The crypto market thrives on stablecoins.
With only 9,4% of total crypto market share they make up a good 85% of the total trading volume. And their growth correlates with DeFi´s Total Value Locked (TVL) growth.
The ratio of TVL to stablecoins seem to not go much beyond $2 in TVL to $1 in stablecoins. So for TVL to increase, stablecoins need to increase. But stablecoin growth crashed since Q2 2021.
Jim Bianco argues that centralized stablecoins like USDT & USDC (which make up 82,6% of the whole stablecoin market) will not be able to grow enough to support the DeFi ecosystem´s growth. Reason being that regulators might not let centralized companies like Circle (USDC) grow into the trillions due reasons like skepticism. So Crypto needs another stablecoin model.
And this model comes as algorithmic stablecoins.
As the name suggests, these stablecoins work through an algorithm (smart contract), that regulates their supply, not a centralized company in the back.
They are free of the centralization risk, which can come from regulation, freezing accounts, hacks, or mistreating funds. This increases their scalability.
But despite this advantage, algorithmic stablecoins only make up about a fifth (17,4%) of the whole stablecoin market. And they also come with their share of problems.
To understand these, we have to divide these stablecoins into their three broad categories:
Here you lock up capital (e.g. ETH) to borrow the stablecoin against. Think of DAI, FEI, or MIM.
Take DAI for example. Using Maker´s ETH-B pool to borrow DAI against your ETH, you have a 130% collateralization ratio at a 4% annual fee . So for every $1 of DAI you need to lock up $1.3 of ETH and pay a 4% annual fee. You have to overcollateralize. And overcollaterization is capital inefficient, which also limits scale.
Collateralization needs a deeper dive before going on with the two other models.
You holding a stablecoin like DAI generally means one of two scenarios (or both):
You borrowed DAI from a protocol like Aave at a variable or fixed interest rate. This interest rate gets you an explicit cost.
You deposited ETH as collateral to mint DAI, or sold/swapped an asset for it. Holding it gets you an implicit opportunity cost, because you´re not lending it out for high yield.
Stablecoins currently have negative carry, which is when the cost of holding an asset is greater than the income you get from holding it.
(Rationally) The only compelling thing you can do with your stablecoins is to lend them out for a return, rather than using them (because of the implicit or explicit costs).
Have you ever wondered how it´s possible that you can get 8% APY on your Stablecoins on BlockFi?
It´s because the demand for stablecoins is too high for the current supply. There´s not enough supply to meet demand, resulting in 10%+ borrowing cost. Contrast that to the near zero interest rates you get at traditional banks.
The collateral requirements contribute to the low supply growth, which results in negative carry and the high borrowing costs. That´s the biggest problem collateralized stablecoins (both centralized and uncentralized) face.
These models maintain the peg via two separate tokens. Think of UST with LUNA, and FRAX with FXS (although FRAX is partially collateralized).
Let´s take UST as example. You can always exchange 1 UST for $1 worth of LUNA. So if UST dips below $1, Arbitrageurs can make a profit by buying and swapping it for LUNA until it reaches $1 again. Same thing goes for when it´s above $1.
A big risk for these is a drop in both token prices, which can result in a bank run.
We´ll continue with LUNA. If people sell large amounts of UST, LUNA would start dropping. The decreasing prices cause a further decrease in LUNA´s trust and demand. This causes more UST sell-offs and downward price pressure on LUNA, creating a negative feedback loop. If you think a contraction comes, it makes sense to burn your UST into LUNA and sell your LUNA.
One way UST combats this threat is with its recently raised Bitcoin reserves.
By far the most unexplored and smallest stablecoin category.
These stablecoins rely solely on credit, with no collateral. This (in theory) makes them infinitely scalable. But they´re also at the risk of bank runs. And because they have no collateral, there´s no backstop for them.
The first big examples for this model were ESD & DSD. But none of these stablecoins held their peg for more than 3 months before crashing to near zero $ levels.
But one credit based protocol is still maintaining its peg after seven months, the Beanstalk Protocol with it´s BEAN stablecoin.
Beanstalk is an Ethereum based stablecoin protocol that issues the credit based BEAN stablecoin. Essentially, it works like this:
When the BEAN price is above $1, the protocol mints new BEANs and distributes them to ecosystem participants, lowering the price back to $1. And when the price is below $1, Beanstalk incentivizes users to buy BEANs off the market and lend them to the protocol, decreasing the BEAN supply and raising the price back to $1.
To accomplish all this, Beanstalk uses the following three core mechanisms and a whole lot of farming terminology.
Because Beanstalk is filled with specific terminology, here´s a short reference table for you:
Sowing Beans = Lending your BEANs to the protocol
Pods = The debt asset of Beanstalk. You get Pods for sowing Beans. How many you get depends on the Weather.
Pod Line = All of Beanstalk’s debt. Pods become harvestable (redeemable 1:1 for Beans) in First In First Out order when the Bean supply increases.
Weather = The interest rate for sowing Beans.
Soil = The amount of debt that Beanstalk is willing to issue. You can only Sow Beans when there is Soil.
