A stablecoin from Cosmos seems like the kind of copy my Head of Marketing would like. While not from the cosmos itself, crvUSD is a boon to a market that sees over $112B worth of FDV locked in centralized counterparts. 

crvUSD is a stablecoin that aims to catapult the world of decentralized stables into widespread adoption. And it’s being led by the protocol that is known to build resilient platforms for stable assets: Curve. 

Curve is one of the leading DEXs in DeFi with a daily trading volume of $100M per day. It is perhaps one of the only reliable exchanges for trading similarly priced assets such as stablecoins, liquid-staking derivatives and more. 

But Curve is not just known for its trading volume (which may or may not be lower than its counterpart Uniswap at the time), the 2000s-Sega-game-styled application is known for building resilient architectures and innovating on perhaps one of the most fascinating tokenomics designs in DeFi. 

The point is that Curve has been at the forefront of innovation in the world of DeFi, and today we are going to tell the tale of one of the most recent products coming out of its garage – crvUSD. 

Admittedly, the curious adventurer wandering into the world of Curve Finance often encounters complexities that take time to fathom. But fear not, I’ll ensure your journey through this wildlands is as fun as this kid on the roller-coaster. 

TLDR 

• crvUSD relies on a soft liquidation mechanism that is employed by its specialized AMM algorithm known as Lending Liquidation AMM Algorithm (LLAMA). It automatically swaps between collateral and a stablecoin (crvUSD) to avoid frequent liquidations. 
• The reduction in these liquidations renders more stability to crvUSD’s peg, which is also protected by its novel arbitraging mechanism. 
• The other added benefit of incorporating the LLAMA mechanism is that Curve is able to offer more fees for LPs, veCRV holders, and enhances the overall user experience – while reducing the IL risks for LPs as well. 
• As of writing this piece, crvUSD only accepts sfrxETH as collateral. The protocol’s contracts have been publicly tested four times. Curve has also announced plans to integrate other assets such as stETH. 
• One of the biggest risks associated with the stablecoin is the very bone that picks on the most resilient of protocols – volatility. Any external volatility in the market has the potential for greater value loss of collateral. But knowing Curve, this is one problem to which they will find a solution. 
• The protocol offers a dynamic borrowing rate; it decreases to incentivize more users to borrow crvUSD and dump it and increases to incentivize buying of crvUSD and repaying the borrowed loans. 

The Problem

It’s pretty simple. If the price of the collateral you provide falls below a certain threshold level, then your collateral is liquidated, effectively closing your borrowed position. As you’d imagine, for assets that are highly volatile, liquidations are pretty common. And when the most common assets such as ETH are used to provide collateral against a stablecoin – in a down-trending market where the prices of assets face a brutal assault – liquidations are quite likely to occur. 

Perhaps the most chilling example from recent history is the depegging of USDC in April 2023, which had domino effects on other (decentralized stablecoins) such as DAI, which was comprised of 50% of USDC as collateral. The 3pool, perhaps one of the heaviest pools by TVL – saw a massive USDC dominance during its depeg driving the price of USDC/DAI to as low as 0.96. 

With centralized stablecoins, it’s much harder to guess when the depegging could happen – because it’s difficult to verify on-chain where the collateral for these stablecoins actually is. So it wouldn’t be remiss to say that the depeg risks for USDC were more or less expected. 

But such risks are not just limited to centralized stablecoins. 

One of the funkiest stablecoins that came out of the 2021’s aka everything-to-the-moon era was Magic Internet Money (MIM) – a stablecoin that could be minted by depositing other assets. The stablecoin – then famous for its endearing name – was held hostage to the crash of LUNA at the onset of the bear market of 2022. It was found that the protocol had accumulated $12M worth of bad debt, which seemed to have a devastating impact on the then $300M worth of the stablecoin. This naturally led to the depegging of MIM, albeit, there were other factors that were driving it. 

The list of past stablecoin depegging and resulting liquidations is endless. And while a journey down history is most delectable for the intellectually curious, we shall refrain from undertaking one now. Rather, a more pertinent question to ask at this point is… especially if they are over-collateralized…

While one might wonder why must stablecoins depeg if they are overcollateralized – the truth is that the reason why overcollateralization is necessary is to guard against the volatility of the provided collateral. If the value of said collateral falls below a certain threshold, then the position must be liquidated otherwise it leads to the creation of what is known as bad debt – which has excessive potential for causing systemic risks in DeFi. 

