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This is a comprehensive guide to get you up to speed on Beanstalk. To take you from “What is a stablecoin?” to “Holy shit, Beanstalk is going to change everything”. If you aren’t familiar with the concept of DeFi, start here. Onwards.
What is a stablecoin?
Types of stablecoins
Centralized, collateralized stablecoins
USDC, USDT, BUSD, etc.
Decentralized, collateralized stablecoins
DAI, MIM
Introducing Beanstalk
How Beanstalk works
The Field
The Silo
Other decentralized algostable models
ESD, DSD, Basis Cash
FRAX, UST
Beanstalk today and in the future
An outdated midwit criticism of crypto was that the larger, traditional crypto assets like BTC and ETH are extremely volatile, thus they weren’t a useful form of money. For example, how many merchants would accept a currency that might drop 20%+ between accepting the payment and paying an employee? Not many. So the stablecoin was born.
A stablecoin is a blockchain-based asset that is designed to be worth (pegged to) the value of some non-blockchain-based asset, like the dollar, the euro, gold, etc.
By far the most popular stablecoins are dollar-pegged stablecoins. This is a reflection of the reality that the world economy generally runs on dollars. If you live in the U.S. you pay taxes in dollars, buy groceries with dollars, and denominate your net worth in dollars. Even if you don’t live in the U.S., the value of foreign currencies is denominated in dollars. For central banks outside the U.S., it is common practice for most reserves to be held in dollars since it is the most traded currency in the world. Similarly, everything in crypto is denominated in dollars. This makes the dollar a good unit of account, an important characteristic of money.
How is a dollar-pegged stablecoin different from the dollar? You get all the benefits of a blockchain-based asset with the price stability of the dollar—benefits like:
Near-instant settlement (vs. 3-5 business days over ACH)
Borderless transactions
And of course, programmable money—developers can build arbitrarily complex (or simple) financial applications in this open system where you don’t have to get permission from a centralized entity to build new things
Stablecoins have now been around for a few years and the market cap of stablecoins increased around 500% in 2021 alone.
There are many use cases for crypto that simply can’t exist without stablecoins. Here are a few:
Prediction markets: Augur, a decentralized prediction market, was a compelling early use case for crypto. But you had to denominate your bids in ETH, which might drop after putting up your bid, completely changing the types of predictions users are willing to make. Better to use stablecoins that store value more reliably and allow for a greater spread of bets. (Augur made this switch in 2019.)
Payments: mentioned earlier, merchants won’t accept a volatile currency that could fluctuate wildly within the same day.
Preservation of buying power in the near term: assuming someone expects ETH price to decline, then converting their ETH to stablecoins enables them to retain their buying power (just like how folks might hold more cash during volatile market periods, either for insurance or to buy market dips).
It’s helpful to fit stablecoins in a matrix that looks something like this:
Centralized, collateralized stablecoins are the most widely used by market cap, totaling more than $150B out of $180B of the stablecoins in circulation. Some of the largest of these kinds of stablecoins are USDC, USDT, and BUSD (issued by Circle, Tether Foundation, and Binance, respectively).
Each of these token’s centralized issuers hold collateral (dollars) in their bank accounts that back their respective tokens on the blockchain. This ensures that one USDC/USDT/etc is redeemable for a dollar—if you give Circle 1 USDC, they’ll give you a dollar back and vice versa. Tether has notoriously been cagey regarding audits of their reserves, but even if we assume they are benevolent actors, from a centralization perspective, the cracks in this system are clear.
These entities have all blacklisted addresses before, effectively freezing the funds at those addresses. Whether it’s governments pressuring them to do so or the issuers making those decisions themselves, particularly as crypto becomes more deeply integrated with the world, this is more power than any one entity should have.
It also doesn’t take a huge mental leap to see regulators preventing these stablecoins from reaching a trillion, or even hundreds of billions in supply (for reference, USDC is at around 50B). It seems inevitable that at a certain point, the Fed is going to do something about the fact that their power to control the money supply is being transferred to these stablecoin issuers.
Lastly, their collateral (the 1:1 backing of dollars) is a significant point of friction that prevents the supply of stablecoins from growing as quickly as demand for stablecoin grows. We’ll get more into this collateral issue in the next section.
DAI is a decentralized, collateralized stablecoin. The creation of DAI was a major innovation in DeFi in 2017—until then, the only prominent stablecoin was Tether. DAI, like USDC, is backed by collateral, but rather than being backed by dollars in a bank account, DAI is backed by ETH and other crypto assets (we’ll stick to ETH for the sake of example).
In order to mint 100 DAI, you must deposit $150 worth of ETH as collateral. This makes DAI even less capital efficient than the 100% collateral USDC/USDT require. It seems obvious that the future of DeFi will primarily use decentralized stablecoins of some kind, but there are still only 9 billion DAI (compared to 50B USDC) because of this requirement to lock up so much capital. As of today’s ETH market cap ($300B), you would have to lock up half of the ETH supply in order to have 100 billion DAI.
That is to say, the decentralization properties of DAI — great (although much of it is backed by USDC, which is not great, we’ll ignore that). The collateralization properties of DAI — not so great.
MIM, another popular decentralized stablecoin sitting around $3B in market cap, is subject to similar collateral issues that prevent the growth of their supply.
