Stablecoins are among the most commonly supplied and borrowed assets on Aave, the open-source decentralized finance protocol we built at Aave Labs and launched five years ago. They bring price predictability and act as a bridge to traditional financial systems. Stablecoins provide vital liquidity for the crypto economy, accounting for nearly half of daily trading volume.
However, not all stablecoins are the same. The core design challenge in creating a stablecoin is how it maintains parity with the asset it is supposed to mirror, which in most cases is the US dollar. Embedded in these design decisions are differing philosophies on the best way to mitigate risk and create resilient systems for issuing new stablecoins. As this asset class continues to grow in use around the world, especially in consumer-facing applications, these design decisions could have major ramifications for how value moves across borders.
Before getting deeper into design choices, it’s worthwhile to define some key differences between stablecoins. The three main categories are centralized, algorithmic and decentralized. Centralized stablecoins are backed by fiat currency reserves held by the issuer. For every stablecoin issued, an equivalent amount of fiat currency and cash-like assets are held in reserve. Examples include Tether (USDT) and USD Coin (USDC). Blockchain-based central bank digital currencies (CBDCs) are similar to centralized stablecoins, but issued by central banks, giving them official status as legal tender. Algorithmic stablecoins rely on smart contracts and algorithms to maintain their peg. Instead of being backed by reserves, these stablecoins use mechanisms like minting and burning to control the supply and stabilize the price.
Decentralized stablecoins, the third major category, operate without a central authority and are typically issued, redeemed and governed by smart contracts on a blockchain. Smart contracts manage the collateral requirements and issuance based on predefined rules in a transparent process that doesn’t require users to place trust in any potentially opaque institutions.
Unstable currencies
Stablecoin use is growing, which in the past year has seen $6 trillion in volume on the Ethereum network alone. While trading between cryptocurrencies is one of the primary sources of this volume, people around the world are turning to stablecoins to preserve purchasing power and wealth in countries where the local currency is unstable and rapidly losing value, as well as remittance payments and, increasingly, for cross-border transaction settlement.
Look no further than some of the most extreme inflationary economies, and you’ll find a very active market for stablecoins pegged to the US dollar. For example, in Argentina, where inflation reached 236% between August 2023 and August 2024,
stablecoins are increasingly used for transacting and storing value.
As much of the world has learned first-hand since 2020, inflation erodes purchasing power and wealth. The US dollar, while still facing inflation, is relatively stable compared to countries that rely more on imports or have large fiscal debts. Argentina’s strict currency controls make it a challenge for people to buy dollars directly, and if they can, they face exorbitant premiums. Stablecoins offer a simpler, cheaper digital way to access dollardenominated assets without needing to go through traditional financial institutions. It’s no wonder that stablecoins have become essential for Argentinians, with recent research showing that 62% of all crypto transactions are executed with stablecoins as of June 2024. Stablecoins provide a digital lifeline to the relative stability of the US dollar.
The growing use of stablecoins is not limited to Argentina. In Venezuela, where hyperinflation has led to a near-collapse of the national currency, stablecoins are often preferred over the local currency. Businesses and individuals alike are relying on stablecoins as a way to manage their finances, with over 34% of small retail transactions in Venezuela involving stablecoins. Research has also shown an inverse correlation between the value of the Venezuelan bolívar (VES) against the US dollar and the volume of stablecoins received for payment in the country.
Transacting across borders
Unlike the creation of the internet, which transformed the flow and access to information in a matter of decades, the global financial system has taken far longer to evolve. The current traditional cross-border payment infrastructure is plagued by high fees, long settlement times and the lack of 24/7 access. For instance, in 2023, immigrants sending $200 remittances back to relatives incurred average fees of 6.2%, according to the World Bank. Those fees add up quickly, given that the World Bank estimated total remittances at $669 billion. Stablecoins provide a cheaper form of cross-border payment, with newer blockchain networks costing less than a cent to transact. Stablecoins are also accessible wherever people have access to the internet. Nowadays, the number of people with cellphones and internet access is far, far larger the 1.5 billion people who don’t have a bank account.
