Written By: Ian Lee
Edited By: Charmyn Ho
At a Glance
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In this series, we take a look at the latest news, developments and innovations within the ever-changing decentralized finance (DeFi) space. We will dive deep into the nitty gritty details to better understand how protocols within the DeFi space work, the problems plaguing the ecosystem, as well as how builders intend to overcome them.
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This week, we dive into GHO, Aave's decentralized stablecoin. Read on as we take a look into the technical details.
Preface
The overall stablecoin market cap took a dive in May during the market crash and has remained relatively flat, contracting slightly over the last few months. The crash of Terra's stablecoin, UST, spurred efforts to regulate stablecoin issuance to protect market participants. Stablecoins like USDC and BUSD gained market share immediately after the crash as investors fled to stablecoins with transparent and sufficient collateral to de-risk. However, the fall of UST has not deterred teams and developers from innovating, as a number of stablecoins have been announced since, including Aave's GHO.
What is Aave?
Aave is a decentralized lending protocol that allows users to lend and borrow assets. As of the time of writing, Aave is the largest DeFi lending protocol, with over $5 billion in TVL (Source: DefiLlama).
Having initially launched on Ethereum, Aave has since expanded to six other chains: Arbitrum, Avalanche, Fantom, Harmony, Optimism, and Polygon. Aave also recently launched Aave Arc, a CeDeFi product focusing on lending to institutions and is compliant with anti-money laundering (AML) regulations, as institutions are required to undergo Know Your Customer (KYC) verification.
What is GHO?
GHO is a decentralized stablecoin that can be minted by users through various means. To mint GHO, the user must supply collateral at a specified collateral ratio. Thus, GHO will be a fully collateralized stablecoin and can be minted with a broad range of assets supported by the protocol.
Despite being minted on Ethereum, Aave plans for GHO to be distributed on various networks to be used by both DeFi-native and retail users for a wide range of purposes.
How GHO Works
Although stablecoins all aim to achieve similar goals, such as being pegged to a fiat currency, there are different kinds of stablecoins — differentiated by means of collateralization, such as:
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Fiat backed (centralized)
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Commodity backed (centralized)
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Cryptocurrency backed (decentralized)
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Algorithmic (decentralized)
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Hybrid — a mix of the above
GHO is a decentralized multi-collateralized stablecoin backed by various crypto assets. However, Aave plans to potentially stabilize GHO by all means available to them, including via algorithmic means, depending on the different facilitators minting GHO. Facilitators refers to protocols or entities whitelisted by AAVE governance that can trustlessly mint and burn GHO tokens.
Source: AAVE
As illustrated by the diagram, facilitators will be able to employ various strategies to generate (mint) and stabilize GHO. Each facilitator will have a governance-determined cap on the amount of GHO they can mint — this is represented by a 'Bucket' level. In this article, we will be looking at GHO minting via the first facilitator, the Aave Protocol.
Borrowing GHO on the Aave Protocol
Source: Aave
Aave Protocol is a liquidity protocol allowing users to supply and borrow against a wide range of assets while earning yield at the same time. Thus, to generate GHO via the Aave Protocol, users must supply collateral before they can borrow (mint) GHO while being limited by a specified collateral ratio. Each time a user borrows GHO, the protocol's Bucket level increases. The borrow action will fail if the amount requested exceeds the Bucket capacity assigned to the protocol.
To repay their loan, a user returns the borrowed GHO to the protocol to be burned, reducing the Bucket level of the protocol. Any interest paid is then transferred to the Aave DAO treasury. As with any type of collateralized borrowing, a user is liquidated when the dollar value of their collateral causes their collateral ratio to fall below the required threshold. When liquidated, the liquidator's acquired GHO is returned to the protocol to be burned.
Interest Rates
Because GHO is minted via borrowing on the protocol, GHO cannot be used as an asset on the supply (lending) side. Thus, the borrow interest rate is not dynamically adjusted by the usual supply and demand mechanics. Instead, the GHO interest rate on Aave is determined via Aave Governance, which will adjust interest rates depending on GHO demand.
In order to bootstrap GHO minting, a Discount Strategy mechanism will allow users to mint GHO at a discount (between 0% and 100%) depending on the amount of stkAAVE supplied. stkAAVE represents the amount of AAVE a user has staked in the Safety Module. Aave in the Safety Module are used to backstop the protocol in the event of a shortfall.
Price Stability Mechanisms
Since Aave employs the overcollateralization strategy, it relies on arbitrage and monetary policy to stabilize GHO:
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When GHO is below $1, borrowers are incentivized to purchase GHO at a discounted price and repay/liquidate, profiting on the difference. Conversely, when GHO is above $1, users are incentivized to borrow GHO and sell it on the market, repaying their loan once GHO stabilizes, profiting from the difference.
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Aave governance can control the borrow interest rate, discount threshold, and discount rate in order to expand or contract GHO supply.
Aave on Bybit Web3
Bybit now offers a way to access your favorite Web3 dApps, via our Web3 custodial wallet. This means that your keys are managed by Bybit, with no KYC required, and with 24/7 support. You'll be able to deposit and withdraw funds and seamlessly access dApps like Aave. Check it out here!
Final Thoughts
Source: DefiLlama
The stablecoin industry is a highly competitive one that is currently dominated by Tether (USDT) and Circle (USDC), none of which are fully decentralized due to the nature of which they are collateralized. Binance's BUSD has also been gaining in market share but remains behind due to the popularity of USDT and USDC on Ethereum and other EVM chains. On the decentralized front, DAI remains the largest stablecoin but has recently come under fire due to its over-reliance on USDC.
GHO will have a lot of ground to cover in order to gain market share over its established peers. However, its position as the largest DeFi protocol could help accelerate the growth of GHO's demand. Its first facilitator, the Aave Protocol, will initially allow users to mint GHO using deposited assets on its lending market. This limits the amount of GHO that can be minted due to overcollateralization requirements. But, once GHO has shown to be stable and having sufficient demand, minting could potentially be carried out using delta neutral positions, real-world assets (RWAs), or automated market operations (AMOs), whether by the Aave Protocol itself or by another facilitator. This would increase the capital efficiency of GHO and allow it to increase its supply as demand increases.
With GHO's testnet deployment imminent and its launch soon after, it will be interesting to see how GHO performs and if it can command demand from the market. We look forward to seeing more developments.
Disclosure: Members of Bybit may be invested in some or all of the tokens and projects mentioned within the following article. This statement discloses any conflict of interest and is not a recommendation to purchase any token or participate in any of the mentioned ecosystems. This content is purely for educational purposes only, and should not in any way be construed as investment advice. Please exercise caution and practice your own due diligence if you are planning to partake in any of these projects in any way. The views expressed in this article are that of the author(s) and do not represent the views of Bybit.
Source: Bybit Blog
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