GHO: A Decentralized Multi-Collateral Stablecoin by Aave

What is GHO?

GHO is a stablecoin developed by the Aave protocol team. It is pegged to the US dollar and users can mint GHO by supplying any (or a combination) of the approved collateral assets. 

Key Takeaways

• GHO is a collateralized decentralized stablecoin developed by the Aave protocol team and managed by the community through a DAO. It is pegged to the value of the US dollar.

• GHO is backed by a basket of assets selected by the DAO. Any or a combination of the approved collateral asset is supplied by the borrower during the issuance. Issued GHO stablecoins are burned when the loan is repaid, or the borrower is liquidated.

• GHO operates via trustees known as Facilitators who are selected by the DAO to execute the minting and burning operation. Facilitators are regulated via limits known as Buckets.

• Through the GHO stablecoin, Aave hopes to develop a stablecoin that alludes to the virtues of blockchain technology; community control, transparency, and flexibility. GHO is also designed to return financial benefits to the Aave DAO through interest generated from borrowers.

Stablecoins control a market cap of over $127 billion, according to data from CoinGecko at the time of writing. They represent an important category of crypto assets, not only because of the liquidity they add to the cryptocurrency market but also for the utilities they offer to routine traders and new investors. Stablecoins are pegged to the value of a commodity or fiat currencies, and stablecoins pegged to the US dollar are the most popular, playing (almost) the same role as their peg currency in the general crypto market.

But despite reaching considerable heights and some stablecoins growing into the elite ranks of crypto assets in terms of market size, stablecoins are still a concept in development. Centralized and decentralized stablecoin projects are growing to meet up with the technological and administrational demands of the contemporary crypto space and the world outside it. In light of this, the Aave team, in a publication made on July 7, 2022, detailed the mechanics of GHO – a proposed decentralized stablecoin that operates on the Aave protocol. 

In this article, we’ll look at the GHO stablecoin, and how it works.

Understanding GHO and Aave

GHO is a stablecoin pegged to the US dollar launched by the Aave protocol team on the Ethereum mainnet. GHO allows users to mint the GHO stablecoin against supplied collateral, which ensures that every GHO minted is backed by at least an equal value of assets held on the protocol’s contract. By minting the GHO stablecoin, holders seek to utilize a relatively more stable asset than their collateral and operate through a low volatility medium. 

As GHO is decentralized, all assets backing GHO are verifiable by on-chain data, offering improved transparency as opposed to other centralized stablecoins like USDT and USDC.

According to the team, the GHO stablecoin is designed to provide more stablecoin options for users and make stablecoin borrowing on the Aave protocol more competitive. The stablecoin is also intended to generate revenue for the Aave DAO through interest paid by the lenders. 

Fun fact: The GHO ticker is derived from GHOST ( Aave is the Finnish word for Ghost ).

The bulk of GHO’s operation will be on Aave, but what is Aave?

What Is Aave?

Aave is a decentralized lending protocol, launched first on the Ethereum blockchain and later on deployed on other networks. Aave operates on the Fantom Opera chain, Avalanche and Polygon networks, and Ethereum Layer 2 networks Arbitrum and Optimism. 

It offers cryptocurrency and mainstream investors an avenue to access loan facilities without having to go through third parties. Aave runs on smart contracts that define the collateral, lending, repayment, and interest system for every loan operated through its platform.

Aave operates an open liquidity system, which powers its decentralized lending protocols. The open liquidity system means anyone can contribute to the protocol’s lending pool, and in the same way, anyone can take loans from the pool. 

Contributors to the pool are the lenders, and they generate revenue from interest paid by borrowers. Borrowers commit their collateral to the pool and take the asset they wish to borrow. In return for this service, they pay interest at a rate defined by the protocol. The interest percentage paid could also differ across assets. Factors affecting this might include volatility of the borrowed asset, volatility of the collateral, or availability of assets in the pool.

To mitigate the volatility of cryptocurrencies, Aave operates an overcollateralized loan system. This means that to borrow an asset from the Aave lending pool, the borrower must provide collateral higher in value than the asset they wish to borrow. For instance, to borrow $100 worth of USDT from the Aave protocol, a total worth of about $130 in collateral must be provided.

Aave offers lending services for crypto assets and real-world assets (RWA) like real estate, cargo, and payment advancements. To operate non-crypto asset tokenization and lending, Aave partners with Centrifuge, an on-chain ecosystem for structured credit.

The Aave ecosystem is furnished by the Aave token (AAVE). AAVE is the utility and governance token of the Aave protocol, where AAVE holders make up the Aave DAO. The DAO members vote on improvement proposals and dictate the direction of the project. 

Now, let’s look at how the GHO stablecoin works.

How Does GHO Work?

