Jun 9
Case Study: USD+, A Fully Collateralized, Yield Bearing Stablecoin
There is no denying that stablecoins continue to be a contentious subject, with recent protocol collapses, decentralization concerns, or insufficient reserve assets fueling this sentiment. Nevertheless, stablecoins have proven their value as a translation to traditional finance, and continue to play a major role in the market, totaling a near $160B USD in market cap. This article provides an analysis of Overnight.fi and their new stablecoin, USD+.
In brief, the analysis of Overnight and USD+ found that:
- Overnight’s token, USD+, is a 1-to-1 USDC pegged stablecoin fully collateralized by immediately USDC-convertible assets
- USD+’s collateral is invested in a decentrally governed portfolio through smart-contracts
- Profits are distributed to USD+ holders via rebase
Background: Stablecoins
A stablecoin is a digital asset pegged to some reserve asset, often $1 USD. They remain a crucial component of the digital currency ecosystem, as they facilitate interactions with traditional finance. Without the significant volatility of an asset such as Bitcoin or Ethereum, stablecoins can be a more reliable transfer of value.
Stablecoins tend to fall into two categories based on the mechanism used to maintain peg: Collateralized and Algorithmic. Collateralized stablecoins are supported by collateralized assets either on-chain or off-chain such as other tokens or cash. In the case of the second largest stablecoin by circulating supply, 1 USDC is minted for every $1 USD deposited, and burned for every $1 USD withdrawn. In contrast, algorithmic stablecoins rely on smart contracts to manage supply — minting tokens when trading above peg, and burning tokens when trading below peg. This algorithmic concept allows for a truly decentralized stablecoin, as no central agency holds deposits.
Regardless of mechanism, the sole purpose of a stablecoin is to accurately and consistently retain its peg. In May 2022, the algorithmic stablecoin from the Terra ecosystem, UST, became the first major stablecoin to depeg. On May 7th, the stablecoin lost nearly 20% of its value when billions of USD worth of UST was unstaked and sold immediately. Within a week, investors withdrew from the protocol until the token was trading under 10 cents, bringing the circulating supply from around $20 billion USD to $2 billion USD over that timeframe. The collapse of UST highlighted several major flaws inherent to algorithmic stablecoins. Extreme volume, inaccurate exchange rates, or smart contract bugs are all vulnerabilities of the algorithmic pegging mechanism, and are powerful enough to take down multi-billion dollar projects on the scale of Terra.
Consequently, collateralized stablecoins, although largely centralized, eliminate this concern with one caveat: the collateralized assets must be liquid to be used to control supply. For example, if a stablecoin was collateralized with debt, it would not be able to maintain its peg if large withdrawals relied on debt’s value; debt is not able to be immediately liquidated. This has been a concern with the largest stablecoin by circulating supply, USDT, or Tether. Although Tether claims to back all tokens 1-to-1, an investigation in Feb 2021 revealed that some of the collateral happened to be commercial paper, a form of debt. Although a settlement was reached with the New York attorney general, distrust in its collateral seems to linger as the token has seen recent volatility — fueled by the collapse of UST. Given the history of stablecoins, it seems the most resilient tokens are those collateralized with liquid assets, as they can accurately maintain peg while withstanding every magnitude of withdrawal.
The Case for USD+
Of course, if you are an investor holding a stablecoin, you would like to be earning interest, and this is typically done through staking and lending platforms which reward the lender in a token. This strategy has a couple major drawbacks: the stablecoin cannot be traded while staked due to lockup periods, and the rewards can only be reinvested when claimed and managed. But what if a stablecoin did not need to be locked to earn interest, and rewards were automatically distributed to holders in the same stablecoin? This is the model for the stablecoin of Overnight.fi: USD+.
Collateral
The first obvious concern for any stablecoin is the pegging mechanism. USD+ opts for a collateralized model using a decentrally governed portfolio consisting of ⅔ USDC, and ⅓ USDT, with no exposure to algorithmic stablecoins.