Stablecoins are also transforming how businesses transact with each other across borders. Nick Philpott of Zodia Markets observed that large corporations are increasingly using stablecoins for cross-border payments and internal treasury management. Settlement time for business-to-business transactions — which in traditional finance can take one to five days, or sometimes even longer — can be reduced to minutes using stablecoins to transact directly. The traditional banking system with high fees, long delays and access restrictions is increasingly being challenged by the 24/7 online world and expectations of consumers.
Transacting in countries without a robust interconnected banking infrastructure can also be challenging. Imagine the complexity of an Ethiopian small business trying to pay a Bhutanese supplier in ngultrum. Few banks maintain trading pairs between every global currency. In this case, stablecoins become a common digital currency for transactions of any size. The advantages of stablecoins extend beyond cost and speed. Stablecoins can provide greater stability in volatile crypto markets, meaning businesses can lock in a fair exchange rate at the time of the transaction.
Given the growing number of practical use cases, and the surge of transactions in stablecoins around the world, a number of different stablecoins have been developed to meet the demand. While centralized stablecoins like USDT were some of the first and most widely used stablecoins, CoinGecko now lists 174 different stablecoins. Many are pegged to the US dollar, but others keep parity with the euro, the yen, the price of gold or certain other commodity prices.
Yet another stablecoin?
Given the abundance of other options, why would my firm, Aave, create its own stablecoin? GHO (pronounced “go”) is a decentralized, overcollateralized stablecoin native to the Aave Protocol pegged to the US dollar. Overcollateralized means the value of the collateral backing the stablecoins exceeds the value of the stablecoins issued, creating a buffer against potential drops in the value of the collateral. Unlike other stablecoins, GHO is created directly within the Aave Protocol, meaning individuals can mint GHO by supplying collateral to the protocol. This structure safeguards that GHO is fully backed by more than the value of the collateral, promoting stability and resilience in volatile market conditions.
‘Markets have learned that a lack of transparency coupled with custodial management of funds is a critical flaw’
The decentralized nature of GHO is also an important distinguishing factor. The Aave DAO votes on key decisions like interest rates and collateral requirements. A “decentralized autonomous organization,” or DAO, operates on blockchain technology and is typically governed by token holders. In the case of the Aave DAO, holding AAVE tokens grants individuals the ability to vote on proposals to change the protocol. Interest paid by GHO minters is directed 100% to the Aave DAO treasury, reinforcing the protocol’s stability and sustainability.
Decentralized, non-custodial stablecoins like GHO are uniquely differentiated from centralized stablecoins. Private companies are responsible for issuing and maintaining custody over centralized stablecoins, creating a single point of failure GHO, on the other hand, is governed by the Aave DAO. While there are certainly specialized roles, GHO is governed transparently in the Aave community forum by the 168,000 AAVE token holders. Moreover, the rules and parameters of GHO are enforced by blockchain smart contracts, which are published so that anyone can audit them.
A DeFi renaissance
Transparency and decentralized governance aren’t just nice attributes to have for a stablecoin; they’ve been shown to be essential for maintaining stability and trust during times of global market uncertainty. Over time, decentralized finance (DeFi) protocols such as Aave have gained the confidence of individuals and institutions because of their resiliency, transparency and conservative approach to risk management. Markets have learned that a lack of transparency coupled with custodial management of funds is a critical flaw. In essence, the newfound interest in DeFi is based on fundamentals such as total value locked, growth and net profits. Because of fundamentals such as these, DeFi is experiencing a renaissance.
As the stablecoin landscape evolves, GHO has the potential to become the payment layer for the internet. As of this writing, there has been more than $138 million GHO minted. We expect GHO to expand to additional blockchains, as determined by Aave DAO governance. Future development could include broadening collateral options or giving users more flexibility to mint and redeem GHO.
The growth of stablecoins reflects a broader shift towards decentralized finance, where individuals can transact freely and securely. As more people discover the benefits of DeFi, the demand for decentralized stablecoins is likely to increase and lead to new use cases such as the tokenization of a variety of real-world assets. By offering a predictable, secure and transparent stablecoin on top of resilient decentralized financial networks, we are likely to see greater adoption by institutions and individuals alike. It will take time, but ultimately, because of its benefits, DeFi and stablecoins are likely to become the backbone of all finance and internet payments.
