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Governor Note: Aave Stablecoin (GHO)

Jul 12, 2022 ⋅  6 min read

Key Insights

  • Aave has announced a native stablecoin: GHO.
  • stkAAVE holders will receive a discount on GHO borrow rates.
  • 100% of the interest paid from GHO borrows will go to the Aave DAO.

On Jul. 7, 2022, Aave Companies, the entity behind the Aave protocol, released an Aave Request for Comment (ARC) introducing GHO to the Aave community. GHO is an Aave native multi-collateral backed stablecoin, pegged to the USD. While GHO will be introduced on the Ethereum blockchain, a multichain vision is anticipated by Stani Kulechov, founder of Aave.

In this note, we will give an overview of GHO, potential benefits and risks, and community sentiment towards GHO.

How GHO Works

To mint GHO, users must supply collateral on Aave. Whenever the user repays their GHO loan, the GHO paid is burned, and the user’s asset is returned. Two strategic mechanisms have been introduced as a part of the GHO introduction:

stkAAVE Discount Strategy Mechanism

The Discount Strategy mechanism allows users contributing to the Safety Staking Module (stkAAVE holders) to borrow GHO at a discounted rate. The initial discounted rate will be set to 2% but may be adjusted via Aave governance.

The Discount Strategy mechanism will incentivize users to deposit AAVE into the Safety Staking Module. Since stkAAVE is used to vote on Aave governance Proposals, this discount strategy will also assist in increasing the number of potential Aave governance participants.

Facilitators

Facilitators are protocols or entities approved via Aave governance that can generate and burn GHO tokens. The Facilitator will be entitled to mint and burn GHO to a specific bucket threshold. Aave governance will determine the bucket threshold for each Facilitator.

The Aave market on Ethereum will become the first Facilitator to initiate GHO minting. Facilitator strategies bring opportunities for possible Real World Asset (RWA) exposure, allowing pre-approved borrowers to take out loans on-chain, using off-chain (Real World) assets as collateral. Aave currently has some exposure to RWA markets, which Centrifuge deployed. Additionally, Facilitators could potentially include Delta Neutral Positions and loans based on credit scores (undercollateralized lending).

Source: Aave Governance Forum

The Benefits of Aave Launching a Stablecoin

The launch of GHO benefits the Aave Protocol and users of the Aave Protocol in many ways. Interest revenues generated on GHO borrows are implied to go directly to the DAO with the DAO directly setting the optimal interest rates. Currently, other token interest revenues are split with a large majority going to liquidity providers. The revenue sent to liquidity providers serves as the cost of capital for the protocol — this value needs to be sufficiently high to attract depositors. By using a minted stablecoin like GHO, Aave can significantly cut its direct capital cost and always ensure deep stablecoin liquidity for borrowers. However, the cost of capital does not go to zero. Incentivizing liquidity to pair with GHO so that it is usable throughout DeFi becomes the primary cost of capital.

The Discounted minting rate for stkAAVE holders will allow users to mint GHO at a discounted rate of up to 2% (initially). The discount will be applied to the borrowing interest rate. By incentivizing users to stake AAVE and mint GHO at a discounted rate, the Aave Protocol benefits from increased safety.

GHO has been designed to integrate into the recently launched Aave V3 features:

  • Aave V3 Portals will allow GHO to scale as a multichain asset efficiently. When launched, Portal will enable users to mint GHO on Ethereum, deposit GHO into the Aave Market to receive aGHO, and withdraw aGHO on any Aave-supported chain. Portal will eliminate the need for bridging funds and allow GHO to scale to any chain that Aave v3 has been deployed on. Current chains supporting Aave V3 include Avalanche, Polygon, Arbitrum, Optimism, Fantom, and Harmony.
  • Aave V3 Isolation Mode enables the creation of isolated pools. The Isolated Pools attempt to allow more tokens without creating a single point of failure for the Aave Market. Instead of exposing the entire market to new assets, Aave V3 introduced Isolation Mode, which allows for assets to be deposited in an isolated pool with a predetermined cap. These assets can only be used with the other assets in the pool. Isolation mode will allow GHO to launch and gain sufficient liquidity before it is introduced to the Aave market.
  • Aave V3 E-Mode enables the creation of pools containing closely related assets. In E-Mode, users can supply and borrow against assets within the collection with an increased LTV. To maintain a $1 peg, GHO will rely heavily on E-Mode to act similarly to MakerDAO’s Peg Stability Module (PSM). E-Mode also reduces the need to source initial stable-paired liquidity on an exchange, one of the most significant costs associated with launching a stablecoin. Instead, users can, in effect, conduct low-slippage swaps using E-Mode, and the revenue earned from these borrows is retained in the Aave ecosystem.

The Potential Risks of GHO

The community has raised concerns regarding whether GHO can maintain a $1 peg. To support this peg, GHO will rely on overcollateralization, collateralization management, and monetary policy (Stani). GHO will depend heavily on arbitrageurs to take advantage of discounted rates to maintain a price of $1.

Source: Aave Governance Forum

Aave will need a source of liquidity for GHO. While no incentive plans have been shared, there will likely need to be incentives of some sort to attract sufficient liquidity to pair with GHO. The cost of the incentives will likely exceed the revenues generated by GHO in the short term.

Additionally, the DAO will have the power to determine the borrowing interest rate based on their assessment of current market conditions. Given that the DAO receives 100% of the borrowing interest rate, there are concerns about the ability of the DAO to handle this parameter properly.

Source: Aave Governance Forum

Community Sentiment

While there have been many questions, mostly surrounding the Facilitator mechanism and borrow rates set by the DAO, the overall community sentiment appears to be supportive of this step for Aave. In addition to community support, multiple DAOs (Frax, Yeti, QiDAO, Paladin, and Notional) have reached out to show support for GHO and to inquire about potential Facilitator roles.

The news was also posted on Maker's forum by a growth core unit member raising concerns about how GHO will affect DAI adoption and distribution. Following the debate, Aave team members, including Stani himself responded highlighting Aave’s desire for collaboration, rather than competition.

GHO Deployment Timeline

The Aave developers have already completed the development process of GHO. The remaining development tasks include third-party audits by OpenZeppelin, scheduled for Jul. 11, 2022.

The first step in the approval process began with the Introducing: GHO forum post to the community. The next step includes a Snapshot proposal to gauge the Aave community’s sentiment on GHO and potential on-chain vote (Aave Arc was voted on-chain while Aave V3 wasn't).

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Prior to joining Messari as a Governance Analyst in May of 2022, Ryan was a protocol lead for Rabbithole's metagovernance. Ryan is currently studying International Business at Arizona State University.

Tomas Molin is the research lead of Messari Governor. Prior to joining Messari, Tomas worked at Ardian in the Growth Equity team focusing on technologies. At Messari, he began within the Intel team covering DeFi and governance related topics before taking the lead of the Governor team when the product was launched.

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About the authors

Prior to joining Messari as a Governance Analyst in May of 2022, Ryan was a protocol lead for Rabbithole's metagovernance. Ryan is currently studying International Business at Arizona State University.

Tomas Molin is the research lead of Messari Governor. Prior to joining Messari, Tomas worked at Ardian in the Growth Equity team focusing on technologies. At Messari, he began within the Intel team covering DeFi and governance related topics before taking the lead of the Governor team when the product was launched.

Mentioned in this report