Introduction to crvUSD

Level 3 - Virgin DeFi Analyst

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We’ve written about Curve Finance at length in the past. Curve is one of the foundational projects in DeFi, fulfilling the important role of helping stablecoins maintain their peg. Their novel governance mechanism marked a key innovation in incentivizing users and how they behave with their capital in the Curve ecosystem. This led to the Curve DEX amassing tens of billions of dollars in liquidity.

The $4 billion of value in Curve today represents a substantial decline from its peak of over $20 billion during the bull market. Since November 2022 (market bottom), there has been no improvement in TVL at Curve.

The CRV token has been beaten down, continuing its nearly perpetual negative performance against ETH. Note: this isn’t a completely fair way to measure CRV performance of course, since many participants earn CRV as rewards. However, surely many of the DAOs that participated in the Curve wars by purchasing large amounts of CRV are licking their wounds.

With the launch of their new crvUSD stablecoin as well as the improving crypto market sentiment more broadly, is Curve at a turning point?

One year ago, Curve founder Michael Egorov began hinting at the launch of a Curve stablecoin. A whitepaper was formally released in November 2022, and as of today the stablecoin crvUSD is in beta testing with over $100 million in TVL.

Today’s article explores the value proposition, functionality, and ecosystem impact of crvUSD.

Curve in Review

Curve Finance is at its core a place for swapping crypto assets, comparable to Uniswap. Curve initially specialized in stablecoin swaps (“stableswaps”), and while the 3pool consisting of DAI/USDC/UST is still its most active single pool, the protocol has seen significant TVL growth from non-stable crypto assets including the ETH/stETH and triCrypto2 pools.

The Curve DAO incentivizes these pools through CRV rewards and trading fees.

crvUSD

crvUSD is a collateralized debt position (“CDP”) similar to DAI, which allows users to deposit collateral and borrow a stablecoin.

Currently, the following collateral is available to borrow against on Curve Ethereum:

$117.4 million of collateral has already been deposited into Curve’s contracts, despite the warning below from Curve:

“The crvUSD stablecoin and its infrastructure are currently in beta testing. As a result, investing in crvUSD carries high risk and could lead to partial or complete loss of your investment due to its experimental nature. You are responsible for understanding the associated risks of buying, selling, and using crvUSD and its infrastructure.”

Some degens are testing in prod. Farmers are earning double digit APR (including incentives) on stablecoin pairs.

crvUSD’s key feature is its “soft liquidation.”

Soft liquidation vs. Hard liquidation

A traditional, or “hard” liquidation involves the protocol immediately selling off collateral when the price breaches a predetermined threshold.

These hard liquidations come with the following costs and concerns:

1. Liquidation penalties: Many DeFi platforms impose a penalty on borrowers who fail to maintain the required collateralization ratio. This penalty (generally a percentage of the borrower's collateral), is liquidated to cover the debt and the cost of the liquidation process.

2. Market Impact / Slippage: When a large amount of collateral is suddenly sold on the market to cover a liquidation, it can negatively impact the price of the collateral asset, especially if the market for that asset is not very liquid. This can lead to a worse execution price for the liquidated assets, increasing the cost of liquidation.

3. Forced Sale: In a hard liquidation, the borrower is forced to sell their collateral at what could be an unfavorable time. If the market price of the collateral is low, borrowers will have to sell their assets at this low price, which could result in a significant loss, especially if the price recovers shortly after the liquidation.

Soft liquidations aim to mitigate these costs by providing a more gradual and flexible liquidation process, reducing the potential for market impact and slippage, and allowing for the possibility of “de-liquidation” if the price of the collateral recovers.

Soft liquidation is a process that allows for a more measured approach to handling collateral. Rather than abruptly seizing and selling the entire collateral when its value dips below a specific threshold, the system proportionally adjusts the collateral based on its market value. This method mitigates the risks and potential losses that can occur from sudden drops in collateral value, offering a more lenient and adaptable way to manage debt collateral.