The volatility of the provided collateral is subject to several macroeconomic factors. Some of these factors could be ambiguity around regulations, or a worldwide macro slowdown in other financial markets which further have an impact on the cryptocurrency markets. Other micro factors such as shifts in demand for stablecoins can also have an impact on why it might depeg. There are still other issues such as smart contract risks, protocol failures, hacks etc. 

These risks notwithstanding, a stablecoin is of no freaking use if it can’t remain stable. 

And to make sure it does so, several lending/borrowing protocols utilize arbitrage mechanisms to ensure the peg remains stable. Moreover, liquidations are managed by liquidators who call out bad debt in the system and choose to liquidate the borrowers’ position – and get a percentage of the liquidated amount as profit for doing so. 

On the other hand, for users, there are some measures that they can take to avoid the risks of these liquidations – the most obvious of which is supplying sufficient collateral if they see the price of their collateral falling. But then the question remains…

Why can’t users simply deposit their collateral of their choice to mint the stablecoin of their choice without worrying too much about liquidation risks? 

We are indeed in need of a more efficient mechanism that helps maintain the collateral value without managing it actively. Enter…*cue Gigachad entry music*…Curve. 

crvUSD 

crvUSD is Curve protocol’s native stablecoin that can be – potentially – backed by a variety of assets such as ETH LSDs. Currently, you can only deposit sfrxETH to mint the stablecoin. At the heart of the stablecoin is LLAMA – a unique algorithm that helps avoid hard liquidations on the collateral deposited for the stablecoin by converting the deposited collateral to crvUSD when its price falls. This preserves the depositors’ collateral while keeping the system stablized. To understand this stablecoin and how it works better, let’s understand the engine of this mechanism. 

LLAMA 

The Lending Liquidation AMM Algorithm (LLAMA) is a fully functional AMM that continuously rebalances users’ collateral using a special-purpose AMM. This way, it carries out what is known as “soft liquidations” that help in capital preservation. It achieves this by converting the collateral into an LP position thereby limiting the potential losses that the borrower could face in events of price volatility. It follows Uniswap V3’s concentrated liquidity model where liquidity is heavily concentrated across specified liquidity bands. 

Core Concepts 

The ‘soft liquidation’ is the phase where the collateral is being converted to crvUSD to avoid liquidations. At this phase, it is impossible to re-deposit more collateral to ensure that your borrowed position stays intact. The only way you can interact with your loan at this stage is to self-liquidate your position. Alternatively, you can wait for the full liquidation to occur and withdraw your assets in crvUSD. 

The price of collateral is put in a concentrated liquidity segment – where there is an upper bound and a lower bound. If the price of the collateral falls within this range, then the collateral is usually left in a single asset such as ETH or crvUSD. However, if the price goes beyond this range, then it is preserved in the collateralized asset (such as ETH). As it starts falling out of the bound, a portion of the amount starts getting converted to crvUSD. 

LLAMA fetches price data from external oracles such as the Uniswap TWAP oracle, Chainlink, and even Tricrypto. It uses an Exponential Moving Average (EMA) to decrease the price volatility and thus reduces the price oracle manipulation risks. 

Let’s understand how LLAMA works through an example. Suppose a user deposits their ETH as collateral to borrow crvUSD against it. The protocol accepts the collateral entirely in ETH. If the price of ETH declines, then the protocol gradually starts converting a portion of that collateral to crvUSD to ensure that the minimum collateral threshold is maintained. 

If the price recovers, then it re-converts the crvUSD to ETH. This is known as ‘deliquidating’ the users’ collateralized position. This repurchase effectively saves the said users’ positions from getting entirely liquidated in the event of a down-trending market, or worse, a crash.  

If the price doesn’t recover and keeps falling, then the entire collateral position is converted into crvUSD, which then ensures that the entire borrowed position is still intact – without the protocol carrying out a liquidation. 

Now, one might wonder – if the protocol is converting the entirety of the collateralized amount into crvUSD, then how does the stablecoin maintain its peg? This is where the arbitrage mechanism and Curve’s PegKeeper contracts come into play. 

