Stablecoin Protocols: Unveiling the Ponzi Magic and Secrets of Bull-Bear Strategy Switching
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Stablecoin Protocols: Unveiling the Ponzi Magic and Secrets of Bull-Bear Strategy Switching
For stablecoins, "maintaining yield during bear markets and increasing leverage during bull markets" might be the right path for designing stablecoin protocols.
Navigating Web3 tides with focused insightsAuthor: Kylo@Foresight Ventures
Tips:
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Heterogeneous-chain stablecoins combined with stablecoin protocols easily generate Ponzi magic;
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MakerDAO switches between bull and bear strategies by shifting yield sources from on-chain to off-chain;
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AAVE’s next strategic move is increasing GHO yields through Aura;
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In the future, numerous crvUSD "cannon fodder" will continue emerging within the Curve and Convex ecosystems;
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Abracadabra has clearly indicated a viable direction for stablecoin protocol development during bull market cycles.
Web3 Stablecoins
Within Web3, there always exists an ideal of a decentralized central bank—one that operates independently of all fiat systems and fully implements central banking logic using only on-chain assets. This utopian vision has inspired countless developers to design various stablecoin systems. Yet regardless of their noble intentions or mathematical soundness, most stablecoin protocols eventually acquire labels like “Ponzi” or “over-leveraged.” When the tide recedes, all stablecoin magic is stripped bare, liquidity drains away, leaving only skeletal mechanisms behind. Ultimately, only sufficiently robust fully-collateralized stablecoins survive.
Perhaps we should reconsider what stablecoins truly mean for the Web3 industry. Setting aside utopian ideals, stablecoins can construct elegant Ponzi systems; they can serve as new asset issuance methods bringing abundant liquidity to the chain; they can also act as leverage, significantly increasing available liquidity for on-chain users.
In summary, the allure of stablecoins in the Web3 industry fundamentally stems from Ponzi dynamics, leverage, and liquidity. The primary goal of this article is to explain certain clever mechanics employed by selected stablecoin protocols, including various Ponzi designs and the operational models of MakerDAO, AAVE, Curve Finance, and Abracadabra. There are also arbitrage-based stablecoin designs such as Luna-UST and Ethena Labs, which we will cover in a follow-up article.
Constructing Rational Ponzis Using Collateralized Stablecoins
When we create a new asset and assign it value via other real assets, this newly created asset acquires value in some sense. Whether the created asset actually holds value depends on its valuation anchor. For example, the value anchoring of so-called "junk stablecoins" is achieved through stablecoin trading pairs—not because these pairs genuinely confer intrinsic value, but merely because they establish face value. Real value refers to hard redemption value, whereas face value is purely nominal, influenced directly by oracles or marginal pricing.
To better understand the concepts of “new asset pricing,” “value anchors,” and “real vs. face value of stablecoins,” consider heterogeneous-chain stablecoins. Each heterogeneous chain functions similarly to a fiat system—its native token can be used as collateral to mint native stablecoins within the ecosystem. In theory, the native token has an off-chain price on centralized exchanges (CEX), enabling it to back large quantities of native stablecoins. Then, via cross-chain bridges, small amounts of USDC or similar stablecoins are transferred into the ecosystem and paired with the native stablecoin, giving it a face value of 1. These incoming USDCs become the value anchor for the native stablecoin. However, this anchored value is essentially just face value, not real value. Since the actual amount of real assets (e.g., bridged USDC) is far smaller than the quantity of minted native stablecoins, full redemption against USDC cannot be sustained at scale.
The Ponzi nature of financial systems often lies in conflating real value with face value. Total asset valuations in financial markets are determined by face value, which sets marginal transaction prices. Thus, within financial transmission mechanisms, a small amount of assets possessing real value can serve as anchors to maintain the face value of new assets, thereby influencing marginal pricing and inflating the nominal size of financial markets.
In a typical heterogeneous chain ecosystem, many native tokens are over-collateralized to mint large volumes of native stablecoins. Within the ecosystem, the sole use of these stablecoins is forming LP pairs with the native token. Meanwhile, a small amount of USDC enters via cross-chain bridges, serving as the value anchor and assigning the native stablecoin a face value of 1. Because most of the native stablecoins exist solely to form LPs, massive buy pressure is generated on the native token, pushing up its price. Notably, the native token’s price is now driven by the face value of the native stablecoin—which remains pegged at 1. CEXs capture on-chain prices via oracles reflecting this face value, creating a nominal price discrepancy between CEX and on-chain markets. Arbitrageurs then tend to buy the native token with real money (USDC) on CEX and sell it on-chain to profit. Unbeknownst to them, when arbitrageurs purchase the native token on CEX, they inadvertently become part of the Ponzi structure—acting as liquidity providers expanding exit liquidity for the native token…
This heterogeneous-chain stablecoin mechanism represents just one basic template among many Ponzi structures found in both TradFi and DeFi. The infamous Luna-UST architecture fundamentally followed the same logic: UST's face value was anchored by Curve’s 4pool and LUNA’s market cap, while LUNA itself was supported by UST’s face value. This framework can also help explain USD-CNY exchange rate dynamics or BTC pair manipulation on Upbit—details we may explore later.
