A deep dive into CrvUSD — a native collateralized-debt-position (CDP) stablecoin based on Curve Finance's Lending-Liquidating AMM Algorithm (LLAMMA).
In the world of decentralized finance (DeFi), few things have been more groundbreaking than the invention and launch of the automated market maker (AMM) protocol. Bancor was the first to ever do it in June 2017 and popularized it alongside Uniswap and Curve. In the years since then, countless AMMs have emerged across every chain and are a staple to any healthy DeFi ecosystem.
Amidst the AMMs that emerged on every new blockchain, Curve Finance launched to fill a specific niche in the AMM space: the optimization of swapping of identically-pegged digital assets — stablecoins. This allowed Curve Finance to grow into the behemoth it is today, holding the third place in Total Value Locked (TVL) across all decentralized applications (DApps). Today, Curve Finance’s TVL sits close to $5 billion despite an 80% fall from its peak of over $24 billion in January 2022.
Source: DeFiLlama
Despite their success, the Curve team continues to ship new pools and features to Curve. In mid 2022, they hinted at a launch of their own decentralized stablecoin and in November the same year, they released the crvUSD whitepaper.
What Is Curve Finance?
Curve Finance launched in January 2020, in the early innings of a period which later came to be known as DeFi Summer. Invented by Michael Egorov and his team of developers, Curve sought to optimize swaps between identically-pegged assets. This niche allowed Curve to become the de-facto stablecoin exchange in DeFi across most Ethereum Virtual Machine (EVM) compatible chains. Beyond stablecoins, Curve is also host to pools holding ETH and its liquid staking derivatives, various wrapped BTC tokens and famously, their tricrypto pool, which holds ETH, Wrapped BTC and Tether.
Source: Curve.fi pools
Like most large DeFi DApps, Curve launched their own token, CRV, allowing major decisions for the protocol to be put to a vote through the Curve Decentralized Autonomous Organization (DAO). Beyond decentralizing decisions, the CRV token also proved to be highly instrumental to Curve’s success due to its unique tokenomics model.
Curve allowed the CRV token to be locked for a specified duration into vote-escrowed CRV (veCRV), which allowed its holders to earn a portion of trading fees on Curve, boost liquidity provision rewards and to vote using their tokens. This was important as veCRV holders effectively controlled where CRV incentives were directed to. This was so crucial to protocol success that several protocols fought over CRV tokens to control liquidity and to direct CRV incentives to their own pools. The battle over CRV incentives later became known unofficially as the Curve Wars.
However, as the 2022’s bear market ravaged on, CRV incentives became less attractive to liquidity providers as CRV price fell. This is a risk to any protocol as less attractive incentives can easily lead to capital flight to better yields which could lead to a negative flywheel.
But in the depths of the bear, the Curve team might have found their answer: crvUSD, a Curve-powered stablecoin.
How Does CrvUSD Work?
CrvUSD is a collateralized-debt-position (CDP) stablecoin by design. Through this mechanism, users deposit collateral in order to take a loan in crvUSD. While not specified yet, crvUSD will likely start by accepting ETH as collateral, similar to DAI by MakerDAO. Eventually, collateral options might include liquidity pool (LP) positions as well.
As with all CDP stablecoins, a robust liquidation system is necessary to ensure timely liquidations against collateral that fall under the liquidation threshold. It is here where Curve showcases their innovation with their proprietary Lending-Liquidating AMM Algorithm (LLAMMA).
Based on the collateral provided, LLAMA fixes specific price bands to liquidate portions of the collateral rather than liquidating fully at a specific liquidation price. This means that as the price of the collateral falls, collateral is being sold for crvUSD. As such, when the collateral value supposedly hits the liquidation point, there will already be enough crvUSD to cover the loan value, averting a typical liquidation scenario. Conversely, as the price of collateral recovers, crvUSD is converted back to the collateral posted.
Source: CrvUSD Whitepaper
In the same situation, a traditional liquidation engine would liquidate the user’s collateral at the liquidation point, leaving the user holding USD positions, less the liquidation fees. In the event that the collateral price bounces back and the user does not actively repurchase their collateral assets, the liquidation locks in the losses for the user’s collateral and causes them to miss out on the subsequent upside.
That said, DeFi heavyweights have pointed out that LLAMMA could potentially lock in losses for the user in the event of a large price swing. Curve has put their LLAMMA to the test on this front, showing that with a price swing of 10% below the liquidation threshold over a period of 3 days, only 1% of collateral was lost.
Source: CrvUSD Whitepaper
Why Is This Important for Curve Finance?
With this model of crvUSD, crvUSD could attract more liquidity providers to provide liquidity in Curve’s LPs to achieve greater capital efficiency with their funds. Coupled with the reduced risk of liquidations with LLAMMA, this could be very enticing for more risk-averse users looking to incorporate elements of leverage in their DeFi strategy.
On the other hand, LLAMA’s constant rebalancing of users’ collateral will generate more trading volume in Curve’s pools, which produces more fees for the protocol and veCRV token holders. Moreover, crvUSD loans will likely also incur borrowing fees, which creates a whole new revenue stream for the protocol and their veCRV token holders.
With these two tailwinds in mind, crvUSD could restart Curve’s positive flywheel and reintroduce new capital to the protocol.
Conclusion
Curve Finance has come a long way since its early days in the beginnings of DeFi Summer in 2020. But even with their dominance, the road ahead is not easy as competitors rise up to challenge their place in the DeFi space. Other dominant players in the space like Uniswap are able to achieve much greater trading volumes and hence fees, with lower capital with their relatively newly implemented Uniswap V3.
However, with the upcoming launch of crvUSD, crvUSD could be the catalyst that Curve needs to revitalize their protocol and enable Curve to stand strong against their competitors to reinforce their position as the giant that they are in DeFi.
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