How application-specific stablecoins are strengthening DeFi protocols: An Exploration

Decentralized finance (DeFi) protocols are constantly seeking ways to diversify and strengthen their revenue streams. With fee-based business models becoming increasingly difficult to sustain and on-chain activity dwindling, DeFi protocols are now turning towards alternative revenue sources, with stablecoins emerging as a new form of diversification.

Application-specific stablecoins refer to stablecoins issued by DeFi protocols as their secondary product offering, backed by deposits in a DeFi protocol. These stablecoins are typically issued in the form of credit, with users able to borrow against their assets directly within a lending market or through a decentralized exchange (DEX) in order to mint a stablecoin.

The most prominent protocols launching stablecoins are Aave and Curve, with Aave issuing GHO and Curve issuing crvUSD. GHO is unique in that its borrow rate will be manually set by governance, giving Aave total control over the cost to mint or borrow GHO, potentially undercutting its competitors. crvUSD will utilize a novel mechanism known as a lending-liquidating AMM algorithm (LLAMA), which gradually swaps a user’s collateral into crvUSD as its value decreases. By doing so, this is likely to lead to far less punishing liquidations, which would increase the attractiveness of opening crvUSD-denominated CDPs.

Creating a stablecoin strengthens the business model of the issuing protocol, as it provides them with an additional stream of revenue. As stablecoins gain more traction, they could potentially steal market share from centralized, fiat-collateralized stablecoins. With DAI and FRAX being the likeliest candidates, stablecoins issued by DeFi protocols may become increasingly popular, with the potential to capture a portion of the $145B stablecoin market in the crypto ecosystem and an addressable market in the tens of trillions.

In conclusion, application-specific stablecoins provide DeFi protocols with an additional revenue stream and form of diversification. As the market for stablecoins continues to grow, stablecoins issued by DeFi protocols may become increasingly popular, potentially capturing a portion of the stablecoin market share. The emergence of stablecoins in the DeFi space represents an exciting development for the industry and signals continued innovation and growth.