How is crvUSD’s peg maintained? 

PegKeepers are smart contracts that have mint and burn capabilities. In an instance where the price of crvUSD starts trading above $1, they mint uncollateralized crvUSD and deposit them to the stableswap pool. This helps return the price back to $1. 

On the other hand, if the price is trading below $1, then crvUSD is withdrawn from the stableswap pool and burned. In addition to this, the protocol also keeps the borrowing rates dynamic, thanks to the incorporation of monetary policy that determines them. The rate changes in accordance with the peg variance of crvUSD. Thus when the price of the collateral falls and some positions are in soft liquidations, then the borrow rate also falls, thereby inviting more users to borrow the stablecoin. 

Risks 

While the LLAMA protocol does offer the ability to passively managed borrowed positions for crvUSD, it comes with its own risks. 

1. One of the biggest risks associated with holding crvUSD is the inability to withdraw or add more funds if your position enters a soft liquidation mode. 
2. The second risk is the fact that if the price of your collateralized asset decreases sharply, then your position is indeed hard-liquidated. 
3. The third risk is due to the overt control over the parameters used for the issuance of crvUSD are under the control of CurveDAO. 
4. Since crvUSD is still relatively new, there are several scenarios that have been left unexplored – albeit the team has conducted several rounds of ‘testing-in-production’ to ensure its immutability. 

Nevertheless, Curve is known for pushing resilient and immutable code that follows the highest standards of security. Their previous products are huge testaments to this fact. Even in the case of crvUSD, it was evident with Michael’s persistent efforts of ensuring that all logical flaws in the contracts were caught before they were made public – he even took out risky loans before announcing the final deployment for the public. This rigorous testing helped stress-test the liquidation process. 

crvUSD Loans, borrows, and markets 

To start borrowing crvUSD, head over to crvUSD Beta. You can view the collateral that can be deposited to mint crvUSD on the “Markets” page. As of writing this piece, only sfrxETH (Frax’s Ethereum LSD) is accepted as collateral. Once you click on the said asset, you are directed to a new screen where you can set the parameters for creating a loan. Note that there is no testnet for crvUSD so if you wish to borrow the stablecoin to try, you will have to do it on mainnet itself. 

They have only launched with Frax’s LSD and have not yet started accepting any other LSD as collateral. This was indeed a surprise for the Curve community as they were hoping to see other LSDs (which have a much larger market cap; like stETH and/or rETH) over sfrxETH. The entire community’s reaction to the selection sfrxETH over other assets was most certainly interesting.

A tale worth telling – what happened during the deployment 

What good is decentralization for a protocol (beyond using it as a marketing tactic, perhaps) if its community is unable to participate in its crucial decision-making process? With Curve, the story behind crvUSD’s deployment might make you want to question its decentralization. 

The first contracts for crvUSD were deployed on mainnet on May 3rd. An initial loan of $1M was drawn, and the protocol wasn’t made available to the public at that point. The second and third deployments – which were aimed to battle-test the architecture – happened over the subsequent few weeks, with the most recent deployment on 14th May. In all of these deployments, the decision to include only sfrxETH as collateral for starters was decided by one man – the top honcho at Curve – Michael Egorov. 

This did not go well with Curve’s community, and some of them even questioned whether there were even considerations for what Curve’s long-standing community thought about the whole asset selection. 

Since then, the protocol has confirmed that it will indeed start accepting other LSDs as collateral for crvUSD. I guess, it’s only a matter of time before that starts happening.

Closing Thoughts 

The community’s response to Curve’s insistence on using sfrxETH as the initial collateral notwithstanding, the protocol has been at the forefront of innovation in DeFi and has been pushing the boundaries for what’s possible. Their LLAMA protocol is an innovative mechanism that acts as the “first line of defence” against a falling collateral price for borrowing stablecoins. The protocol helps open up an entirely new market for LSD holders while giving them a much simpler experience to borrow a stablecoin.

With this implementation, the protocol also inspires fellow lending/borrowing protocols to implement better liquidation practices – and pushing the boundaries of stablecoins. We are certainly excited for all the new LSDs and other assets the protocol starts accepting as collateral to mint the crvUSD stablecoin! 

This article was written by the great and powerful – Brown Bacon