Downsides of collateralized stablecoins
So why does this matter? As mentioned, stablecoins have cemented their place as a critical piece of this new financial infrastructure. Yet there is a significant supply shortage of dollar stablecoins on the blockchain, and this is reflected in the high lending and borrowing costs of all existing stablecoins. On lending markets like Aave and Compound, you’ll find anywhere from 3% to 15%+ interest rates for borrowing stablecoins. On the other side of the market, CeFi platforms like BlockFi give out 8-10% APY to their users for depositing their stablecoins.
These collateralized stablecoins have what’s known as negative carry—a condition in which the cost of holding an asset exceeds the income earned while holding it. In other words, holding the asset has an inherent cost. Let’s say you are holding DAI—in practice this generally means one of two things:
You borrowed DAI from a protocol like Aave with an interest rate of 10%+. This is an explicit cost, you must pay back the loan.
You deposited ETH as collateral to mint DAI, and you leave it in your wallet. The same analogy can be made with giving USD to an entity like Circle, and leaving the USDC you get in return in your Coinbase account. This is an implicit opportunity cost, because you aren’t lending it out to a borrower for a significant yield much higher than in traditional finance.
Ok, that might’ve been a lot. But what this means is that the only compelling thing you can do with your stablecoins is lend them out for a return, rather than actually using it, whether that means placing a bid on Augur, using it for payments, etc.
Contrast this with near zero interest rates for borrowing dollars from a bank. There aren’t negative carry costs associated with holding the dollar, apart from inflation of course. It is the collateral that results in low supply growth, which results in negative carry costs because the demand to borrow stablecoins is so high.
There aren’t any stablecoins of this flavor. The centralized entities that we discussed (Circle, Tether Foundation, etc) are typically required by government regulators to maintain 1:1 reserves to back each stablecoin of theirs in circulation (thus, they are always collateralized). A centralized issuer of an algorithmic stablecoin would be a non-central bank money printer exposed to all the downside risks of centralization. A government would never allow this.
Otherwise affectionately referred to as decentralized algostables. These stablecoins have no assets backing their value. Their peg stability mechanisms are centered around increasing supply when demand pushes their prices above peg, and decreasing supply when demand decreases and the price dips below the peg.
Most of these projects, like Empty Set Dollar and Basis Cash, have failed. Projects like FRAX and UST are close but not quite uncollateralized, which we’ll discuss later.
Beanstalk however, is totally decentralized and backed by no collateral.
There aren’t enough stablecoins in DeFi, which is reflected in high borrowing costs. This is due to the structural inefficiencies associated with collateral as we’ve covered. Enter Beanstalk—a decentralized, Ethereum-native, credit-based stablecoin protocol (and it’s working).
Decentralized:
Unlike USDC, USDT, etc., Beanstalk is immune to oversight and regulation from central banks and centralized stablecoin issuers. Its price oracle, governance token issuance schedule, and DAO are censorship resistant. There was no pre-mine, pre-launch, or team allocation. In order to censor Beanstalk, Circle would have to blacklist the liquidity pool for USDC, effectively destroying its value proposition—and Beanstalk could simply use a different stablecoin liquidity pool as an oracle the following day.
Decentralization means that anyone with an internet connection can participate. This should be a core feature of any stablecoin.
Credit-based (i.e., no collateral required):
Beanstalk is able to maintain its dollar peg with no collateral requirement via its decentralized credit facility known as the Field. Because Beanstalk doesn't have to back Beans with collateral, it can flexibly and reliably expand to meet demand. We’ll talk about how this works in the next section.
Working (i.e., it’s actually stable):
People in DeFi have been burned in the past by failed attempts at algorithmic, uncollateralized stablecoins like Empty Set Dollar, Dynamic Set Dollar, and Basis Cash. The price of each of these stablecoins went into free fall with respect to their dollar pegs within a couple months of launch. As of writing, the Bean price has returned to its $1 peg over 3,600 times in its ~7 months of existence and paid off $23M of its debt.
The most important thing is that the Bean token maintains its dollar peg. This price stability is what makes a stablecoin. Beanstalk maintains the peg by attempting to increase or decrease supply of Beans in response to changes in demand. At a high level, when the Bean price is below $1, Beanstalk will incentivize users to buy Beans off the market and lend them to the protocol, which will then remove them from the supply. When the Bean price is above $1, Beanstalk will mint Beans to bring the price back down and distribute those Beans to participants in the ecosystem.
There are two core parts of Beanstalk, the Field and the Silo.
The Field
Terminology (feel free to skim and return to this):
Sowing Beans — Lending your Beans to the protocol, which are then burned to reduce supply.
Pods — The debt asset of Beanstalk. You get Pods in exchange for sowing Beans.
Pod Line — The line of Pods that represent all of Beanstalk’s debt. Pods become harvestable (redeemable 1:1 for Beans) in First In First Out order when the Bean supply increases.
Soil — The amount of debt that Beanstalk is willing to issue. You can only Sow Beans when there is Soil.
Temperature — The interest rate for sowing Beans.
Season — 1 Season is equal to 1 hour, more or less. At the beginning of every Season, the Temperature may be adjusted, Soil may be issued, and new Beans may be minted (all depending on certain conditions).