Season = Beanstalks time-keeping unit. 1 Season is 1 hour. At the beginning of every Season, the Weather may be adjusted, Soil may be issued, and new Beans may be minted.
Beanstalk creates its own on-chain price oracle by comparing the time weighted average BEAN:ETH and USDC:ETH Uniswap pool ratio. The price of 1 BEAN is $1 when the two pool ratios are identical.
The Silo is where governance takes place. Participating is pretty straightforward:
You deposit BEANs (or ETH which gets converted into BEANs) in the Silo.
In return, you get both STALKs and SEEDs.
SEEDs give you 1/10.000th STALK every Season.
STALKs give you 1) the right to vote on and create governance proposals 2) a share of all future BEAN supply increases.
You can withdraw your siloed BEANs anytime, but have to return all your STALKs, SEEDs and the STALKs gained from SEEDs to do so. 50% of every new BEAN supply goes to the Silo for STALK holders.
Example - Deposit: The Stalk supply is 75 and you deposit 25 BEANs into the Silo.
You get 25 STALK and now own 25% of the total STALK supply.
This entitles you to 25% of all future Bean mints allocated to the Silo.
Example - Withdrawal
Silo withdrawals happen on a Last In First Out basis. Each deposit you make carries a Season ID of when it was deposited. This is to reduce the amount of Stalk and Seeds you need to burn (since older deposits will have more Grown Stalk than newer deposits).
Example (simplified):
Season 5000: You deposit 1000 BEANs in the Silo and receive 1000 STALKs & 2000 SEEDs
Season 5001: You receive 10 BEANs because of supply expansion. Those 10 BEANs also get you 10 STALKs and 20 SEEDs. Now you have 1010 BEANs, 1010 STALK, 2020 SEEDs and 0.2 STALK grown from your SEEDs.
Season 5002: You withdraw 10 BEANs. This burns 10 STALKs and 20 SEEDs. The rest is still intact.
The Field is where peg maintenance takes place. You participate by buying debt positions called PODs. There are three steps to this process:
First, the Soil. When Beanstalk is willing to issue debt (PODs), it produces Soil. Soil determines how much PODs the protocol is willing to sell. It issues the amount of Soil that would be required to bring the price of Bean back up to $1.
Second, the Weather. Beanstalk measures the Oracle´s Time Weighted Average Price (TWAP), the debt level, and the change in demand for Soil to define the interest rate (Weather). If people don´t sow into the Soil to bring the price back up to $1, Beanstalk raises the Weather. If Soil is hitting zero at the beginning of a Season, it lowers the Weather.
Third, the PODs. You buy PODs from the protocol with BEANs. Those BEANs are now taken out of the supply. The PODs have no expiry date, but a fixed interest rate determined by the Weather. They´re paid out (become harvestable) on a first in, first out basis (this creates the POD Line). So if you were the first POD buyer, you also were the first in the POD line. You can redeem harvestable PODs 1:1 for BEANs. 50% of every BEAN supply increase goes to paying back POD holders. You can also buy and sell PODs on a secondary market.
Example:
The Weather is 7.100%.
There´s 10.000 Soil.
The Pod Line is 635M long.
You sow 2000 BEANs. Now:
There is 8.000 (10.000 Soil - 2.000 BEANs) Soil left.
You receive 144.000 Pods (2.000 BEANs * (71 + 1) at 670M in the Pod Line
Your Pods are at 670M in the Pod Line. So the Bean supply needs to increase by 1.340M for your Pods to get to the front of the line and you being able to harvest them. Remember, 50% of new BEANs harvest PODs at the front of the line, and the other 50% go to STALK owners.
Based on the Oracle, Silo, and Field, Beanstalk maintains the peg by changing 4 different parameters.
These peg maintenance parameters are:
changing the BEAN supply
changing the Soil supply
changing the Weather
selling BEANs on Uniswap
When the BEAN price is below peg, Beanstalk:
Increases the Soil supply.
Raises the Weather.
By increasing the Soil and raising the Weather, Beanstalk decreases the BEAN supply and brings the price back to its peg.
And when the BEAN price is above peg, Beanstalk:
Increases the Bean supply.
Lowers the Weather.
Sells BEANs on Uniswap.
By increasing the BEAN supply and lowering the Weather, Beanstalk brings the BEAN price back to its peg. And as a fail safe mechanism for times of inorganically high demand (people buying BEANs over $1 for multiple Seasons), Beanstalk has the Season of Plenty. Here, the protocol mints BEANs and sells them on Uniswap for ETH, distributing that ETH to Silo Members.
The primary way for Beanstalk to fail would come in no attracting enough Sowers (people buying PODs) to lift the price back up.
The two ways you can profit from Beanstalk are
Depositing BEANs into the Silo for STALK & SEED to gain BEANs on supply increases
Buying PODs with BEANs to profit when/if the protocol grows enough for your PODs to become harvestable.
There was no Pre-Mine, Pre-Sale, nor a Team allocation. All circulating BEANs come from:
Deploying the contract. Here the first 100 BEANs were minted.
