Summary Aave DAO has approved a vote to launch an over-collateralized stablecoin on the Ethereum network, pegged to the US dollar. The stablecoin offers additional perks to attract new DeFi users to the Aave protocol and creates an additional income stream for Aave. As a prominent DeFi protocol, Aave's native stablecoin could potentially revolutionize the DeFi space. Introduction Initially designed as a hedge against the crypto market's typical volatility, stablecoins are now integral to the portfolios of crypto investors and traders. Stablecoins have grown enormously in market capitalization and currently dominate a significant portion of the total crypto cash and liquidity flow. They exert considerable influence on the broader crypto market - bullish or bearish stablecoin news is capable of sending the crypto market into a frenzy. The current total stablecoin market cap stands at ~$127 billion, with Tether ( USDT-USD ) dominating about 65% of the stablecoin market. Like other crypto industry segments, stablecoins have evolved and undergone various iterations. Early stablecoins, like USDT, were designed with a straightforward fiat-collateralized approach. However, new stablecoins have emerged with alternative approaches to pegging their value to underlying assets. Several leading crypto companies and platforms issue and control their proprietary stablecoins. Binance USD ( BUSD-USD ) is issued by Paxos Trust Co., Gemini is behind the dollar-pegged stablecoin Gemini Dollar ( GUSD-USD ), Circle issues and manages the Circle USD Coin ( USDC-USD ), and now-imploded TerraUSD ( UST-USD ) was issued and run on the Terra blockchain. DeFi giant Aave ( AAVE-USD ) is the latest protocol to enter the stablecoin space with GHO (GHO-USD). Stablecoins' Farrago of Missteps Stablecoins, though designed to be safe and stable, have faced challenges, including regulatory squeezes. There have been cases of depeg of stablecoins, where they lose their 1:1 peg value to their underlying asset. These depeg incidents can occur due to protocol exploits, market manipulation, or mismanagement by the stablecoin issuer, resulting in the depletion of the stablecoin's reserves. Depegs could also be caused by a failure of the model or algorithm on which the stablecoin is built and run. The 2022 implosion of the Terra ecosystem and the subsequent overnight depeg of its UST stablecoin is one such instance of a stablecoin fiasco. Another noteworthy depeg incident occurred when Acala USD, a stablecoin issued by the Acala network - a DeFi hub on Polkadot ( DOT-USD ) - lost peg after suffering an exploit . Aave's Game-Changing Native Stablecoin The proposal to launch Aave's native stablecoin has been approved by delegates of Aave DAO. This places Aave in the ranks of DeFi protocols, like MakerDAO and Curve Finance, that have launched a native stablecoin. Aave is an undisputed giant in the DeFi space and the launch of its native stablecoin signals the beginning of a fierce DeFi-native stablecoin competition among leading DeFi protocols. Aave's native stablecoin, called GHO, is a decentralized, collateral-backed, and USD-pegged stablecoin. Aave introduces the concept of Facilitators in its stablecoin. Facilitators are independent entities that can trustlessly mint and burn the stablecoin tokens. Facilitators are assigned a Bucket with a specific minting capacity, and they can decide on which minting strategy to employ in minting the stablecoin tokens. For example, Aave V3 Ethereum Pool, one of the initial Facilitators, employs an overcollateralized model to mint in its Bucket. Another approved Facilitator, say a DAI-based entity, could decide to employ an algorithmic overcollateralized minting strategy in its Bucket. These different strategies help regulate the stablecoin's supply. To maintain true decentralization, Facilitators must be approved through governance votes in Aave DAO, and the limits of their Buckets are also subject to updates through governance votes. This ensures a balanced capacity for each Bucket, favoring overall collateralization and system stability. Setting a minting cap on Facilitators' Buckets helps mitigate the risk of an implosion. Other key ecosystem parameters such as interest and discount rates are also decided by the Aave community through Aave DAO. These rates' configurations are proposed and adjusted accordingly to maintain the stability of Aave's stablecoin. Another notable feature of the Aave stablecoin is its ability to be "flash minted." Inspired by DeFi flash loans (popular for granting users instant liquidity and for facilitating arbitrage), Aave's stablecoin introduces the concept of FlashMinting . FlashMinting adheres to the current ERC3156 Flash Loan standard . Similar to flash loans, where borrowing and repayment occur within a single transaction, GHO can be minted (borrowed) and burned (repaid) in a single transaction. How Does This Benefit Aave Protocol? Stablecoins play a vital role in DeFi lending markets, as they provide users with a means to manage volatility-associated risk. Having a native stablecoin pushes Aave a step closer to becoming an all-encompassing DeFi platform, directly addressing every DeFi need of its users. Aave's new stablecoin offers additional perks that will attract new DeFi users to Aave protocol and encourage existing users to stake Aave tokens. One such perk is the implementation of a Discount Strategy mechanism, which allows users who stake Aave in the protocol's Safety Module to access a discount on the stablecoin's borrow rate. In addition to incentivizing new and existing users to participate in Aave's Safety Module staking, the stablecoin creates an additional income stream for Aave protocol - all interest accrued from lending the stablecoin is retained in Aave DAO treasury, to be put into further research and the development of Aave protocol. Risk As with any crypto investment, investing in a DeFi-based platform carries inherent risks. One major foreseeable risk is the possibility of exploitation by attackers. Latest reports reveal that DeFi users have lost ~$400 million to exploits in the first half of 2023. Aave's native stablecoin introduces novel stablecoin concepts like Facilitators and Buckets. Some of the new concepts are somewhat experimental and may not function as intended in the long run. It will take some time before these new concepts prove their capacity to maintain the peg rate and stability of the stablecoin. With regards to regulation, decentralized protocols and decentralized stablecoin issuers have not directly faced regulatory sanctions yet; however, some centralized stablecoin issuers have encountered scrutiny from the SEC. Paxos, the issuer of BUSD, faced an SEC enforcement action earlier this year; the SEC cited a violation of securities laws. The SEC has also made attempts to amend and expand the definition of the word "exchange." The expanded definition would encompass alternative trading systems, which might include DeFi protocols like Aave. Takeaway Although Tether, a centralized stablecoin, still holds a significant share of the stablecoin market, the demand for decentralized stablecoins continues to grow. Aave is on the right path to capture a significant portion of the stablecoin market with the introduction of its native stablecoin. If Aave's native stablecoin maintains price stability, capital efficiency, and true decentralization in the long run, it would address the stablecoin trilemma and capture a significant portion of the stablecoin market, making Aave a go-to DeFi platform.
