher yield than any traditional bank could offer. At least that was the case during the bull market.
Farming is an active investment strategy. To maximize returns, yield farmers need to find the highest yield while reducing risks and consider gas and time opportunity costs.
Origin Dollar (OUSD) and mStable (MUSD) launched to solve these pain points. Both stablecoins are backed by other stablecoins like USDT, USDC and DAI. mUSDT also includes sUSD and allows to swap one stablecoin for another.
The protocols function as hedge funds that use pooled funds and employ different strategies to earn returns for their investors.
Users deposit any supported stablecoin and receive OUSD or MUSD. The protocols then deploy those stablecoins to Aave, Curve or anywhere else where the yield is highest while accounting for risks. The gas costs are minimized and users don’t need to actively manage farming positions.
Reserve’s RSV stablecoin is also backed other stablecoins: 1/3 USDC, 1/3 TUSD, and 1/3 PAX. Yet no active farming strategies are employed.
Finally, I would put FEI in this ‘Hedge fund stablecoin’ category. Fei is over-collateralized by various crypto assets, but in contrast to Maker, those assets are ‘owned’ by the protocol. Users ‘sell’ any supported asset to get FEI and the ‘sold’ asset is included in the Protocol controlled value (PCV).
The PCV is deployed into a strategies to defend the peg, yield farm and create utility for FEI and its governance token TRIBE.
The ‘hedge fund’ model is struggling. With the yields in DeFi decreasing and risks increasing FEI announced shutting down. MUSD, OUSD and RSV too are low-cap stablecoins.
To be fair, most of the stablecoins in this research focus on yield generation with different strategies, but the most popular is via Automated-Market-Operations (AMO)
AMOs do a lot more than just generate yield, though.
Automated-Market-Operations: When stablecoins go brrrrr
Central banks engage in “Open Market Operations” by minting their own currencies to buy securities, lend to banks etc., this way influencing the money supply and manipulating interest rates.
Buying securities adds money to the system, making loans easier to obtain thanks to lower interest rates. But it devaluates the currency leading to inflation.
There’s a lot of backlash against this money printing among crypto enthusiasts, but several stablecoins learnt from Fed.
Frax’s v2 monetary policy can issue new FRAX as long as it does not change the FRAX price off its peg. Protocol can mint FRAX and deposit it to Curve, Aave or anywhere else that the DAO deems beneficial.
These Automated Market Operations (AMOs) have the following effects:
- Minting and depositing FRAX into lending protocols decreases the borrowing rate, thus making FRAX more attractive to borrow then other stablecoins.
- Curve AMO supplies excess collateral plus FRAX from the Frax protocol to the FRAX3CRV pool to ensure deep liquidity and strengthen the dollar peg.
- Generates revenue from lending, swap fees, yield farming etc., which is redistributed to veFRX holders.
- Increases FRAX supply and capital efficiency beyond Frax v1 fractional-algorithmic model.
Differently from central banks, smart-contracts allow to algorithmically revert the AMO if FRAX goes below the peg. Withdrawn FRAX decreases it’s supply and restores the confidence.
This approach increases capital efficiency and partly solves the Stablecoin Trilemma.
To understand the relationship between capital efficiency and AMOs, I recommend reading FRAX founder’s Tweet below.
Frax is not alone to brrrrrrrrrr (mint) their own stablecoin. Under same or different names, the protocols below do the same:
- Maker launched D3M (Direct Deposit Module) in 2021 to mint and directly deposit DAI on Aave. It seems the operation has been suspended, which might have encouraged Aave to issue its own stablecoin GHO.
- Synthetix proposed to create sUSD Direct Deposit Module to deposit 50–100m of additional sUSD to Aave.
- Angle’s Algorithmic Market Operations deposits agEUR to Euler finance to bootstrap agEUR liquidity, reduce borrowing rates and generate revenue for the protocol.
- MAI: Supplied MAI directly into money markets, such as Market.xyz. More AMOs are in the making.
- Inverse Finance’s DOLA: Whale Extractable Value lends itself DOLA and swaps it for other assets to farm elsewhere. It can also mint DOLA with no collateral and deposit to other protocols.
- Alchemix: Uses Elixir AMO (Automated Market Operations) to farm with extra funds on Curve/Convex and boost yields.
- FEI had several operations. Integrated with Ondo to match FEI to another project’s token (Liquidity as a Service for other DAOs). It also supplied FEI to lending markets on Rari Capital’s Fuse and across DeFi, bootstrapping markets and increasing FEI liquidity.
Those operations are complex, just take a look at Alchemix’s Elixir AMO below:
In short, AMOs increases capital efficiency by creating money cheaply or at no cost and at the same time generating revenue for the protocol.
This also explains why Aave and Curve are launching their own stablecoins.
Aave and Curve need liquidity to generate revenue. Currently they attract liquidity thanks to liquidity mining, but by issuing their own stablecoins they increase capital efficiency to liquidity providers (LPs).
While their tokens will require collateralization, AMOs will allow Aave and Curve to mint stablecoins at no cost and increase revenue generation beyond their own protocols.
As more stablecoin protocols conduct AMOs yields for stablecoins will continue to drop. The lending rates will drop even for USDT, BUSD and USDC (and other crypto assets) as they will be deposited as collateral to borrow FRAX, DAI etc., at low interest rates to farm elsewhere.
This could potentially jump start a new bull market, as leverage will become cheap and liquidity abundant.
Follow for insight on DeFi and what’s happening in the crypto world.
👉Twitter: https://twitter.com/DefiIgnas
💵Referrals for discounts: https://linktr.ee/defiignas