Process: When the Bean price is below $1, Beanstalk creates an incentive to remove Beans from the supply in order to bring the price back up to a dollar. This incentive is the interest rate (Temperature) for lending your Beans, known as Sowing Beans. When you Sow Beans, Beanstalk will burn those Beans and give you Pods in exchange. The number of Pods you receive is the number of Sown Beans multiplied by the Temperature + 1.
Example:
The Temperature is 500%
There’s 1000 Soil
The Pod Line is 400M long
Say you decide to Sow 200 beans. The result is that you:
receive 1200 Pods (200 Beans * ((5 + 1) * 100)) at 400M in the Pod Line
and there will be 800 (1000 Soil - 200 Beans) Soil leftover.
Explanation:
Beanstalk will issue the amount of Soil that would be required to bring the price of Bean back up to $1, more or less.
Beanstalk will look at a few conditions to determine if the Temperature should increase, decrease, or stay the same. At a high level, if Soil is not being sowed into to bring the price back up to $1, Beanstalk will raise the Temperature. If Soil is hitting zero at the beginning of a Season, it will lower the Temperature. The goal is to create an efficient market for Soil.
The primary way that Beanstalk fails would be in the inability to attract Sowers that would lift the price back up. The mechanism has been working well in that regard.
The ultimate question is when your Pods become redeemable for Beans. If your Pods are at 300M in the Pod Line, the Bean supply needs to increase by 600M in order for your Pods to get to the front of the line, because 50% of new Bean mints harvest Pods at the front of the line, 50% go to Silo Members. (June 2022 edit: After the governance exploit, 1/3 of Bean mints harvest Pods at the front of the line, 1/3 goes to Silo Members, and 1/3 goes to participants in the Barn Raise. Read more here.) We’ll cover more about the future of Beanstalk in the final section.
A note: it is natural that you’ll see larger price fluctuations in the Bean price than you would with something like USDC. That is part of the tradeoff of having no collateral. But as liquidity increases you’ll see price fluctuations decrease with time. Additionally, the more times that the Bean price crosses the peg, the opportunity to arbitrage the price increases (buying Beans below a dollar and selling them above a dollar keeps the price even tighter to the dollar peg).
The Silo
Terminology:
Stalk – The yield-generating governance token. Stalk holders earn passive interest in the form of a share of future Bean mints.
Seeds — Yields 1/10000 new Stalk every season.
Process: The Silo is the DAO of Beanstalk. You can think of the Silo as your passive-yield bank account for your Beans. By depositing Beans (or LP tokens) in the Silo, you earn Stalk and Seeds. Seeds earn you more Stalk over time, and Stalk determines how many Beans you earn when the supply increases. Stalk also allows you to vote on proposals to improve Beanstalk.
Example: The Stalk supply is 9,990,000 and you deposit 10,000 Beans into the Silo. The result is that 10,000 Stalk are minted, resulting in a 10M total Stalk supply. You own 0.1%, which entitles you to 0.1% of all Bean mints allocated to the Silo. This percent ownership will fluctuate as you and others earn more Stalk, and as more Stalk is minted from Silo deposits.
Explanation:
The purpose of Seeds is to create an opportunity cost to withdrawing from the Silo during periods when the Bean supply is not increasing. Your Stalk and Seeds associated with a Silo deposit are burned when you withdraw.
The Silo is important because participants are incentivized to add liquidity to the pools that Beans are traded in. Additionally, depositing your Beans in the Silo to earn seigniorage is the primary use case for Beans before larger market adoption of Beans in other protocols.
We’ll talk about the implications of these mechanisms in the final section—but first here are a few stablecoin projects that also attempt(ed) to create a decentralized and scalable stablecoin.
Empty Set Dollar (ESD) / Dynamic Set Dollar (DSD)
ESD was one of the firsts of its kind and a well known attempt to build a decentralized, scalable stablecoin. Beanstalk is in many ways inspired by ESD—in order to benefit from supply growth you either had to lend ESD to the protocol (sowing in the Field) or lock your ESD in the DAO (depositing in the Silo). DSD was similar but the epoch time was changed from 1 day to 1 hour, which helped with more frequent supply increases / debt issuance. However, the price of both tokens death spiraled shortly after launch and the prices now both sit below $0.01.
The protocols had a few inefficient mechanisms that led to their crashes.
Supply increase: ESD/DSD minted supply based on (price * total supply). Using the total supply while ignoring the liquidity pool that sets the price caused significant overinflation when the price was above peg. Beanstalk increases the supply by the liquidity and time weighted average shortage of Beans in the liquidity pools over a given Season (accounting for that liquidity).
Debt market: The debt issuance in ESD/DSD was primarily based on the debt level. This caused a tragedy of the commons problem, where lenders were incentivized to wait for other people to lend in order to get a higher interest rate, until eventually nobody lent. Beanstalk instead measures the TWAP, the debt level, and the change in demand for Soil in order to let the market define the interest rate (Temperature). Because the Temperature is set by the market and is not predefined (and adjusts somewhat slowly), lenders are incentivized to sow as soon as possible given the First In First Out nature of the Pod Line, rather than waiting for the Temperature to increase.