Based on the GHO stablecoin proposal, there are four key areas to take note of:

• A collateral system

• A minting and burning mechanism

• A facilitator and a bucket

• An interest and discount system

The collateral system defines the asset supply strategy for the stablecoin’s operation. To ensure that the stablecoin is fully backed, anyone who wishes to mint GHO must supply collateral. A collateral ratio is also defined and delineates the fraction of the collateral constituted by each asset in the basket.

According to the proposal, the Aave DAO will vote on a set of assets that will make up the collateral options. Assets provided as collateral on the protocol must be from this approved list. The basket of assets will also consist of relatively stable assets; this is in an attempt to protect the protocol from extreme volatility. To further protect against volatility, minting GHO requires over-collateralization, where borrowers will have to supply collateral higher in value than the amount they wish to borrow, and the percentage of extra collateral will also be determined by the DAO.

The proposed minting and burning mechanism for GHO ensures the smooth operation of the stablecoin’s system. New GHO stablecoins are minted when a borrower provides collateral; the collateral is held on the protocol’s contract, and the borrower can mint the allocated amount of GHO. The collateral stays on the smart contract until the borrower repays their loan or gets liquidated. On this occasion, the allocated GHO is burnt, and the collateral becomes available to the borrower or the liquidator.

To keep the stablecoin protocol in check, the Aave protocol elects facilitators. Facilitators are entities with the authority to mint and burn GHO tokens. 

Source: https://governance.aave.com/t/introducing-gho/8730

According to the proposal, elected facilitators will be able to apply their own strategies to the minting and burning of GHO tokens. The Aave protocol will be the first facilitator to be activated in case the proposal passes. Facilitators are also defined by the bucket allocated to them, where a bucket is the maximum number of GHO tokens that can be minted by each facilitator. The bucket allocated to each facilitator is approved by the Aave DAO.

Source: https://governance.aave.com/t/introducing-gho/8730

GHO will also generate revenue for the Aave DAO, as interest rates will be applied to borrowed/minted GHO, which is paid to the Aave DAO. Information from the proposal suggests that the interest rate will be stable but could change according to market conditions, as decided by the Aave DAO.

However, a certain class will be able to enjoy discounts on interest rates. A partial discount will be applied to borrowers who are part of the Aave Safety Module. Safety Module Participants are stkAAVE holders; this represents AAVE tokens staked on the Safety Module. At the time of writing, the discount is 30% and applies to 100 GHO for every 1 stkAAVE held, although the discount strategy will be stipulated by the Aave DAO.

Now that you understand how the GHO is proposed to work, here are some use cases for GHO.

What Can GHO Be Used For?

As a stablecoin, GHO exists between crypto assets and fiat currency, with a value equal to the US dollar and tightly maintained around that figure. Because of this, GHO has potential use cases across the crypto space and mainstream systems. Some of these include:

A Stable Value Asset

A major use of stablecoins is to store value in between trades, as cryptocurrencies are volatile and values can swing drastically in a short time. Through stablecoins, investors can preserve value by converting to a more stable currency.

There is also the possibility of introducing real-world assets (RWA) as collateral to GHO, where users from other sectors can then easily make their way into the crypto space by obtaining the GHO when they lock their RWA. The obtained GHO will in turn make it easier for them to purchase other crypto assets.

Profit Generation Through Arbitraging

Every GHO token is fully backed and is, therefore, redeemable for a basket of assets. While GHO is designed to maintain a stable price, there could be periodic and significant shifts. Arbitraging helps restore the price in cases like this and can also reward the arbitrager handsomely. One way to put GHO tokens to use is by trading them against situations like this and generating profits.

When GHO trades below $1, borrowers are incentivized to repay their loans by purchasing GHO below the dollar price to repay their loans at $1 per GHO. When GHO trades about $1 users are incentivized to borrow from the protocol. That is, users can borrow GHO at $1 each and sell on the open market at prices above $1.

For instance, in a situation where GHO trades around $0.95 in the market, a user with an unpaid loan of 1,000 GHO can purchase 1, from the open market for $950 and repay their loan, saving $50.

GHO vs. USDT

USDT is currently the largest stablecoin based on market cap, ranking third in the overall cryptocurrency market. With over $83 billion worth of US dollar-pegged stablecoins minted over the past nine years, USDT controls the largest share of the stablecoin market. It is also the most paired crypto asset and records an average of $10 billion in daily trading volume.

Here's a summary of the key differences between GHO and USDT:

Issuance and Backing

USDT issuance and management are piloted by Tether, which defines the procedure for minting and redeeming USDT stablecoin. USDT is backed by fiat money, cryptocurrencies like Bitcoin, real assets such as bonds, and precious metals like gold. These assets are held in banks, and the project’s treasury, and Tether claims that USDT can be redeemed at will for these assets. To issue USDT, the client (this can be Tether itself) sends cash or the cash equivalent of the USDT they wish to be issued to Tether’s reserves. USDT is then issued and sent to the client’s wallet. 

In comparison, GHO issuance is automated by smart contracts, and GHO is backed, also by a basket of assets, but this is mostly cryptocurrencies. As mentioned above, the minting and redemption procedure for GHO is designed to be self-functioning, where the collateral is held in a smart contract and will be released upon the return of the borrowed GHO.