Protocol native inflation. It comes as a reward for manually calling the so called
sunrise()function. This function starts the new Season and can only be called once an hour. The caller gets a BEAN reward which starts at 100 BEANs and increases exponentially every second up to a maximum of 2,000 BEANs.Peg Maintenance. Beanstalk increases the supply by the time weighted average shortage of Beans in the liquidity pools over a given Season.
The founding team behind Beanstalk is anonymous under the alias Publius, similar to OHM´s founder OHM Zeus. In a Podcast, they mentioned starting the project around Thanksgiving 2020 after following the launch and design of ESD. They still own the Beanstalk smart contract via a multisig on the address 0xefd0E9ff0C4E1Bee55Db53FDD1FAD6F6950CeD0b.
Besides Publius, Beanstalk also has a decentralized contributor community called Beanstalk Farms with a mix of 25+ full- and part-time contributors.
Publius also was the psuedonym of the Federalist Papers authors like Alexander Hamilton, the first secretary of the treasury. Him being a big influence to the team, they start the whitepaper with his quote:
“A national debt if it is not excessive will be to us a national blessing; it will be powerful cement of our union.”
At the core of Beanstalks governance are the STALK owners. They vote on and create Beanstalk Improvement Proposals (BIPs) or Fundraisers.
Anyone with min. 0.1% of the total outstanding Stalk supply can create a BIP.
For a BIP to pass, it must receive either
more than a 50% majority at the end of its 168th Season (1 Week) Voting Period
more than a 66.66% supermajority at any point 24 hours or more after proposal and before the end of the Voting Period
BIPs cannot pass in under 24 hours.
Beanstalk was deployed on the Ethereum main net on August 6, 2021.
By holding its peg for over 7 months, it lasted more than double the life span of prior stablecoin projects like ESD, DSD & Basis Cash.
BEAN maintained relative stability since its inception and recovered from two major depegging events as seen in the chart above.
And its market cap grew to $43mil since inception.
The correlation between the ETH and BEAN prices also decreased over time.
Another trend so far was the total liquidity increasing after each demand shock, compared to pre-shock liquidity.
Soil supply became more efficient over time.
the implementation of the efficiency-related Beanstalk Improvement Proposals (BIPs) — BIP-2 and BIP-6 — increased demand for Soil, and that since early January, when the BEAN:3CRV pool was created and BIP-9 was implemented, the available Soil has been close to zero. Source
So far, Beanstalk has issued over $672 million of debt, despite paying back only $23million of debt.
All in all, Beanstalk held it´s peg, decreased its volatility and became more efficient over the last 7 months, but racked up a hefty amount of debt.
Beanstalk´s Roadmap for 2022´s first half is full of developments. Some of the plans are:
Audits by Omniscia in Q1 (report will be published in April) & Trail of Bits in June
Integrating multiple LP Pools into the Price oracle, like the BEAN:3RCV Pool In the not too distant future, the BEAN:3CRV pool will also likely be used for minting in a similar fashion. Using both a TWAP and only factoring in the amount if liquidity in the Silo into the calculation (which is locked for a period of time) makes Bean minting resistant to flash loan
Integrating more assets into the Bean Farm besides ETH & BEAN
STALK as liquid ERC-20 token (and possibly SEEDs)
Silo Deposits as ERC-1155 tokens
Various Gas Optimizations
Creating the Diamond Foundation together with Nick Mudge (EIP-2525 Diamond Standard creator) to further development and adoption of the Diamond Standard which Beanstalk is built on
Beanstalk wants to become the defacto DeFi stablecoin.
And a decentralized, credit-based stablecoin like BEAN (in theory) seems superior to existing models, especially to collateralized stablecoins like USDT, USDC, and DAI.
It´s without centralization risk.
The growth of Beanstalk directly benefits users by distributing yield back to anyone placing their BEANs in the Silo or Field.
If widely adopted, it will be cheap to use.
Since BEAN has no collateral, it can mint enough BEANs to meet demand, no matter how big demand gets. And once demand is met, there will be no new supply of BEANs. Then there´s no more use in leaving the Beans in the Silo or Field (since there´s no more yield).
This should culminate in there being no underlying borrowing cost to using BEAN.
Beanstalk is still a long way off of reaching its vision of becoming the defacto DeFi stablecoin. And there are sill risks and uncertainties.
First, the protocol code is novel and still unaudited, but audits are already underway.
Second, and by far the biggest risk, adoption. Since Beanstalk is a credit based stablecoin, it relies on a decentralized community of creditors to maintain BEAN price stability. So it fails if it can no longer attract creditors, if it can´t gain widespread adoption and trust. This is true and a hurdle for every protocol, since no protocol nor fiat currency can succeed without trust & adoption. And a Black Swan can always lead that trust and the value to collapse. Just look at the Russian Ruble. It lost over 53% of its value between February 28th and March 7th with the invasion and sanctions.
If Beanstalk reaches its vision, it could become a cornerstone of the crypto market and support it in growing to new heights. However, that´s still a long tractor ride away. So ultimately, Beanstalk´s success depends on it being trusted and adopted across DeFi and attracting creditors.
But with Beanstalk becoming the longest lasting credit based stablecoin project, it´s off on a successful start.
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