Withdrawing from the DAO: When the ESD/DSD price was below peg, there was no incentive to leave your tokens deposited in the DAO. In Beanstalk, there is an opportunity cost to withdrawing from the Silo a la your compounding Stalk rewards. By withdrawing, you burn your associated Stalk and Seeds that have accumulated during your time in the Silo.
Basis Cash
Basis Cash was another algostable attempt that had a couple primary issues, resulting in its current price below $0.01. Like ESD/DSD, it did not account for liquidity in its minting schedule—Beanstalk only mints the amount of Beans that would need to be sold to move the TWAP price back to peg.
Basis Cash also did not handle inorganic demand well, resulting in the price jumping up over $100. Beanstalk has what’s known as a Flood, a condition that is met when both the Pod Rate is less than 5% and the Bean price is above a dollar for more than 1 Season. Basically, when there aren’t many Pods and there is excessive inorganic demand for Beans (people buying Beans above $1), Beanstalk must have some fail-safe mechanism for bringing the price back down. During a Flood, Beanstalk will mint Beans, sell them on the market for ETH, and distribute that ETH to Silo Members (June 2022 edit: Beanstalk now sells Beans on the market for 3CRV and distributes that 3CRV to Silo Members).
This is the mechanism that saved Beanstalk during the pump and dump in September 2021.
FRAX
FRAX is currently sitting around $3B in market cap. It is known for being partially algorithmic and partially collateralized, with the intention of getting a little bit of the best of both worlds: decentralized but stable.
At inception, FRAX started out 100% collateralized by USDC. Every hour, the collateralization ratio can be refreshed by a user by 0.25%. If the price of FRAX is above a dollar, the collateralization requirement can be decreased to bring FRAX down to a dollar, and vice versa when it's below a dollar. FRAX can always be minted and redeemed for a $1 of value. If the collateralization ratio is 85%, then FRAX can be redeemed for 0.85 USDC and $0.15 of FXS, the governance token.
You can think of the collateralization ratio as how much USDC they need to hold compared to FXS as collateral. When the collateralization ratio goes up, the protocol has to acquire USDC by selling FXS. Given that FXS is ultimately the asset underpinning the system, forcing the protocol to sell FXS at the exact time that the rest of the market is doing so reinforces a negative feedback loop.
But regardless, any collateralization ratio (particularly 85%, which it often hangs around) is going to result in a requirement to lock up capital, decreasing scalability. And given that so much of it is backed by USDC, it is not all that decentralized either.
TerraUSD (UST)
June 2022 edit: Check out my article on Terra vs. Beanstalk after the UST collapse.
UST is currently sitting around $14B in market cap. About $10B of that sits in a protocol on the Terra blockchain known as Anchor. At the time of writing, only $370M of it is bridged to ETH mainnet.
A core innovation of UST is the burn-to-mint mechanism, using the LUNA token (which is native to the Terra blockchain and has a free-floating price) as pseudo-collateral. UST maintains its peg through a simple swap mechanism—1 UST can be exchanged for $1 worth of LUNA at any time. If UST dips below $1, buyers can scoop it up and swap for $1 of LUNA, making a profit.
You can earn interest on UST on the Terra blockchain by depositing into the Anchor protocol, earning 19% APY as of today. Beanstalk, however, offers a protocol-native way to earn interest in the form of the Silo. UST also depends on the decentralization and security of another blockchain and its accompanying bridge. The fact that comparatively little UST is bridged to ETH is reflective of those factors.
The thing about decentralization and security is that they aren’t critical until they are. From a risk perspective, it’s difficult to see UST becoming the primary stablecoin for DeFi.
Beanstalk’s capital-efficient credit mechanism has the potential to make it the dominant stablecoin issuer in DeFi because it can meet arbitrary amounts of demand. This is already true today, but will be even more true when demand for stablecoins is orders of magnitude higher. Current centralized and/or inefficient models won’t be able to meet it. There is even research that claims a decentralized stablecoin with mass adoption is what would end crypto’s correlation to legacy markets.
It’s worth reiterating that stablecoin utility is a function of 1) censorship resistance, 2) liquidity, and 3) stability. Beanstalk has all 3 and each will increase with time. Beanstalk—
is censorship-resistant, as mentioned.
has several million in liquidity that is incentivized to be deposited in the protocol-native Silo. When Stalk becomes liquid and tradable, the Silo will become even more of a black hole for liquidity because you need Stalk to withdraw. Not to mention the implications of a future generalized Silo that accepts any ERC-20 token.
has crossed the price of Bean over its dollar peg more than 3,600 times since deployment on ETH mainnet in August 2021. Each time the price crosses the peg, the value proposition of arbitraging price deviations becomes higher, resulting in tighter oscillations.
One of the most exciting things about Beanstalk today is that it’s working. After attempts like ESD and Basis Cash, many people in the crypto industry thought an ETH-native, fully uncollateralized stablecoin simply wasn’t possible. But Beanstalk fits those criteria and the implications are huge. The community is strong and sticks around because they know that.
The vision of Beanstalk is to be the world’s most fair and abundant internet money, and it’s on the right track.
