Third-generation stablecoins are a novel type of fixed-value crypto asset class.
Stablecoins are a very popular asset class and an important part of blockchain ecosystems. They bridge the gap left by volatile cryptocurrencies and introduce price stability to all financial blockchain use cases. Therefore, they take the benefits of cryptocurrencies such as eliminating intermediaries, low cost of funding and financial inclusivity to the next level by making the storage and transaction of value across blockchains efficient.
While knowledge of their existence is widespread thanks to their ability to drive increased cryptocurrency adoption, the world is preparing to witness the emergence of a new generation of stablecoins. The Davos Protocol brings the third generation of stablecoins with its stable asset DAVOS. First, let’s look at its predecessors – the first and second generation of stablecoins.
First generation stablecoins
The widely used stablecoins like USDT, USDC and DAI are some of the most popular first generation stablecoins. These crypto assets are backed by sufficient collateral so that they can always hold a fixed value.
USDT and USDC are pegged to the US dollar, and each unit of either stablecoin is backed by $1. There are several other stablecoins that are pegged to and mimic the value of various national currencies and commodities such as gold.
DAI, on the other hand, is also pegged to the US dollar, but in different ways. Instead of using fiat currencies or commodities, it uses cryptocurrency collateral like ETH to maintain its peg. However, the volatility associated with ETH and other cryptocurrencies can pose problems when their values start to decline. So, crypto-backed stablecoins are over-collateralised, which prevents stablecoin providers from incurring losses on the amount lent and losing the bond maintained by their coins.
Nevertheless, the huge amount of collateral provided by users for acquiring such stablecoins is locked in smart contracts and does not bring any returns. This leads to capital inefficiency, making over-collateralization of stablecoins a not-so-good investment. Additionally, collateral like ETH and other proof-of-stake cryptocurrencies can be used for purposes like securing their networks.
Second generation stablecoins
In fact, capital-inefficient over-collateralization is why second-generation stablecoins, so-called algorithmic stablecoins, have emerged. Essentially, such stablecoins do not require collateral – fiat or crypto. Instead, they maintain the bond using algorithms that link stablecoins to supporting cryptocurrencies.
Suppose the value of an algorithmic stablecoin needs to remain pegged to $1 but increases. Users can burn the $1 worth of sister cryptocurrency to purchase the stablecoin.
As a result, the stablecoin supply begins to inflate. Meanwhile, the coins can be sold in the markets for their estimated value. The process is known as arbitrage and will be carried out until the stablecoin’s value falls back to the $1 mark.
Conversely, if its value falls below $1, arbitrageurs will buy the stablecoin at its discounted rate and burn it to get the $1 supporting cryptocurrency. The burning continues, restricting the stablecoin supply until the stablecoin’s value rises back to $1.
But algorithmic stablecoins lack the strong base that collateralized stablecoins possess in terms of maintaining stability. The lack of collateral, reliance on arbitrageurs’ interest in buying and selling stablecoin pairs, and reliance on the value of the backing tokens can be disastrous.
When the value of the backing cryptocurrency starts falling and holders lose confidence in the stablecoin peg, the assets experience a dumping frenzy, leading to their de-pegging and value-tanking. In other words, the stablecoins end up losing their stability. The Terra ecosystem debacle was a prime example of how second generation stablecoins are not as reliable as their collateralised counterparts.
The capital inefficiency caused by first-generation stablecoins and the second-generation stability issues highlight the need for better stablecoin infrastructure. The solution to the current problems with stablecoins lies in third generation stablecoins.
Third generation stablecoins
Third-generation stablecoins are a novel type of fixed-value crypto asset class. Led by the likes of DAVOS, these stablecoins implement aspects of both of their predecessors to provide the best stablecoin experience for DeFi users. For example, DAVOS is overcollateralized by MATIC to maintain strong underlying value and prevent it from experiencing crashes that algorithmic stablecoins have experienced.
However, these stablecoins also integrate algorithmic functions that help stabilize their value during minor price swings due to differing demand and market cycles. The algorithms change lending rates and rewards, encouraging users to either freeze or liquidate the offer.
Therefore, tokens are minted or burned, affecting supply and demand. With this, their price can be changed to the desired value, which represents the binding. Therefore, third generation stablecoins are backed by real value and protocols that ensure efficient price stability. The stable asset of DAVOS is therefore a reliable store of value, with strong fundamentals supporting its composition.
The benefits that come with the design of third-generation stablecoins don’t stop there. For example, the Davos Protocol brings capital efficiency despite the over-collateralization required to underpin the value of DAVOS tokens. Beyond the stable DAVOS fortune, the Davos Protocol brings a native DeFi ecosystem that allows DAVOS holders to generate higher yields than other stablecoin holders.
It does this by generating profits from various industries. The protocol accepts proof-of-stake collateral like MATIC (and soon others like ETH) from DAVOS borrowers. The collateral is placed into liquid staking protocols to generate profits. In addition, it also generates profits from the fees paid by the borrowers.
Now, those who borrow the DAVOS stablecoins can participate in the platform’s liquidity pools as liquidity providers. This is where they can use DAVOS, creating liquidity for those looking to trade and earning significant returns in the 7% to 9% APY (Annual Percentage Yield) range. Liquidity provision premiums, which represent a mix of the platform’s liquid staking revenue and borrower interest, are handed out in DAVOS tokens to those staking and creating liquidity.
The combined incentive offsets the cost of borrowing and offers significant returns to users who provide DAVOS liquidity. Additionally, the protocol’s model makes it worth investing in the stablecoin even during times of market distress when DeFi yields stay consistently dry.
DAVOS – The sustainable revenue-generating stablecoin
DAVOS spearheads a new generation of stablecoins that allow users to hold assets with reliable stability while earning significant returns. All this with risks as low as can be observed in traditional financing.
The underlying mechanisms of the Davos Protocol make it possible to launch a new class of stablecoins that are truly stable and capital-efficient. Such solutions bring a lot of utility to the DeFi world and provide users with an opportunity to earn sustainable returns even in adverse market conditions.
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