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CryptoEconomic Research

Tokenomics Research | Introducing GHO and Situating it in the Stablecoin Ecosystem

Stablecoins have enabled users to efficiently transfer value on a blockchain. We look at the various forms of stablecoins driving DeFi economies, with focus on Aave's proposed stablecoin, GHO.
by Laurence Smith, David ShuttleworthJuly 29, 2022
GHO  Introducing Dave  039 s Proposed Stablecoin  and Situating it in the Stablecoin Ecosystem

What are Stablecoins?

The advent of stablecoins has introduced massive liquidity, composability, and interoperability in the Web3 economy. While there are many different classes of stablecoins, their core function remains the same: to enable users to efficiently transfer value on the blockchain. The marketcap of stablecoins is now over $150B and represents roughly 15% of the entire Web3 marketcap. Part of their broader appeal is that they represent a fixed and predictable store of value that is designed, resolutely, to be indifferent to market volatility. This is often achieved through their peg to USD.

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This report will first dive into the various types of stablecoin, providing an overview and example for each, before examining the latest stablecoin on the block – Aave’s GHO. We will deep dive into the four main classes of stablecoins: commodity-backed, crypto-backed, fiat-backed, and algorithmic. 

Fiat-backed Stablecoins

The most common and simplest class of stablecoins to understand are fiat-backed. Each token is backed by a fiat currency, such as USD, EUR or GBP, offering a 1:1 backing with the fiat currency it represents. These tokens can be redeemed with the entity managing the token supply in exchange for the equivalent fiat amount. Once the token is redeemed, it is burned. Alternatively, new tokens can be minted by the supplying entity as long as they have the capital reserves to back it up. This minting and burning mechanism helps control the supply and establish the token’s 1:1 peg with the underlying currency.

USD Coin

USD Coin (USDC) is a 1:1 USD-backed stablecoin founded by Circle and is managed by a consortium of Coinbase and Bitmain. Each USDC is 100% backed by fiat cash and short-dated U.S. treasuries. This enables USDC to always be redeemable 1:1 for U.S. dollars. Moreover, USDC reserves are held in the custody of leading financial institutions, such as BlackRock and BNY Mellon and are audited on a monthly basis by a third-party.

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Commodity-backed Stablecoins

One of the less common classes of stablecoins are those that are commodity-backed. As the name alludes to, these refer to stablecoins that are backed by a variety of interchangeable assets, like precious metals, real estate or oil. The key benefit here is that it provides the holder with ownership of the underlying tangible asset which backs the token. In effect, commodity-backed stablecoins act as an on-chain representation of the real world asset backing the token, enabling investors, irrespective of geography, to invest in commodities. Another interesting dimension is that the divisibility of token amounts allows for more granular holdings of commodities. 

Paxos Gold 

Paxos Gold (PAXG) is one of the most widely used commodity-backed stablecoins and is backed by gold reserves held by Paxos. Each token can be redeemed for one troy fine ounce of gold, which is custodied in vaults by Paxos, and on secondary markets the token directly tracks the price of the underlying physical gold. Given that it is an ERC-20 token, it can be exchanged with other tokens on the Ethereum blockchain, making PAXG easily tradable throughout the globe. 

Paxos performs monthly audits to ensure the physical gold supplies are sufficient to back the tokens in circulation. It also charges a 0.03% – 1% fee for the minting and redemption of PAXG tokens, with all transactions being monitored in case of fraud or money laundering. 

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Algorithmic Stablecoins

Algorithmic stablecoins are a form of non-collateralised stablecoin, meaning they have no assets or collateral backing up their value. Instead, as the name suggests, they utilise an algorithm to automatically buy and sell the tokens to control the supply. When an algorithmic stablecoin increases in demand (and consequently price) new stablecoins are created to reduce the price to the desired level. Alternatively, when demand is low the stablecoins are bought off the market to reduce the circulating supply. 

In principle, algorithmic stablecoins feature the highest level of decentralisation amongst stablecoins. However, they are highly dependent on continual growth, as sharp drops in prices caused by low demand can be difficult to recover from due to the capital required to purchase sufficient tokens on the secondary market to bring the price back to the desired level. A notorious example of an algorithmic stablecoin gone wrong is Terra’s UST, which led to the capitulation of the LUNA token, and consequently, many lenders in the space. 


Whilst there are a variety of models for algorithmic stablecoins, one example is a rebase algorithm, as used by the Ampleforth stablecoin (AMPL). Holders do not own a fixed amount of AMPL tokens but instead own a percentage of the total AMPL circulating supply. When the price of AMPL exceeds $1, the circulating supply is increased accordingly and new tokens are distributed to existing holders. Equally, when the price drops below $1, the token supply is reduced accordingly and AMPL balances for existing holders are reduced. In short, AMPL holders will have the same percentage of the total token supply regardless of whether tokens are minted or burned. Ampleforth performs this rebase once every day to ensure price stability. 