The Beanstalk site and whitepaper: https://bean.money/
Follow the Beanstalk Farms Twitter
This is a comprehensive guide to get you up to speed on Beanstalk. To take you from “What is a stablecoin?” to “Holy shit, Beanstalk is going to change everything”. If you aren’t familiar with the concept of DeFi, start here. Onwards.
What is a stablecoin?
Types of stablecoins
Centralized, collateralized stablecoins
USDC, USDT, BUSD, etc.
Decentralized, collateralized stablecoins
DAI, MIM
Introducing Beanstalk
How Beanstalk works
The Field
The Silo
Other decentralized algostable models
ESD, DSD, Basis Cash
FRAX, UST
Beanstalk today and in the future
An outdated midwit criticism of crypto was that the larger, traditional crypto assets like BTC and ETH are extremely volatile, thus they weren’t a useful form of money. For example, how many merchants would accept a currency that might drop 20%+ between accepting the payment and paying an employee? Not many. So the stablecoin was born.
A stablecoin is a blockchain-based asset that is designed to be worth (pegged to) the value of some non-blockchain-based asset, like the dollar, the euro, gold, etc.
By far the most popular stablecoins are dollar-pegged stablecoins. This is a reflection of the reality that the world economy generally runs on dollars. If you live in the U.S. you pay taxes in dollars, buy groceries with dollars, and denominate your net worth in dollars. Even if you don’t live in the U.S., the value of foreign currencies is denominated in dollars. For central banks outside the U.S., it is common practice for most reserves to be held in dollars since it is the most traded currency in the world. Similarly, everything in crypto is denominated in dollars. This makes the dollar a good unit of account, an important characteristic of money.
How is a dollar-pegged stablecoin different from the dollar? You get all the benefits of a blockchain-based asset with the price stability of the dollar—benefits like:
Near-instant settlement (vs. 3-5 business days over ACH)
Borderless transactions
And of course, programmable money—developers can build arbitrarily complex (or simple) financial applications in this open system where you don’t have to get permission from a centralized entity to build new things
Stablecoins have now been around for a few years and the market cap of stablecoins increased around 500% in 2021 alone.
There are many use cases for crypto that simply can’t exist without stablecoins. Here are a few:
Prediction markets: Augur, a decentralized prediction market, was a compelling early use case for crypto. But you had to denominate your bids in ETH, which might drop after putting up your bid, completely changing the types of predictions users are willing to make. Better to use stablecoins that store value more reliably and allow for a greater spread of bets. (Augur made this switch in 2019.)
Payments: mentioned earlier, merchants won’t accept a volatile currency that could fluctuate wildly within the same day.
Preservation of buying power in the near term: assuming someone expects ETH price to decline, then converting their ETH to stablecoins enables them to retain their buying power (just like how folks might hold more cash during volatile market periods, either for insurance or to buy market dips).
It’s helpful to fit stablecoins in a matrix that looks something like this:
Centralized, collateralized stablecoins are the most widely used by market cap, totaling more than $150B out of $180B of the stablecoins in circulation. Some of the largest of these kinds of stablecoins are USDC, USDT, and BUSD (issued by Circle, Tether Foundation, and Binance, respectively).
Each of these token’s centralized issuers hold collateral (dollars) in their bank accounts that back their respective tokens on the blockchain. This ensures that one USDC/USDT/etc is redeemable for a dollar—if you give Circle 1 USDC, they’ll give you a dollar back and vice versa. Tether has notoriously been cagey regarding audits of their reserves, but even if we assume they are benevolent actors, from a centralization perspective, the cracks in this system are clear.
These entities have all blacklisted addresses before, effectively freezing the funds at those addresses. Whether it’s governments pressuring them to do so or the issuers making those decisions themselves, particularly as crypto becomes more deeply integrated with the world, this is more power than any one entity should have.
It also doesn’t take a huge mental leap to see regulators preventing these stablecoins from reaching a trillion, or even hundreds of billions in supply (for reference, USDC is at around 50B). It seems inevitable that at a certain point, the Fed is going to do something about the fact that their power to control the money supply is being transferred to these stablecoin issuers.
Lastly, their collateral (the 1:1 backing of dollars) is a significant point of friction that prevents the supply of stablecoins from growing as quickly as demand for stablecoin grows. We’ll get more into this collateral issue in the next section.
DAI is a decentralized, collateralized stablecoin. The creation of DAI was a major innovation in DeFi in 2017—until then, the only prominent stablecoin was Tether. DAI, like USDC, is backed by collateral, but rather than being backed by dollars in a bank account, DAI is backed by ETH and other crypto assets (we’ll stick to ETH for the sake of example).
In order to mint 100 DAI, you must deposit $150 worth of ETH as collateral. This makes DAI even less capital efficient than the 100% collateral USDC/USDT require. It seems obvious that the future of DeFi will primarily use decentralized stablecoins of some kind, but there are still only 9 billion DAI (compared to 50B USDC) because of this requirement to lock up so much capital. As of today’s ETH market cap ($300B), you would have to lock up half of the ETH supply in order to have 100 billion DAI.
That is to say, the decentralization properties of DAI — great (although much of it is backed by USDC, which is not great, we’ll ignore that). The collateralization properties of DAI — not so great.