Governance

USDT is centralized, where Tether oversees every aspect of USDT’s operation. 

Unlike USDT, GHO is a DAO-managed decentralized stablecoin. The affairs of GHO are vested on the Aave DAO, which defines, through community voting, the core aspects of the stablecoin. The Aave DAO will be able to adjust parameters such as interest rates and collateral ratio, along with selecting facilitators and their allocated buckets.

Interest Bearing

By design, GHO operates as a loan and collateral system. Every GHO token in circulation is a loan, where the basket of assets supplied during the minting is collateral for the minted coins. In this light, an interest rate accompanies every minted GHO, except in cases where the borrower receives a 30% discount for staking their Aave on the Safety Module. 

GHO was meant to generate revenue for the DAO. However, assets supplied to mint USDT are known as reserves and every USDT in circulation is a plain asset, although independent projects might offer USDT lending facilities with interest rates.

Multichain operation

USDT can be minted on several blockchain networks including Ethereum, Bitcoin, Tron, Algorand, and Polygon networks. Tether has also shared plans of expanding to other networks in the future. USDT on these chains are not bridged assets. 

Despite operating on multiple networks, Aave suggests that the GHO minting will be localized on the Ethereum network and bridged to other networks based on information from the official proposal. This could change in the future, but at launch, the Ethereum network is expected to take full responsibility for GHO minting.

GHO vs. DAI

Aave’s GHO is very similar to DAI; DAI is an overcollateralized stablecoin issued by Maker protocol and managed by the Maker DAO powered by MKR. Based on plain principles, both decentralized stablecoins are closer to each other than the previously described USDT. But they still share a handful of differences in their core operation, as summarized in the table below:

Minting Mechanism

DAI and GHO operate the decentralized minting and burning mechanism; however, while DAI operates a vault-specific minting, GHO will operate a position-based minting. 

DAI’s vault-specific minting means that the assets in the DAI vault dictate the amount of DAI in circulation. For every DAI minted, a corresponding value of a collateral asset(s) is deposited in MakerDAO’s vault. This is referred to as Collateralized Debt Position (CDP). 

Position-based minting takes a slightly different approach which, according to the proposal, is more resource efficient. When a borrower commits an asset to the GHO smart contract, they take a position on the protocol; this position is equal to the value of their collateral, the borrower can then mint GHO (gradually or all at once) against this position. The GHO in circulation is a representation of the minted stablecoins but not necessarily equal to the total value of assets held in the vault.

Collateral Assets

Like GHO, DAI has selected a basket of assets that can be provided as collateral, including Ether, LINK, WBTC, along with selected real world assets. 

GHO will attempt to operate a more diverse and decentralized collateral pool by accepting native cryptocurrencies and not centralized stablecoins. The GHO proposal hints that assets accepted on Aave’s lending protocol will also be accepted as collateral for GHO. This will see assets like Ether, AAVE, and other native cryptocurrencies become part of the collateral pool for GHO. As mentioned above, there’s also the possibility for future inclusion of RWAs as collateral for GHO.

Interest System

GHO, at launch, will become a source of income for the Aave treasury. Interest paid by every borrower drips down to the treasury where it will likely be utilized to further develop the protocol as decided by the DAO. 

DAI also operates an interest system through the DAI Savings Rate (DSR) where DAI holders deposit their stablecoin and earn interest. However, this interest is reserved for the holders and not the DAO although the DAO decides on the interest rate in line with market conditions.

Final Thoughts

Stablecoins make crypto go around. Unfortunately, nine years after the launch of the first major stablecoin and over $120 billion in cumulative market capitalization, stablecoins are still far from perfect. This is considering the commendable developments in this space and the fact that there are no perfect systems. Each stablecoin falls short in at least one of such areas as stability, transparency, sustainability, and ease of adoption. Compliance with traditional financial regulation is also an important one.

A working stablecoin is expected to maintain its peg in the harshest market conditions and operate an open financial and technological system where holders and the general community can verify its operations and mechanism. Aave, through the GHO stablecoin, will attempt to develop a transparent, accessible, and (possibly) stable stablecoin. We have discussed its mechanisms and compared it to some older and similar stablecoin projects. The GHO development team hopes to apply their knowledge of blockchain technology, crypto, traditional finance, and decentralized finance towards achieving this goal.

Are you looking to explore the GHO stablecoin and its mechanism? It is recommended that you understand the theories and how it interacts with other systems. Note that no protocol is without risks, and mishaps are hardly reversible. Risk management strategies are advised. Also, note that this article is only for educational purposes and not financial advice.

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Joel Agbo

Joel is deeply interested in the technologies behind cryptocurrencies and blockchain networks. In his over 7 years of involvement in the space, he helps startups build a stronger internet presence through written content. Follow the author on Twitter @agboifesinachi