When you think of crypto’s killer use cases, what comes to mind? Stores of value, NFTs, maybe gaming — but if the term ‘stablecoins’ hasn’t entered your brain yet, it absolutely should! Stablecoins occupy an essential niche in crypto. This article seeks to guide you through the increasingly complex ecosystem of stablecoins and Gro DAO’s interweaving relationship with them.
Table of contents
- What are Stablecoins?
- What types of Stablecoins Exist?
- Fiat-Backed Stablecoins
- Algorithmic Stablecoins
- Crypto Collateralised
- How Gro Protocol Utilises Stablecoins
- Conclusion
What are Stablecoins?
Stablecoins are a type of digital asset designed to have a stable or fixed exchange rate relative to another asset. Stablecoins are often pegged to the value of fiat currencies such as the U.S. Dollar, Euro, or Pound — providing a way to store and transfer value without worrying about price volatility. As a result, stablecoins are often used for trading and remittances.
History
The first stablecoin, BitUSD, was launched on the BitShares blockchain in 2014. BitUSD is pegged to the US dollar and backed by BitShares’ native cryptocurrency, BTS. Since then, organisations such as Circle, Tether, and MakerDAO have designed stablecoins for a plethora of needs.
What types of Stablecoins Exist?
This article will classify stablecoins into three main categories:
- Fiat-backed stablecoins — those that are backed by fiat currency
- Crypto-collateralised stablecoins — those that are backed by other forms of cryptocurrency
- Algorithmic stablecoins — those that maintain their value by way of using algorithms
Let’s take a more in-depth look at these below.
Fiat-Backed Stablecoins
Fiat-backed stablecoins are the most commonly used type of stablecoin. They are collateralised on a 1:1 ratio by equivalent “real world assets” held in reserves of (traditional) financial institutions, and are therefore redeemable for real world dollars (or other currencies )— which is what makes these tokens pegged. A user could send their token to the corresponding institution who will then send a fiat dollar back to their bank account. Because of this redeemability, the price on both decentalised and centralised exchanges is, under regular market circumstances, extremely close to $1 (real world dollar).
To date, fiat-backed stablecoins have been more recognised by the mainstream, with the most popular being:
- USD Coin (USDC) — a stablecoin pegged to the US dollar, with each USDC token backed by a corresponding US Dollar or asset with equivalent fair value. USDC is issued by the CENTRE Consortium, a collaboration between Circle and Coinbase.
- USDT — a stablecoin pegged to the US dollar, with each USDT token backed by a corresponding US dollar or asset with equivalent fair value. USDT is issued by Tether Limited.
While USDC and USDT share broad similarities, there are notable differences in the transparency of their reserves and collateralisation. Accordingly, users tend to have a preference for one over the other.
Crypto-collateralised
Crypto-collateralised stablecoins are pegged to a stable value and backed by a reserve of cryptocurrencies. They are also typically over-collateralised, meaning the assets that back the token are worth more than the token itself.
Crypto-collateralised stablecoins offer several advantages. For example, they are primarily backed by crypto assets and are accordingly more decentralised (than fiat-backed stablecoins). This design feature also protects such stablecoins against some of the risks faced by traditional banking systems. Crypto-collateralised stablecoins are often considered more transparent than other types of stablecoins, as the reserves of the collateralising cryptocurrencies are on-chain and can be audited by anyone. Well-known examples include:
- DAI — is a stablecoin built on the Ethereum blockchain that aims to maintain a value of $1. It is backed by collateralised debt positions (CDP) with a mix of collateral types and is managed by MakerDAO, a decentralised autonomous organisation (DAO). DAI may be the most well-known crypto-collateralised stablecoin, however, some no longer consider it to be fully crypto-backed as it has expanded to include a portion of real-world assets and fiat-backed stablecoin assets in its collateral.
- LUSD (Liquity USD) — is a decentralised stablecoin that is soft-pegged to the value of the US dollar. It is used on the Liquity protocol, which allows users to borrow against their ETH deposits without the need for interest payments. LUSD is created when users deposit ETH as collateral and can be redeemed for ETH when the loan is repaid.
- MIM (Magic Internet Money) — is a decentralised stablecoin that is pegged to the value of the US dollar. It is created through the Abracadabra.money protocol, which utilises an over-collateralised approach. MIM is backed by a basket of stablecoins and crypto tokens, including liquidity provider tokens.
Algorithmic Stablecoins
Algorithmic stablecoins utilise smart contracts to help maintain their stable price. Typical stability mechanisms for algorithmic stablecoins include adjusting supply in response to market demand and/or incentivising arbitrageurs via fee adjustments. Historically, the most prominent algorithmic mechanisms include(d) rebasing and seigniorage, though this has changed over time for reasons below.
- Rebasing
Rebasing is a mechanism that changes the supply of a token to typically achieve a target price per token (price stability) or some other economic effect such as yield distribution.
To achieve price stability, the rebasing algorithm will periodically and automatically adjust the circulating supply if the market price of the token deviates from a specific target price. For example, if the token’s market price is higher than its target, supply is increased to reduce the price, while if the market price is below its target, supply is decreased to raise the price. Accordingly, this adjustment process creates arbitrage opportunities for users who are incentivised to buy or sell to bring the value of the rebasing tokens back to the target price, while pocketing a profit. An example of a currently functioning stablecoin that uses rebasing to achieve price stability, is Ampleforth.