MIM, another popular decentralized stablecoin sitting around $3B in market cap, is subject to similar collateral issues that prevent the growth of their supply.
Downsides of collateralized stablecoins
So why does this matter? As mentioned, stablecoins have cemented their place as a critical piece of this new financial infrastructure. Yet there is a significant supply shortage of dollar stablecoins on the blockchain, and this is reflected in the high lending and borrowing costs of all existing stablecoins. On lending markets like Aave and Compound, you’ll find anywhere from 3% to 15%+ interest rates for borrowing stablecoins. On the other side of the market, CeFi platforms like BlockFi give out 8-10% APY to their users for depositing their stablecoins.
These collateralized stablecoins have what’s known as negative carry—a condition in which the cost of holding an asset exceeds the income earned while holding it. In other words, holding the asset has an inherent cost. Let’s say you are holding DAI—in practice this generally means one of two things:
You borrowed DAI from a protocol like Aave with an interest rate of 10%+. This is an explicit cost, you must pay back the loan.
You deposited ETH as collateral to mint DAI, and you leave it in your wallet. The same analogy can be made with giving USD to an entity like Circle, and leaving the USDC you get in return in your Coinbase account. This is an implicit opportunity cost, because you aren’t lending it out to a borrower for a significant yield much higher than in traditional finance.
Ok, that might’ve been a lot. But what this means is that the only compelling thing you can do with your stablecoins is lend them out for a return, rather than actually using it, whether that means placing a bid on Augur, using it for payments, etc.
Contrast this with near zero interest rates for borrowing dollars from a bank. There aren’t negative carry costs associated with holding the dollar, apart from inflation of course. It is the collateral that results in low supply growth, which results in negative carry costs because the demand to borrow stablecoins is so high.
There aren’t any stablecoins of this flavor. The centralized entities that we discussed (Circle, Tether Foundation, etc) are typically required by government regulators to maintain 1:1 reserves to back each stablecoin of theirs in circulation (thus, they are always collateralized). A centralized issuer of an algorithmic stablecoin would be a non-central bank money printer exposed to all the downside risks of centralization. A government would never allow this.
Otherwise affectionately referred to as decentralized algostables. These stablecoins have no assets backing their value. Their peg stability mechanisms are centered around increasing supply when demand pushes their prices above peg, and decreasing supply when demand decreases and the price dips below the peg.
Most of these projects, like Empty Set Dollar and Basis Cash, have failed. Projects like FRAX and UST are close but not quite uncollateralized, which we’ll discuss later.
Beanstalk however, is totally decentralized and backed by no collateral.
There aren’t enough stablecoins in DeFi, which is reflected in high borrowing costs. This is due to the structural inefficiencies associated with collateral as we’ve covered. Enter Beanstalk—a decentralized, Ethereum-native, credit-based stablecoin protocol (and it’s working).
Decentralized:
Unlike USDC, USDT, etc., Beanstalk is immune to oversight and regulation from central banks and centralized stablecoin issuers. Its price oracle, governance token issuance schedule, and DAO are censorship resistant. There was no pre-mine, pre-launch, or team allocation. In order to censor Beanstalk, Circle would have to blacklist the liquidity pool for USDC, effectively destroying its value proposition—and Beanstalk could simply use a different stablecoin liquidity pool as an oracle the following day.
Decentralization means that anyone with an internet connection can participate. This should be a core feature of any stablecoin.
Credit-based (i.e., no collateral required):
Beanstalk is able to maintain its dollar peg with no collateral requirement via its decentralized credit facility known as the Field. Because Beanstalk doesn't have to back Beans with collateral, it can flexibly and reliably expand to meet demand. We’ll talk about how this works in the next section.
Working (i.e., it’s actually stable):
People in DeFi have been burned in the past by failed attempts at algorithmic, uncollateralized stablecoins like Empty Set Dollar, Dynamic Set Dollar, and Basis Cash. The price of each of these stablecoins went into free fall with respect to their dollar pegs within a couple months of launch. As of writing, the Bean price has returned to its $1 peg over 3,600 times in its ~7 months of existence and paid off $23M of its debt.
The most important thing is that the Bean token maintains its dollar peg. This price stability is what makes a stablecoin. Beanstalk maintains the peg by attempting to increase or decrease supply of Beans in response to changes in demand. At a high level, when the Bean price is below $1, Beanstalk will incentivize users to buy Beans off the market and lend them to the protocol, which will then remove them from the supply. When the Bean price is above $1, Beanstalk will mint Beans to bring the price back down and distribute those Beans to participants in the ecosystem.
There are two core parts of Beanstalk, the Field and the Silo.
The Field
Terminology (feel free to skim and return to this):
Sowing Beans — Lending your Beans to the protocol, which are then burned to reduce supply.
Pods — The debt asset of Beanstalk. You get Pods in exchange for sowing Beans.
Pod Line — The line of Pods that represent all of Beanstalk’s debt. Pods become harvestable (redeemable 1:1 for Beans) in First In First Out order when the Bean supply increases.
Soil — The amount of debt that Beanstalk is willing to issue. You can only Sow Beans when there is Soil.
Temperature — The interest rate for sowing Beans.
