Aave Governance proposed a new crypto-backed stablecoin, GHO, which could be a game-changer for the DeFi giant. Learn how it works and why it matters.
Aave Governance recently dropped a voting proposal for a new stablecoin: the GHO token. The GHO stablecoin is a cryptocurrency with stability to the U.S. Dollar, which will be owned and managed via the Aave community, who will be voting on the proposal in the coming months. At a time when the blockchain industry is in the midst of a depression following another stablecoin’s death, Terra’s UST, it is important to understand how GHO is different and why it matters.
Aave is a Decentralized Finance (DeFi) protocol that facilitates peer-to-peer lending and borrowing of cryptocurrency and dollar-valued stablecoins. Initially launched as ETHLend, Aave quickly rose to stardom as the second-largest DeFi lending platform due to its ability to provide interest on a wide range of crypto deposits while issuing crypto-collateralized stablecoin loans without any credit or identity checks. Aave is owned and governed by the Aave DAO, a global collective of token holders who vote on proposals to determine the direction and future of the protocol and thus operates like a decentralized bank run by a shareholder democracy.
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According to Aave Governance, the proposal will soon be voted on to determine if the Aave community wants to move forward with GHO’s development. If successful, then GHO will be backed by users’ cryptocurrency deposits in the Aave protocol the same way DAI is backed by user deposits in the Maker Protocol. Initially, GHO will only be available on Ethereum, the home of NFTs and the birthplace of DeFi. Once the system has been developed, the community will vote to expand to other blockchains and “Layer 2” networks, where lower gas fees may find much greater adoption.
A New DAI, Not Another UST
GHO is an example of a crypto-backed stablecoin. It’s a class of stablecoins that are issued as loans backed by collateralized cryptocurrency deposits and are in no way comparable to algorithmic stablecoins such as Terra’s UST, which rely on clever algorithms to manage supply and demand instead of backing assets. The advantage of a decentralized design is that it does not depend on a centralized issuer (such as USDT’s Tether) and cannot be frozen while still being fully backed by important cryptocurrencies with large market caps. Most importantly, they do not require lenders to provide liquidity for borrowers, thus easing a major bottleneck. To date, DAI is the only memorable example of this design, but it has proven its effectiveness and stability many times over and barely twitched during UST’s death spiral collapse.
There are many advantages to Aave creating a crypto-backed stablecoin, especially the ability of the Aave DAO to manage the token’s monetary policy. Specifically, the total supply of GHO that can be borrowed, who/what can issue GHO, and the interest rate charged for borrowing GHO. Interest paid on GHO loans will be paid entirely to the Aave DAO. It will provide an income source of crypto and stablecoin assets that can be used to invest in the ecosystem, innovate new features, or protect the Aave treasury. Aave V3 will also be able to issue GHO as interest payments on deposits, thus paying users in dollar-valued stablecoins instead of volatile cryptocurrencies. The option to borrow GHO would provide greater choice to borrowers and improve stability during periods of high volatility by siphoning away borrowing demand from fatigued stablecoin pools, thus avoiding a hypothetical bank run and an ensuing liquidity crisis.
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According to CoinGecko, stablecoins (presently) amount to a massive $154 billion market capitalization. This is due to their usefulness in hedging against cryptocurrency volatility and serving as a global payment method, but they have found their best use cases in DeFi lending/borrowing dApps. However, the largest crypto-backed dollar stablecoins (USDT, USDC, BUSD) are run by centralized companies backed by cash reserves (somewhat). Therefore, launching a DAI competitor with Aave’s lending/borrowing system makes sense, both in terms of innovation and business strategy. Furthermore, Maker Protocol is often regarded as the “central bank of DeFi,” as its DAI token is currently the only decentralized stablecoin, and Aave could potentially take its place as the DeFi King with GHO.