Aave GHO Stablecoin Proposal Has Merit But Also Carries Risks

Aave GHO Stablecoin: Stablecoins have become a big part of the cryptocurrency and decentralized finance industry. Julia Magas breaks down this latest offering.

Despite recent setbacks affecting UST and other algorithmic stablecoins, interest in these products remains fairly high. Aave, a leading DeFi protocol, will introduce a fully collateralized pegged currency on the Ethereum blockchain.

Aave: A New Stablecoin

The Aave community, in the form of Aave Companies, has put together a new proposal to introduce support for a different digital asset. More specifically, that new asset would be a stablecoin, dubbed GHO, to help improve various key features of Aave’s lending platforms. Holders of Aave’s AAVE token were able to respond to this proposal and offer comments, support, concerns, and criticisms. Interestingly, 99% of the community seemed in favor of this idea, which is a tad surprising.

No one can deny the growing popularity of stablecoins within the cryptocurrency industry. Assets like Tether (USDT), USD Coin (USDC), Binance USD (BUSD), and other assets continue to grow in market cap and popularity. Users can exchange these pegged currencies for nearly all other cryptocurrencies on both centralized and decentralized exchanges. In addition, these three stablecoins are backed by hard assets, unlike their algorithmic counterparts, which have seen a fair few issues. 

Algorithmic Stablecoin Cons

Algorithmic stablecoins are not backed by cash reserves or precious metals. Instead, they retain their peg to the US Dollar by keeping cryptocurrency reserves. As cryptocurrencies are volatile in nature, it is a very precarious balancing act. The recent collapse of Terra’s UST, USDD briefly losing its peg and dropping to $0.93, Fantom’s DEI de-pegging, and Solana’s NIRV losing over 85% of its value all confirm the algorithmic approach is very risky. As such, demand for more secure and – frankly, stable – pegged currencies continues to rise. Interestingly, the GHO proposal involves a mainly algorithmic currency, albeit backed by a basket of other digital assets. 

Following the successful proposal, GHO will be offered to Aave users by minting it against their supplied collateral. Users can mint GHO through various supported crypto assets, and GHO holders will continue to earn interest on their supplied collateral. That makes GHO a yield-generating stablecoin, yet the team has to ensure it retains the peg to the US Dollar at all times. 

Can GHO Succeed?

Given the algorithmic nature of GHO, there will undoubtedly be some questions regarding its viability. It is logical for Aave to focus on letting users borrow against their collateral, as it is a decentralized lending platform. Introducing support for a native stablecoin makes sense in this regard, but only if GHO can support its $1 price peg without skipping a beat. As we have seen with other algorithmic stablecoins, that is easier said than done. 

Under the hood, users can mint $1 of GHO by supplying their Aave collateral. There will be a dedicated collateralization ratio to acquire GHO, although those details remain unclear at this time. In addition, if a user repays their borrow position – or, in the worst case, faces liquidation – the protocol will automatically burn the user’s GHO balance. 

Furthermore, the interest payments on GHO balances will be sent to the AaveDAO to generate more revenue for the community and beef up the DAO’s treasury. That same DAO will determine the borrow interest rates for GHO, although the stable rate may fluctuate depending on market conditions. 

Overall, the proposal has potential, but there are many aspects that need to be figured out along the way. Introducing GHO may pose a real risk to Aave and its position in the decentralized finance industry due to it borrowing some elements from other algorithmic stablecoins. 

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Source: https://beincrypto.com/aave-gho-stablecoin-proposal-has-merit-risks/