Season — 1 Season is equal to 1 hour, more or less. At the beginning of every Season, the Temperature may be adjusted, Soil may be issued, and new Beans may be minted (all depending on certain conditions).
Process: When the Bean price is below $1, Beanstalk creates an incentive to remove Beans from the supply in order to bring the price back up to a dollar. This incentive is the interest rate (Temperature) for lending your Beans, known as Sowing Beans. When you Sow Beans, Beanstalk will burn those Beans and give you Pods in exchange. The number of Pods you receive is the number of Sown Beans multiplied by the Temperature + 1.
Example:
The Temperature is 500%
There’s 1000 Soil
The Pod Line is 400M long
Say you decide to Sow 200 beans. The result is that you:
receive 1200 Pods (200 Beans * ((5 + 1) * 100)) at 400M in the Pod Line
and there will be 800 (1000 Soil - 200 Beans) Soil leftover.
Explanation:
Beanstalk will issue the amount of Soil that would be required to bring the price of Bean back up to $1, more or less.
Beanstalk will look at a few conditions to determine if the Temperature should increase, decrease, or stay the same. At a high level, if Soil is not being sowed into to bring the price back up to $1, Beanstalk will raise the Temperature. If Soil is hitting zero at the beginning of a Season, it will lower the Temperature. The goal is to create an efficient market for Soil.
The primary way that Beanstalk fails would be in the inability to attract Sowers that would lift the price back up. The mechanism has been working well in that regard.
The ultimate question is when your Pods become redeemable for Beans. If your Pods are at 300M in the Pod Line, the Bean supply needs to increase by 600M in order for your Pods to get to the front of the line, because 50% of new Bean mints harvest Pods at the front of the line, 50% go to Silo Members. (June 2022 edit: After the governance exploit, 1/3 of Bean mints harvest Pods at the front of the line, 1/3 goes to Silo Members, and 1/3 goes to participants in the Barn Raise. Read more here.) We’ll cover more about the future of Beanstalk in the final section.
A note: it is natural that you’ll see larger price fluctuations in the Bean price than you would with something like USDC. That is part of the tradeoff of having no collateral. But as liquidity increases you’ll see price fluctuations decrease with time. Additionally, the more times that the Bean price crosses the peg, the opportunity to arbitrage the price increases (buying Beans below a dollar and selling them above a dollar keeps the price even tighter to the dollar peg).
The Silo
Terminology:
Stalk – The yield-generating governance token. Stalk holders earn passive interest in the form of a share of future Bean mints.
Seeds — Yields 1/10000 new Stalk every season.
Process: The Silo is the DAO of Beanstalk. You can think of the Silo as your passive-yield bank account for your Beans. By depositing Beans (or LP tokens) in the Silo, you earn Stalk and Seeds. Seeds earn you more Stalk over time, and Stalk determines how many Beans you earn when the supply increases. Stalk also allows you to vote on proposals to improve Beanstalk.
Example: The Stalk supply is 9,990,000 and you deposit 10,000 Beans into the Silo. The result is that 10,000 Stalk are minted, resulting in a 10M total Stalk supply. You own 0.1%, which entitles you to 0.1% of all Bean mints allocated to the Silo. This percent ownership will fluctuate as you and others earn more Stalk, and as more Stalk is minted from Silo deposits.
Explanation:
The purpose of Seeds is to create an opportunity cost to withdrawing from the Silo during periods when the Bean supply is not increasing. Your Stalk and Seeds associated with a Silo deposit are burned when you withdraw.
The Silo is important because participants are incentivized to add liquidity to the pools that Beans are traded in. Additionally, depositing your Beans in the Silo to earn seigniorage is the primary use case for Beans before larger market adoption of Beans in other protocols.
We’ll talk about the implications of these mechanisms in the final section—but first here are a few stablecoin projects that also attempt(ed) to create a decentralized and scalable stablecoin.
Empty Set Dollar (ESD) / Dynamic Set Dollar (DSD)
ESD was one of the firsts of its kind and a well known attempt to build a decentralized, scalable stablecoin. Beanstalk is in many ways inspired by ESD—in order to benefit from supply growth you either had to lend ESD to the protocol (sowing in the Field) or lock your ESD in the DAO (depositing in the Silo). DSD was similar but the epoch time was changed from 1 day to 1 hour, which helped with more frequent supply increases / debt issuance. However, the price of both tokens death spiraled shortly after launch and the prices now both sit below $0.01.
The protocols had a few inefficient mechanisms that led to their crashes.
Supply increase: ESD/DSD minted supply based on (price * total supply). Using the total supply while ignoring the liquidity pool that sets the price caused significant overinflation when the price was above peg. Beanstalk increases the supply by the liquidity and time weighted average shortage of Beans in the liquidity pools over a given Season (accounting for that liquidity).
Debt market: The debt issuance in ESD/DSD was primarily based on the debt level. This caused a tragedy of the commons problem, where lenders were incentivized to wait for other people to lend in order to get a higher interest rate, until eventually nobody lent. Beanstalk instead measures the TWAP, the debt level, and the change in demand for Soil in order to let the market define the interest rate (Temperature). Because the Temperature is set by the market and is not predefined (and adjusts somewhat slowly), lenders are incentivized to sow as soon as possible given the First In First Out nature of the Pod Line, rather than waiting for the Temperature to increase.