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Crypto-backed Stablecoins

Crypto-backed stablecoins operate similarly to their fiat-backed counterparts, with the obvious exception of crypto acting as collateral rather than fiat. The key difference is in the fluctuations in price that tokens are subject to, which can change the collateral value. Where fiat-backed stablecoins can easily be traded on a 1-to-1 basis, crypto-backed stablecoins tend to be over-collateralised. As an example, you may provide $100 of ETH as collateral in exchange for $50 of a crypto-backed stablecoin. As long as the ETH collateral remains above $50 there is no impact, but if the price were to drop below $50 then the user would be automatically liquidated. 

The key benefit here is the level of decentralisation, as there is no single entity controlling your funds. Additionally, some crypto-backed stablecoins opt to use multiple tokens to distribute risk and improve liquidity. 


One of the most widely used stablecoins generally is MakerDAO’s DAI. It is a crypto-backed stablecoin with a soft peg to the US Dollar. DAI is generated and comes into circulation by depositing approved collateral assets (tokens) into Maker Vaults on the Maker Protocol. 

There are a couple of features implemented to mitigate risks:

  • All tokens used as collateral must be approved through DAO governance. 
  • Multiple tokens can be used as collateral – diversifying risk as if one of the collateral tokens decreases substantially in value it may still retain sufficient collateral. 
  • Each token that has been approved to be used as collateral has specific risk parameters, decided via DAO governance. These risk parameters detail the amount of over-collateralisation required, with riskier assets requiring greater over-collateralisation. 
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GHO Stablecoins

What is GHO?

The newest entrant to the stablecoin market is GHO, created by Aave as they look to boost platform usage (note that GHO is yet to go live as it is in the process of going through Aave governance). GHO is a native stablecoin on Aave that is fully decentralized, collateralised, and pegged 1:1 with USD. It also has algorithmic elements to it since users mint GHO tokens against their supplied collaterals. In terms of collateral, GHO is backed by a basket of cryptocurrencies chosen at the users’ discretion. This is similar to existing algorithmic stablecoins, which mint $1 worth of tokens when users provide $1 worth of cryptocurrency. Overall the GHO borrowing process functions quite similar to traditional borrowing on Aave and GHO utilises the same mechanisms as any other asset on the protocol. This begins by an end user depositing collateral into Aave. The protocol then mints a corresponding amount of GHO and sends it to the borrower. The collateral remains locked on Aave and accrues interest until the borrower repays their position, which includes the principal amount of GHO borrowed along with any accompanying interest fees accrued. When this position is repaid, Aave burns the user’s GHO and returns the locked collateral.  All of the interest fees that accumulated during the loan period are sent to the Aave DAO treasury. This is an important distinction between GHO and traditional borrowing on Aave as the latter sends just a portion of fees back to the DAO treasury when engaging in traditional lending and borrowing with other assets on Aave. 

As a decentralised stablecoin, it is fully transparent and censorship-resistant. Aave users can leverage their capital on the protocol as collateral to mint GHO. It is also backed by a diversified basket of crypto-assets that are chosen by the users and approved via DAO governance. This means that users can utilise multiple tokens for collateral, increasing convenience for the borrower. Another particularly attractive feature of GHO for borrowers is that they continue to earn interest on the underlying collateral they use to mint GHO. Overall, the over collateralisation model is similar to that of DAI, which has shown resilience, and that imbues us with faith in the token. 

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As for the benefits for Aave, GHO makes stablecoin borrowing on the platform more competitive and generates additional revenue for the Aave DAO by sending 100% of the interest fees accrued from borrowing GHO to the DAO treasury. Additionally, with the advantage borrowers have using GHO, it is likely to boost borrowing levels on Aave and reintroduce more leverage into the system. 

Security for Aave

Beyond the over-collateralisation model being used for GHO Aave have introduced various stability mechanisms to manage market volatility and higher loan-to-value (LTV) instances. In the event of a market downturn, GHO demand increases as the price of collateral contracts and users borrow more GHO using other non-volatile collateral assets to repay their positions. This would increase the amount of GHO that enters the market and reduce demand. Stablecoin holders can also access GHO with a rate close to 1:1 with zero slippage (E-Mode).

Another interesting dynamic of GHO is that it has built in mechanisms that both reduce the secondary market selling pressures of $AAVE and help secure the Aave protocol. By incentivising users to acquire $stkAAVE in order to leverage the discount model, there is an inherent incentive for borrowers to stake $AAVE, acquire $stAAVE, and then stake this token to reduce the total cost of minting GHO (vis-a-vis a lower interest rate on the GHO borrowed). Moreover, the staked $stAAVE helps secure the protocol as it is sent to Aave’s Safety Module. You can use this spreadsheet to look into the GHO borrow interest rate discount. 