There are other rebasing tokens designed to automatically distribute yield from an underlying protocol, to token holders. In this case, the rebasing mechanism is designed to increase the number of tokens in each holder’s wallet over time, proportional to the yield generated by the protocol. This can make such tokens an attractive choice for those seeking passive income, as the yield is automatically reinvested into their holdings.
While there are similarities with stablecoins that focus on maintaining a certain value, rebasing tokens operate differently. The former maintain its value through reserves or collateral, while rebasing tokens use an algorithmic approach to adjust supply. Accordingly, PWRD is an example of a crypto-collateralised token that uses a rebasing mechanism to distribute accrued protocol yield while keeping the price of 1 PWRD token very close to $1.
Rebasing is a complex mechanism, and its actual effects can vary depending on market conditions and the specific implementation of the rebasing algorithm. The long-term efficacy of rebasing as either a price stabilisation mechanism or a yield distribution strategy is still a topic of ongoing debate within the crypto community
- Seigniorage
Algorithmic stablecoins using seigniorage typically adopt a burn-mint multi-coin structure, where one token is minted or burned to control the value of another.
Most notable examples of stablecoins using this mechanism to date have failed. Basis Cash, a project with ties to other notoriously failed projects, is far from its intended price, while UST crashed spectacularly.
- Fractional Algorithmic Stablecoins
Fractional-algorithmic stablecoins are partly collateralised, meaning they are somewhat backed by other assets. At one point, Frax would have been an example of a fractional-algorithmic stablecoin, as it is partially backed by USDC and partially maintained by seigniorage. As of February 2023, the community behind Frax Finance agreed to completely collateralise its native stablecoin Frax (FRAX), putting Frax on a path to ending its previous reliance on algorithmic support.
How Gro Protocol Utilises Stablecoins
Yield Aggregation
This is a method used by certain decentralised finance (DeFi) protocols, such as Gro Protocol, to yield farm by automatically allocating funds to other DeFi protocols. By doing so, yield aggregators can enable users to access wealth generated from a portfolio of (DAO-determined) strategies.
Within Gro Protocol, user funds deposited into PWRD and Vault are deployed to provide liquidity to a range of Curve Pools that pair 3CRV (DAI, USDC, USDT) with other stablecoins. When users swap stablecoins using these pools, they pay fees to the liquidity providers (such as Gro Protocol). In addition, the liquidity provided is tokenised and deposited on Convex for additional governance token rewards. These accrued yields are then distributed back to users of Gro Protocol.
The complete breakdown of the strategies behind Gro Protocol can be found on the Gro.xyz documentation page.
PWRD Stablecoin
Designed to offer safer access to DeFi yields, PWRD is Gro DAO’s version of a stablecoin that is pegged to the value of the dollar, with built-in yield and deposit protection. Its value is backed by three of the most utilised stablecoins on the market — DAI, USDC, and USDT (via 3CRV). As a yield-bearing asset, PWRD accrues most of its yield by providing 3CRV liquidity to a handful of DAO-approved Curve Pools (yield strategies) that pair 3CRV with other stablecoins (e.g. FRAX, OUSD, TUSD, LUSD). The yield generated from these underlying strategies accrues to PWRD holders through a rebasing mechanism, which automatically mints additional tokens directly to PWRD users’ wallets.
PWRD is also protected from failures that these underlying yield strategies may incur — for example, if any of the stablecoins paired with 3CRV in the selected Curve Pools fails, and/or if any of these Curve Pools generate losses. This is achieved through deposit protection via a risk tranching mechanism, in which losses incurred from the underlying yield strategies are absorbed by the Vault product, subsequently protecting PWRD. Moreover, by spreading across multiple yield strategies, and balancing protocol deposits across them through its Risk Balancer, Gro Protocol further diversifies its risk. It is worth noting however, that as the value of PWRD is entirely based on the virtual price of 3CRV, PWRD inherits the risks associated with 3CRV and is therefore not protected against 3CRV itself.
You can learn more about the PWRD token by visiting the Documentation Page.
Conclusion
Stablecoins form one of the most important foundations of DeFi. There have been a vast amount of changes, successes, failures, and innovations in the lifecycle of stablecoins more broadly.
This article briefly touched on stablecoins at a surface level. Expect to see more educational content from Gro DAO to help you utilise, manage, and interact with stablecoins. By having more knowledge of stablecoins and crypto as a whole, you can conduct better research in your own time.
This article is for informational purposes only. It is not legal, tax, financial, or other advice. All of the products mentioned are speculative and involve risks. Refrain from taking action solely based on the information in this article. Please do your own research, make your own financial decisions, and/or seek independent financial advice from a licensed person. None of the information included in this article is an endorsement of the strategies mentioned.
All software developed by Gro DAO are tools that can be used to access and/or operate various DeFi protocols. Accordingly, users of Gro DAO products continue to be in control of their assets and decide how to manage them with the help of these tools.
Originally written by @Infinitehomie