Withdrawing from the DAO: When the ESD/DSD price was below peg, there was no incentive to leave your tokens deposited in the DAO. In Beanstalk, there is an opportunity cost to withdrawing from the Silo a la your compounding Stalk rewards. By withdrawing, you burn your associated Stalk and Seeds that have accumulated during your time in the Silo.
Basis Cash
Basis Cash was another algostable attempt that had a couple primary issues, resulting in its current price below $0.01. Like ESD/DSD, it did not account for liquidity in its minting schedule—Beanstalk only mints the amount of Beans that would need to be sold to move the TWAP price back to peg.
Basis Cash also did not handle inorganic demand well, resulting in the price jumping up over $100. Beanstalk has what’s known as a Flood, a condition that is met when both the Pod Rate is less than 5% and the Bean price is above a dollar for more than 1 Season. Basically, when there aren’t many Pods and there is excessive inorganic demand for Beans (people buying Beans above $1), Beanstalk must have some fail-safe mechanism for bringing the price back down. During a Flood, Beanstalk will mint Beans, sell them on the market for ETH, and distribute that ETH to Silo Members (June 2022 edit: Beanstalk now sells Beans on the market for 3CRV and distributes that 3CRV to Silo Members).
This is the mechanism that saved Beanstalk during the pump and dump in September 2021.
FRAX
FRAX is currently sitting around $3B in market cap. It is known for being partially algorithmic and partially collateralized, with the intention of getting a little bit of the best of both worlds: decentralized but stable.
At inception, FRAX started out 100% collateralized by USDC. Every hour, the collateralization ratio can be refreshed by a user by 0.25%. If the price of FRAX is above a dollar, the collateralization requirement can be decreased to bring FRAX down to a dollar, and vice versa when it's below a dollar. FRAX can always be minted and redeemed for a $1 of value. If the collateralization ratio is 85%, then FRAX can be redeemed for 0.85 USDC and $0.15 of FXS, the governance token.
You can think of the collateralization ratio as how much USDC they need to hold compared to FXS as collateral. When the collateralization ratio goes up, the protocol has to acquire USDC by selling FXS. Given that FXS is ultimately the asset underpinning the system, forcing the protocol to sell FXS at the exact time that the rest of the market is doing so reinforces a negative feedback loop.
But regardless, any collateralization ratio (particularly 85%, which it often hangs around) is going to result in a requirement to lock up capital, decreasing scalability. And given that so much of it is backed by USDC, it is not all that decentralized either.
TerraUSD (UST)
June 2022 edit: Check out my article on Terra vs. Beanstalk after the UST collapse.
UST is currently sitting around $14B in market cap. About $10B of that sits in a protocol on the Terra blockchain known as Anchor. At the time of writing, only $370M of it is bridged to ETH mainnet.
A core innovation of UST is the burn-to-mint mechanism, using the LUNA token (which is native to the Terra blockchain and has a free-floating price) as pseudo-collateral. UST maintains its peg through a simple swap mechanism—1 UST can be exchanged for $1 worth of LUNA at any time. If UST dips below $1, buyers can scoop it up and swap for $1 of LUNA, making a profit.
You can earn interest on UST on the Terra blockchain by depositing into the Anchor protocol, earning 19% APY as of today. Beanstalk, however, offers a protocol-native way to earn interest in the form of the Silo. UST also depends on the decentralization and security of another blockchain and its accompanying bridge. The fact that comparatively little UST is bridged to ETH is reflective of those factors.
The thing about decentralization and security is that they aren’t critical until they are. From a risk perspective, it’s difficult to see UST becoming the primary stablecoin for DeFi.
Beanstalk’s capital-efficient credit mechanism has the potential to make it the dominant stablecoin issuer in DeFi because it can meet arbitrary amounts of demand. This is already true today, but will be even more true when demand for stablecoins is orders of magnitude higher. Current centralized and/or inefficient models won’t be able to meet it. There is even research that claims a decentralized stablecoin with mass adoption is what would end crypto’s correlation to legacy markets.
It’s worth reiterating that stablecoin utility is a function of 1) censorship resistance, 2) liquidity, and 3) stability. Beanstalk has all 3 and each will increase with time. Beanstalk—
is censorship-resistant, as mentioned.
has several million in liquidity that is incentivized to be deposited in the protocol-native Silo. When Stalk becomes liquid and tradable, the Silo will become even more of a black hole for liquidity because you need Stalk to withdraw. Not to mention the implications of a future generalized Silo that accepts any ERC-20 token.
has crossed the price of Bean over its dollar peg more than 3,600 times since deployment on ETH mainnet in August 2021. Each time the price crosses the peg, the value proposition of arbitraging price deviations becomes higher, resulting in tighter oscillations.
One of the most exciting things about Beanstalk today is that it’s working. After attempts like ESD and Basis Cash, many people in the crypto industry thought an ETH-native, fully uncollateralized stablecoin simply wasn’t possible. But Beanstalk fits those criteria and the implications are huge. The community is strong and sticks around because they know that.
The vision of Beanstalk is to be the world’s most fair and abundant internet money, and it’s on the right track.
The Beanstalk site and whitepaper: https://bean.money/
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