Why are protocols like Aave and Curve creating their own stablecoins?

Written by: Blockworks Research & Westie

Compiled by: Shenchao TechFlow

The launch of $GHO and $crvUSD is just around the corner. Is protocol-specific stablecoin the next big narrative?

Among all types of cryptocurrencies, stablecoins still have the greatest product-market fit.

This is because they allow investors to trade, pay, store value, or earn yield with dollar exposure in DeFi.

Today, the market capitalization of all stablecoins has grown to over $150 billion.

Given the widespread adoption of stablecoins and the expectation of protocol innovation that provides value to its token holders and users, protocol-specific stablecoins are beginning to emerge.

Recently, both Aave and Curve plan to launch stablecoins GHO and crvUSD.

Why are protocols seeking to create their own stablecoins?

The first major reason is to increase revenue. In an over-collateralized model, protocols calculate revenue based on the dollar amount of outstanding loans.

To illustrate how stablecoins help protocols achieve revenue growth, we can predict that Aave's growth is a result of launching GHO.

Assuming a stablecoin reserve ratio of 10%, an optimal loan interest rate of 4%, and a GHO interest rate of 3%.

This revenue is entirely held by the protocol. As of now, out of Aave's total interest of about $150 million, approximately $18 million is retained by the protocol and distributed to the DAO. Therefore, if the supply of GHO grows to around $700 million, it would double the protocol's revenue.

In addition to revenue, protocols can also use stablecoins as a way to increase the value accumulation and utility of governance tokens. For example, holders of stkAAVE will be able to mint GHO at rates favorable to regular borrowers, incentivizing users to buy and stake AAVE.

These protocols also have the ability to scale and adjust certain strategies regarding the supply or use of collateral. For instance, stablecoin issuers can establish direct deposit modules with other lending markets or deposit collateral into AMM LPs (e.g., Maker's D3M and FRAX AMO).

Ultimately, a protocol that can issue its own stablecoin increases its competitive moat and reduces sensitivity to forks or vampire attacks.

This all sounds great, but where are the risks?

The main risk is the increased complexity of the protocol, which also serves as a vector for attacks. In recent years, there have been many stablecoin vulnerabilities (Cashio, Acala, Bean, etc.) that have led to complete protocol failures.

The competition in the stablecoin space is also fierce, with some decentralized stablecoins establishing significant moats in on-chain liquidity and partnerships with other protocols (like Frax and Curve).

Protocol stablecoins may struggle to achieve deep liquidity, or the cost of doing so may be very high.

Moreover, as seen with Maker's PSM, maintaining strong peg capabilities while remaining decentralized is very challenging, and regulatory or OFAC sanctions could make the creation and maintenance of protocol stablecoins very difficult.

Finally, a very important consideration is the liquidation process. If not executed properly, protocols may end up with significant losses on their balance sheets. crvUSD has also designed a novel liquidation mechanism due to its importance.

So, in a future with multiple protocol stablecoins, who will be the ultimate winner?

Besides those who successfully create their own stablecoins, other beneficiaries are projects that directly benefit from the increased demand for stablecoins and liquidity provision: Curve and Frax.

• Any stablecoin issuer will need to use Curve to ensure sufficient on-chain liquidity—this will bring more revenue and TVL to Curve.

• Frax also accumulates through CVX integrated into Curve's flywheel, with its FraxBP pool becoming a major liquidity pair.

Outside of Aave and Curve, which projects are likely to follow suit in establishing their own stablecoins?

The most likely candidates are those that have already achieved strong product-market fit and accumulated significant TVL or user deposits: Compound, Lido, and Uniswap.