In short, users can stake $AAVE into the protocol’s Safety Module, which is used to help protect the protocol from a short fall event and insolvency. In return, the user receives an equivalent amount of $stkAAVE and earns rewards in $AAVE as long as their tokens are locked in the Safety Module smart contract. So the discount model acts as a mechanism to further incentivise $AAVE staking and add more liquidity into the Safety Module. 


Facilitators are fundamental within the system, serving as a way of GHO generation and management beyond the native Aave protocol and to other Aave-supported blockchains, such as Avalanche and Polygon, and other Layer 2 networks such as Arbitrum and Optimism. These facilitators are other protocols (e.g. Compound) or entities (e.g. Coinbase) that are whitelisted to trustlessly generate and burn GHO tokens. Aave governance will vote to approve facilitator appointments. Moreover, facilitators will be able to apply different strategies to their generation of GHO (e.g. delta neutral strategies). In order to limit risk and exposure to malicious behaviour, Aave governance will place upwards limits on the amount of GHO that a specific facilitator can generate.

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Revenue Generating Function 

As users mint GHO, the amount of revenue collected from lending fees will increase. This provides the Aave DAO treasury with an additional revenue generating mechanism. Again, a key differentiating feature of GHO is that all of the fees are collected by the DAO treasury; while the majority of the fees for traditional borrowing on Aave are captured by liquidity providers.

After launch, the Aave DAO will determine the native interest rate for GHO and will actively update this rate to reflect current market conditions. This preserves and enables the Aave community to determine monetary policy in a truly decentralised fashion.

Discount Model 

GHO is also composed of a discount model which enables additional features to drive utility for participants, improves Aave security, and reduces secondary market pressure on $AAVE. In its first iteration, the discount model sets aside a predefined amount of GHO in which $stkAAVE token holders can borrow at a discounted rate (i.e. lower than the current prevailing the GHO borrow rate). This discount rate can range between 0% (no discount) to 100% (full discount). The Aave DAO can vote to change these parameters and make adjustments that they see best for the health of the protocol.  


Whilst there are some reservations in the market against stablecoins, and rightly so following the collapse of UST, the various mechanisms underpinning each stablecoin have their own unique benefits as well as their respective risks. So when deciding between using a stablecoin for a particular purpose, it is useful to evaluate what the desired end result is along with a clear level of risk tolerance. Ultimately, stablecoins provide a predictable unit of value that can be used frictionlessly throughout the Web3 economy and can facilitate more usage for DeFi protocols and dapps across different blockchains. 

In terms of Aave’s potential launch of GHO, this move has broader implications for DeFi protocols throughout the ecosystem. In specific, GHO’s development can be thought of as a secondary revenue generating function of the protocol, which operates independently and in the background of the protocol’s core business. In Aave’s case, lending and borrowing can continue to run at the forefront, whilst users that want to obtain additional liquidity can utilise GHO, thereby providing Aave’s treasury with another source of revenue. Moreover, all of the revenue generated by this secondary function is captured directly by the protocol and flows back into the treasury. This is much different than Aave’s traditional lending and borrowing business, as LPs capture most of the revenue generated there. 

Given the potential for both revenue generation and user growth, Aave’s approach could be a model that is replicated throughout DeFi, especially by protocols with high total value locked (TVL) and where users may want to gain additional capital efficiency. For instance, Curve, a leading automated market maker, recently hinted that they will be launching their own stablecoin. While the details are not yet known, Curve has a tremendous TVL and its user base may want to further deploy their assets while they earn rewards in Curve’s pools. Curve users could then mint a stablecoin by borrowing against the assets they have staked in a pool, similarly to how Aave users can borrow against collateral that has already been approved by the protocol for its core business. Both stablecoins, if approved and adopted, could yield enormous returns for their creators through increased product usage, and may set them up to be a central authority in the world of Web3. 

While the potential for additional revenue generation is certainly present for protocols that follow this path, it is not entirely without risk. Some general concerns that ought to be further fleshed out are around LTV ratios, liquidation thresholds, and general liquidity and composability for these new stablecoins. For instance, Aave will need to ensure that the proper parameters around a borrower’s LTV are established in such a way that protects the protocol from insolvency risks, especially since the end user has the discretion to compose the basket of assets utilised as collateral. Moreover, it is also not clear how the liquidation mechanisms will function or what the liquidation thresholds will be. Finally, once the native stablecoins are launched, the protocol will need to proactively deploy bootstrapping efforts to ensure sufficient liquidity that enable users to actually deploy these stablecoins to other purposes. Otherwise the end user could be stuck with a stablecoin that cannot easily be converted and could experience significant slippage when trying to move in and out of different positions or simply when repaying their initial loan.

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