1 USD+ is minted for every 1 USDC deposited on Overnight.fi, and 1 USD+ is burned for every 1 USDC withdrawn, although USDT and DAI will be supported soon. Unlike other collateralized stablecoins, USD+ claims all assets used as collateral are immediately convertible into USDC, which would allow it to have full withdrawal capability. This positions USD+ as a second layer of collateralized stablecoins, being diversely backed by other collateralized stablecoins.
Yield Generation
With the ultimate goal of retaining peg in mind, yield generation must be managed prioritizing stability in investments. For this reason, USD+ only considers a stablecoin to be used as a collateral asset if it is fully or over-collateralized, specifically refusing algorithmic stablecoins. These assets are then deposited into lending protocols such as AAVE or into stablecoin-stablecoin liquidity pools such as USDC-USDT with no impermanent loss. The deposits are reallocated to specifically avoid daily losses to streamline income rate. This income coupled with a 0.04% minting fee allows USD+ to generate a profit to be distributed to its holders.
Instead of these rewards needing to be manually claimed or reinvested, they are automatically paid daily in USD+ via rebase. This interest is variable based on daily returns, but tends to be in the 8–12% APY range. On top of this, USD+ can even be staked in liquidity pools, which allows depositors to earn rewards from their liquidity position, and still receive rebases on their USD+ daily.
Performance
If there would be any set of market conditions to rigorously test USD+, the last several months would be the ideal culprit. The market saw a 30–40% drop across the board, led by the Terra ecosystem collapsing on the scale of tens of billions of dollars. Despite the bearish conditions, USD+ has posted an average 11.3% APY since Feb 2022, a very competitive yield compared to other staking and lending options. In fact, USD+ even saw a massive influx of value immediately after the Terra collapse:
Meanwhile, the options for staking USD+ are expanding as well due to the evolution of the Sphere ecosystem. Holders can now stake a liquidity pair on Dystopia and then deposit these LP tokens into Penrose, analogous to Curve and Convex on Ethereum. These Penrose tokens can be further locked, but even with just the staked LP tokens, a USDC/USD+ pair is currently generating a 42% APY, while the USD+ continues to rebase. This yield from collateralized stablecoin investments is not only unprecedented, but it is highly desirable for any individual or entity looking to find a stable store of value in cryptocurrency.
Future + Risks
With USD+’s potential to significantly restructure stablecoin investing, it also carries some risks, but not necessarily unique ones. Its main vulnerability would be the depegging of one of its collateralizing stablecoins, since this would cause USD+ to be undercollateralized and thus lose value. With the collateralized stablecoins used by USD+, this risk is mitigated, but it is still a legitimate possibility as the Terra collapse has proven. One of the more interesting unreleased items on the Overnight.fi roadmap is the option for insurance. There are no details out yet, but presumably this insurance would protect against a depegging event. Overnight is also planning on releasing a governance token, which could be the influencing factor in voting on USD+ portfolio allocation, although it is not being released yet due to the current crypto market climate.
In Summary
USD+ significantly improves on many of the existing flaws in stablecoin investment strategies, and has security that mirrors the stability of other collateralized stablecoins. It provides simple cash management for investors looking to generate low risk interest on stable assets, while also being an extra valuable liquidity pair asset for exchanges. With that said, we have now seen a major stablecoin collapse (albeit algorithmic), and USDC or USDT maintaining peg is never an absolute guarantee. As always, DYOR and thank you for reading!
Author: Kevin Braner
References:
Browne, R. (2022, May 18). Investors withdraw over $7 billion from tether, raising fresh fears about Stablecoin’s backing. CNBC. Retrieved June 8, 2022, from https://www.cnbc.com/2022/05/17/tether-usdt-redemptions-fuel-fears-about-stablecoins-backing.html
https://coinmarketcap.com/view/stablecoin/
Not financial advice
