Why DeFi projects are creating their own stablecoins
A new market development in decentralized finance (DeFi) aims to shake up the stablecoin industry - here's what's behind it.
A new market development in decentralized finance (DeFi) aims to shake up the stablecoin industry. Here's what's behind it.
Centralized stablecoin projects, issued by certain companies, have dominated cryptocurrency trading in the DeFi space for years. Whether you swap tokens on Uniswap, take out a loan with Aave, or run a leveraged trade on dYdX — almost nothing in DeFi works without stablecoins like Tether (USDT) or USD Coin (USDC).
Since January 1, 2021, the market capitalization of stablecoins in DeFi protocols has grown from about $20 billion to more than $90 billion now (+360%). Most of this growth is due to the stablecoins USDT, USDC and Binance USD (BUSD). Collectively they account for nearly 90 percent of total stablecoin market cap in DeFi.
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USD Coin (USDC) - $36.88 billion.
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Tether (USDT) - $28.21 billion.
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Binance USD (BUSD) - $14.89 billion.
What are protocol-owned stablecoins?
In recent years the risk associated with such centralization has been underrated. How decentralized is the DeFi ecosystem really when the main stablecoins are in the hands of a few big companies?
The Tornado Cash ban recently showed how powerful stablecoin companies can be in DeFi. Soon after the U.S. banned Tornado Cash, Circle, the company behind USDC, froze all USDC that had ever interacted with Tornado Cash. This left thousands of users who typically do nothing wrong unable to transfer their USDC tokens without a warning.
Especially for DeFi protocols or so-called decentralized stablecoins that rely heavily on centralized stablecoins, one has to ask how decentralized they really are. In light of these developments, more DeFi projects have inched to reduce their reliance on stablecoins like USDC or USDT over the past few months. This has led to the rise of so-called protocol-owned stablecoins. These are stablecoins created by DeFi projects that typically offer other products or services in DeFi (token swaps, lending, etc.).
Aave and Curve launch stablecoins
A good example of protocol-owned stablecoins are GHO and crvUSD from two DeFi staples Aave and Curve. Both decentralized autonomous organizations (DAOs) from the DeFi projects recently announced they want to launch protocol-owned stablecoins. Both projects are usually focused on other tasks within the DeFi ecosystem. Curve is a decentralized exchange (DEX) and Aave is a DeFi lending protocol. The release of a protocol-owned stablecoin is therefore new ground for both protocols. Both the Aave stablecoin (GHO) and Curve’s stablecoin (crvUSD) will be over-collateralized stablecoins, similar to MakerDAO’s DAI. What does this mean?
In contrast to centralized stablecoins like Circle’s USDC or Tether’s USDT, which are backed by hard money and assets, the value of crvUSD and GHO will be backed by deposited cryptocurrencies. This type of stablecoins are called over-collateralized stablecoins. This is because their total value is significantly higher than the value of the crvUSD or GHO tokens in circulation. When exactly the two protocol-owned stablecoins hit the market and how they will ultimately affect the tokenomics of AAVE and CRV remains unclear.
Why DeFi projects want their own stablecoins
On the one hand, DeFi projects with their own stablecoins want to reduce their reliance on centralized stablecoin providers. On the other hand, by issuing their own stablecoin, DeFi protocols can participate in a market that has grown tremendously in recent years.
Drawbacks of USDT, USDC and Co. for DeFi
Relying on centralized stablecoins like USDT or BUSD is very risky for DeFi, because they can be frozen. Centralized stablecoin providers like Binance or Circle thus hold enormous power and could theoretically wipe out whole DeFi protocols on their own. This dependence makes a large part of the DeFi world highly vulnerable to censorship. If Circle runs into trouble with authorities or certain reserves for the stablecoin USDC are seized or stolen, it could trigger the collapse of entire DeFi ecosystems, since there would suddenly be no reserves for the smart contracts of DeFi protocols.
Benefits of stablecoins like crvUSD and GHO
By moving away from centralized stablecoins, protocols can achieve a higher level of security and decentralization. Also, depending on how a DeFi protocol designs its own stablecoin, the project’s tokenomics can improve as well. Curve, for example, could use crvUSD to provide more liquidity on its platform by letting users use their existing Curve liquidity positions as reserves to generate crvUSD, directly benefiting Curve’s CRV token.
Conclusion
Ultimately, DeFi projects with their own stablecoins can not only raise the censorship resistance of their protocols but also integrate them in a useful way. Stablecoins currently account for about 14 percent of the total crypto market cap. The stablecoin industry is likely to keep growing as the digitization of our financial system, crypto, and the DeFi ecosystem gain momentum. For DeFi projects, a protocol-owned stablecoin can be meaningful, not just for decentralization but for the continued development of their platforms.
