Stablecoins Based on Debt or Collateralized Debt Positions (CDPs)
In the rapidly evolving world of decentralized finance (DeFi), stablecoins have become a cornerstone for providing price stability and liquidity. Among the various mechanisms for creating stablecoins, Collateralized Debt Positions (CDPs) [1] stand out as a decentralized method that allows users to lock up cryptocurrency assets as collateral to mint stablecoins. This article explores the prominent stablecoins that utilize CDPs or debt-based mechanisms, highlighting their protocols and key features.
What is a Collateralized Debt Position (CDP)?
A CDP is a smart contract-based system where users deposit cryptocurrency, such as Ethereum (ETH), as collateral to borrow stablecoins. These stablecoins are typically pegged to a fiat currency like the U.S. dollar to maintain price stability. The collateral must exceed the value of the borrowed stablecoins, often by a ratio of at least 150%, to protect against market volatility. If the collateral's value falls below this threshold, the position may be liquidated, with the collateral sold to repay the debt and associated fees. This mechanism, pioneered by MakerDAO, has become a foundation for several stablecoin protocols in DeFi.
Prominent CDP-Based Stablecoins
DAI (MakerDAO / Sky)
DAI, one of the most well-known decentralized stablecoins, is issued through MakerDAO’s CDP system [2], now part of the rebranded Sky protocol. Users lock up assets like ETH, Wrapped Bitcoin (WBTC), or USDC in a smart contract to mint DAI, which is pegged to the U.S. dollar. The collateral must maintain a minimum 150% collateralization ratio to avoid liquidation, with a 13% liquidation penalty and an 8.5% annual stability fee applied if undercollateralized. Initially limited to ETH, MakerDAO now supports multiple assets, including BAT, TUSD, and MANA, with nearly 440 million DAI in circulation as of early 2022. DAI’s decentralized nature and robust adoption make it a staple in DeFi for trading, lending, and liquidity provision.
LUSD (Liquity)
Liquity is a decentralized lending protocol that issues LUSD [3], a stablecoin backed primarily by ETH collateral. Unlike traditional CDP models, Liquity offers a lower minimum collateralization ratio of 110%, making it more capital-efficient. Users mint LUSD without ongoing interest fees, paying only a one-time issuance fee. Liquity’s stability pool, funded by users depositing LUSD, enhances system resilience by covering liquidations. This innovative approach has positioned Liquity as a strong contender in the CDP-based stablecoin space, with plans for further enhancements in its upcoming v2 release.
DUSD (Davos Protocol)
Davos Protocol introduces DUSD, a stablecoin minted through CDPs [4] that accept a variety of cryptocurrencies, including Liquid Staking Tokens (LSTs) from platforms like Lido Finance and Rocket Pool. This allows users to earn staking rewards on their collateral while accessing DUSD for trading or yield farming. Davos Protocol’s unique mint-and-burn strategy and integration of reward-bearing tokens enhance capital efficiency and provide additional incentives, making DUSD a versatile option in DeFi.
crvUSD (Curve)
Curve’s crvUSD is a newer entrant in the CDP-based stablecoin market, gaining traction with over 100 million in circulating supply. Integrated with the Curve ecosystem, crvUSD benefits from a soft liquidation model that offers flexibility in collateral management. This model reduces the risk of abrupt liquidations, making it attractive for users seeking stablecoin liquidity while managing volatile assets.
mkUSD (Prisma Finance)
Prisma Finance issues mkUSD through CDPs collateralized by liquid staking derivatives, allowing users to mint stablecoins while retaining exposure to Ethereum staking rewards. With over 100 million in circulation, mkUSD leverages incentive programs and integration with the Curve ecosystem to drive adoption. Prisma’s multi-collateral support and focus on staking synergy make it a promising player in the CDP stablecoin space.
SAI (MakerDAO)
SAI, also known as Single-Collateral DAI, is an earlier decentralized stablecoin from MakerDAO backed solely by ETH. While largely replaced by the multi-collateral DAI, SAI remains notable for its role in the early adoption of CDPs in DeFi. It operates similarly to DAI but with a more limited collateral base.
Benefits and Risks of CDP-Based Stablecoins
CDP-based stablecoins offer significant advantages, including access to liquidity without selling assets, the ability to leverage holdings for investment opportunities, and decentralized operation via smart contracts. However, they come with risks such as liquidation due to collateral value drops, smart contract vulnerabilities, and market volatility. Users must actively monitor their collateralization ratios to avoid penalties, which can include liquidation fees and stability fees, as seen with DAI’s 13% penalty and 8.5% annual fee.
The Future of CDP-Based Stablecoins
The success of CDP-based stablecoins like DAI, LUSD, and emerging options like crvUSD and mkUSD underscores their importance in DeFi. Protocols are exploring innovations such as lower collateralization ratios, cross-chain compatibility, and privacy-enhanced transactions, as seen with potential CDP implementations on networks like Oasis Sapphire. As DeFi continues to grow, CDPs are expected to remain a cornerstone, offering flexible and secure solutions for stablecoin creation and decentralized lending.
Conclusion
Stablecoins backed by CDPs, such as DAI, LUSD, DUSD, crvUSD, mkUSD, and SAI, represent a transformative approach to decentralized finance. By allowing users to mint stablecoins against crypto collateral, these protocols provide liquidity and flexibility while maintaining asset ownership. As the DeFi landscape evolves, CDP-based stablecoins are poised to drive further innovation, balancing opportunity with the need for careful risk management.