In the context of crvUSD, the soft liquidation process involves dividing the collateral into several segments, known as bands. When the value of the collateral falls within a band's price range, a portion of the collateral is liquidated and converted into crvUSD.

Source: Curve

Each band represents a portion of the collateral that gets liquidated at a particular price point. A small portion of collateral will be liquidated each time the price falls into a new band.

If the value of the collateral subsequently rebounds, the system allows for de-liquidation, which just means that the crvUSD is converted back into the original collateral. This strategy aims to facilitate a more controlled and manageable liquidation process.

Soft liquidations are made possible by Curve’s LLAMA (Lending Liquidation Automated Market Maker Algorithm).

Note that if the price of collateralized assets decreases sharply, the protocol will shift to a hard liquidation.

Keeping Pegged

The protocol maintains its peg via two smart contracts: PegKeepers, which uses a mint and burn mechanism, and the dynamic borrow rate or monetary policy.

PegKeepers are specialized smart contracts with the ability to create (mint) and destroy (burn) crvUSD. When the price of crvUSD rises above $1, these contracts generate uncollateralized crvUSD and deposit them into the stableswap pool, which helps to bring the price back down to $1.

Conversely, if the price of crvUSD falls below $1, the PegKeepers remove crvUSD from the stableswap pool and eliminate it, helping to push the price back up to $1. The protocol also employs a dynamic borrowing rate system, influenced by a monetary policy that adjusts rates based on the peg variance of crvUSD.

For instance, when the collateral's price decreases and some positions enter soft liquidations, the borrowing rate also decreases. This lower rate encourages more users to borrow the stablecoin, helping to maintain its stability.

The borrow rate is variable based on conditions in the pool. For instance, when the collateral price is down and some positions are in soft liquidation, the rate can fall. A decreasing rate creates an incentive to borrow and dump, while an increasing rate creates incentives to buy crvUSD and repay the loans.

Key Considerations

A soft liquidation temporarily swaps a collateral asset for the stablecoin asset when the collateral price falls, and then buys it back if the collateral price rises. This means borrowers are buying high and selling low, possibly repeatedly, and therefore locking in losses.

Further, external arbitrage bots are needed to provide rebalancing - the protocol is designed to offer good prices (better than market) to incentivize this activity. Good prices for the arb bots mean bad prices for the borrowers - soft liquidations create Impermanent Loss on steroids.

Note that crvUSD is brand new, and has yet to be battle tested in the severe market conditions that are all too common to crypto. Stablecoins have to survive for a long time before they can thrive. Even USDC depegged back in March.

Other risks associated with crvUSD include the inability to withdraw or add more funds during a soft liquidation, the potential for hard liquidation if the price of the collateralized asset decreases sharply, and the control over the parameters used for the issuance of crvUSD being under the control of the Curve DAO.

Most of crvUSD’s contracts are non-upgradeable which means they are immutable. The flipside is that if there are bugs, Curve will likely have to redeploy the smart contracts.

In any event, crvUSD is in the early stages of its launch. At ~$117 million in borrowings, it’s a drop in the bucket when it comes to the big stablecoin players. This is an introduction to their product in simplified terms.

On Thursday, we are going to wrap up our deep dive on the economics behind crvUSD for paid subscribers and provide our detailed thoughts on how this new stablecoin stacks up against the alternatives.

Many stablecoins have come on the market over the years, with some even boldly claiming themselves to be “DAI killers.” DAI’s network effects have been extremely resilient in the face of stablecoin competitors.

If there was to be a stablecoin that could unseat DAI, it would likely come from an established, well-capitalized player with a trusted brand in DeFi.

The return potential from investing early into the next big stablecoin can’t be ignored, hence why we’re dedicating the next few days into figuring this out!

Become a paid subscriber to receive the report along with access to all our past research as well as our monthly Q&As.

Regardless, thanks for reading.

Until next time..

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Disclaimer: None of this is to be deemed legal or financial advice of any kind. These are opinions from an anonymous group of cartoon animals with Wall Street and Software backgrounds.

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