Why is Aave’s native USD stablecoin GHO always below $1?

Editor's note:

The local stablecoin GHO in the Aave protocol has been consistently below $1 since its launch, currently around $0.96. Liquidity engineer @TokenBrice explained this phenomenon on social media, pointing out the lack of liquidity management. However, he also stated that holding GHO currently has no practical use value other than providing liquidity.

BlockBeats reported on October 16th, that the Aave community has passed an ARFC proposal to "further increase the stablecoin GHO borrowing rate to 3%" to enhance GHO anchoring and increase revenue. On the 17th, the native stablecoin GHO issued by Aave has exceeded 25 million, reaching 25,152,308.

Based on this, @TokenBrice will propose and implement a series of governance DAO measures as a member of the liquidity committee, and promises to raise the GHO price to at least $0.985 within a month. BlockBeats translated the original article as follows:

Original author: @TokenBrice

Translated by: Peisen, BlockBeats

Since its inception, GHO has been trading below its benchmark price (currently around 0.96). You may wonder why and whether this situation will change. The simple answer is that GHO's price fluctuations are due to an imbalance of supply and demand, and this problem is about to be solved. Do you want to know the detailed answer? Please continue reading, a wonderful exploration journey is about to unfold.

Firstly, we need to understand GHO: it is a native stablecoin in the Aave ecosystem that can be minted using any token supported as collateral on Aave. Borrowers are required to pay interest rates determined by governance, while stkAAVE holders can enjoy a discount on those rates. The current interest rate range is 2.13% to 3.05%, and it is expected to increase soon.

GHO Interest Rate Issue

The current situation of GHO is similar to that of Maker/DAI in the early days: its interest rate is determined by governance (without PSM/GSM), which means that GHO cannot naturally adjust under constantly changing market conditions. However, since the birth of GHO, market conditions have undergone significant changes. I have shared my views on this design many times, and there is no need to repeat them here. You can read my blog for more detailed information.

If you want to know why the current interest rate and interest rate model are problematic, the answer is simple: it is still far lower than other alternative solutions, such as borrowing DAI on Maker with an interest rate, or even borrowing other stablecoins on Aave with an interest rate of over 5% for DAI or USDC. This has led to an arbitrage cycle, where stkAAVE holders can borrow GHO at an annualized yield of about 2.13%, exchange it for DAI, and enjoy the DAI savings rate (currently 5%).

As I mentioned earlier, the regulatory authorities are well aware of this issue and are actively working to address it. Therefore, from this perspective, the outlook is positive and it is only a matter of time. Now let's discuss another main topic that explains the current situation of GHO, which is closely related to interest.

GHO Practicality

One effective method to ensure the long-term stability of stablecoins is to give them actual utility value. Indeed, this is crucial for holders who borrow or purchase stablecoins in large quantities and keep them as such assets. For example, the $LUSD stability pool of @LiquityProtocol enables LUSD holders to earn ETH profits from the liquidation process and LQTY profits from the emission process. The stability pool is a special case as it also serves as the main reserve for liquidation on the protocol.

Other CDP protocols have implemented different solutions, but have achieved the same goal of providing practicality for stablecoins, such as the Dai savings rate in MakerDAO: users can stake DAI to earn more DAI.

Although these solutions have their own characteristics, from a macro perspective, they achieve the same goal: to ensure that there is a group of stablecoin holders who are willing to keep them as such assets, that is, not to exchange them for another stable or other asset.

This is exactly what GHO is currently lacking: besides providing liquidity, holding GHO has no practical application value. Therefore, most borrowers who enjoy borrowing costs lower than the market are happy to sell their GHO to another stablecoin in order to earn profits with these currencies, such as DAI.

Now, in this regard, governance has already realized and is considering its options, which mainly include:

1. Add wGHO as collateral on Aave.

2. Provide betting options for GHO holders: GHO savings interest rate.

Now, the stage has been set, and we can talk about my favorite topic: liquidity strategy!

Shortcomings of GHO Liquidity Management So Far

Liquidity management is a challenging game: maintaining a stable balance between expenditure, efficiency, political and market objectives. Without anchored stablecoins (such as GHO), it becomes even more challenging to determine what is necessary and what is harmful.

Actually, despite my complaints about liquidity efficiency issues every day, this is the least of your concerns when formulating a strategy for re-anchoring stablecoins. This is because re-anchoring requires taking some less efficient measures, such as using liquidity outside the range as price support.

Although the GHO Liquidity Committee is composed of experienced professionals, they have fallen into a trap in pursuit of efficiency, which is harmful to anchoring. To help you better understand, let's give some examples.

Support GHO Stableswap Pool

For stablecoins, Stableswap is often considered an excellent liquidity concentration choice: it concentrates liquidity around the 1:1 price, providing significant liquidity depth when all involved stablecoins are actually anchored.

However, if an asset is to be decoupled, the situation will become worse, as Stableswap may actually exacerbate the problem. Why is this? We can observe the liquidity distribution of the main Stableswap pool for $GHO.

Due to the low anchoring price of GHO, the concentration of GHO in the pool is far higher than the target 50%. Assuming the TVL is 10 million for ease of calculation, if all stablecoins are in a perfect anchoring state, there will be approximately 5 million GHO in the pool and 1.33 million of each of the other three coins.

However, in reality, we have about 7.5 million GHO and 2.5 million other coins. From the perspective of buying and selling pressure, this means that there is a surplus of 2.5 million GHO that will be rebalanced to GHO when the price rises. Essentially, it is a sell wall of 2.5 million GHO distributed between GHO prices of 0.95 to 1.00.

For assets with anchor prices that are too low or too high, stableswap is harmful: when the stablecoin anchor price is too high, we observe a similar but opposite effect to the situation with the LUSD Curve pool a few months ago: the paired assets in the pool become heavier. As the LUSD price drops, it can act as a purchasing reserve to prevent its effective decline.

Supports Uniswap V3 pools with 0.95-1.003 GHO

Now, the issue has become more delicate, but the concept remains similar. When the price of GHO is around 0.96, Bunni launched a GHO/USDC pool on Uniswap v3, with a price range set at 0.95-1.003. As usual, to calculate buying and selling pressure, you must calculate the balance of each token. Since the liquidity distribution of Uniswap v3 is linear, you need to find our current position within the range (in terms of price) in order to calculate the balance. This is actually quite simple!

The uniqueness of DeFi lies in the fact that everyone can watch, verify, and participate in the live activities. Regardless of your views on GHO, it is strongly recommended that you closely monitor the developments here in the coming weeks, as the ongoing experiments are of unprecedented scale.

What's even more exciting is that you can not only be an observer, but also actively contribute to these efforts. Here are some feasible ways:

1. If you have idle USDC, you can pay attention to the upcoming Maverick mining pool similar to BP#57 and provide funds for it. In the process, you will also receive considerable returns.

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