MakerDAO
At inception, MakerDAO did not have complex subsequent designs like PSM or D3M—it began with a simple CDP (Collateralized Debt Position) model. Users deposited ETH as collateral at a given collateralization ratio to mint DAI. They could then swap DAI for ETH and repeat the process recursively to achieve leveraged positions. As many users engaged in recursive borrowing—effectively selling DAI—DAI frequently traded slightly below par before the DeFi summer. To address this de-pegging issue, MakerDAO implemented transfer payments via DSR (DAI Savings Rate): users paid interest when minting DAI, which was redistributed to DSR depositors. By adjusting the DSR rate, MakerDAO could modulate DAI supply across the market and maintain its peg.
MakerDAO introduced PSM (Partial Stablecoin Module) after the DeFi summer. With massive capital inflows, DeFi farming yields became extremely high, and DAI was a common farming asset. This demand drove DAI premiums. To resolve the premium issue while stabilizing DAI’s price, MakerDAO launched PSM, allowing users to redeem DAI 1:1 from accepted stablecoins like USDC and USDP. This greatly enhanced DAI’s price stability. However, since USDC came to dominate DAI’s collateral base, it laid the groundwork for ripple effects during future USDC de-peg events.
D3M (Direct DAI Deposit Module) represents MakerDAO’s collaboration with AAVE and Compound to stabilize DAI deposit rates. Since AAVE and Compound determine interest rates based on pool utilization, DAI lending rates could spike unexpectedly. To ensure stable borrowing costs, MakerDAO introduced D3M, granting emergency minting allowances to AAVE and Compound to cap DAI borrowing rates within a target range. This move weakened the competitiveness of fixed-rate lending products on-chain. Additionally, Morpho Labs further eroded this niche from another angle. Today, only long-tail asset lending retains meaningful room for innovation. MakerDAO’s D3M partnerships with AAVE and Compound may eventually phase out as Spark Protocol matures.
During transitions between bull and bear cycles, MakerDAO made several adjustments to DAI’s product strategy:
- Reduced the types of DAI collateral, retaining only core assets like ETH, wBTC, and stETH
- Set GUNI’s eligible collateral share to zero
- Shifted stablecoin holdings within PSM toward RWA (real-world assets) via Coinbase and trusted custodians when Treasury yields began rising
The latter two moves reflect MakerDAO’s cyclical strategy: earning yield on-chain during bull markets and off-chain during bear markets. GUNI was a DAI-USDC auto-yield LP strategy developed by Gelato during the previous bull cycle. MakerDAO once allowed GUNI LP tokens as DAI collateral. The proposal sparked intense community debate: opponents argued that using derivative instruments as collateral posed risks to DAI’s long-term stability, while supporters noted that newly minted DAI would remain locked in Uniswap LPs alongside USDC, thus having no direct impact on DAI’s circulating price. After integration, GUNI’s AUM reached billions of dollars. Primary beneficiaries included MakerDAO and Arrakis Finance—an offshoot of the Gelato team specializing in automated Uni V3 LP strategies—which gained substantial TVL via GUNI. But once MakerDAO removed GUNI as acceptable collateral, Arrakis faced massive TVL outflows. Its decline reflects the fate of many dependent DeFi protocols…
During bull markets, on-chain activity is intense, allowing GUNI to capture significant DAI-USDC swap fees. But as Treasury yields rise and on-chain activity cools, GUNI generates little fee income. To pursue higher returns, MakerDAO pivoted toward RWA, converting large portions of PSM-held stablecoins into Treasuries-linked assets. This shift gained momentum throughout Q2 2023, catalyzing the emergence of the RWA sector.
AAVE
AAVE is currently evolving into a Super Dapp. Its social protocol Lens Protocol and lending business are maturing, and the stablecoin GHO represents AAVE’s next strategic frontier. Currently, GHO minting is integrated into AAVE’s lending platform—users can mint GHO using idle collateral deposited in AAVE. The minting rate decreases with increased individual AAVE staking, currently ranging between 3.38% and 4.83%. Due to GHO’s relatively low minting cost and limited yield opportunities compared to DAI or crvUSD, GHO has been significantly de-pegged. Restoring GHO’s peg is therefore a key priority, achievable through two main approaches:
- Raise GHO’s minting rate closer to those of DAI and crvUSD
- Expand GHO yield farming use cases
These strategies complement each other. A lower minting cost combined with higher yield farming returns allows expansion of GHO supply while maintaining its peg. Given that AAVE already offers below-market minting rates, boosting GHO yield farming incentives becomes the optimal strategy.
To enhance GHO yields, AAVE leverages Balancer and Aura Finance. AAVE and Balancer have maintained a close partnership—the introduction of Boosted Pools marked a milestone. Now, stablecoins deposited in Balancer’s boosted pools earn both swap fees and AAVE deposit yields, significantly improving capital efficiency. The next phase of cooperation centers on GHO: Balancer will act as GHO’s liquidity hub, while Aura Finance serves as the yield booster. To achieve this, AAVE purchased approximately $800k worth of AURA and deposited a large portion of its veBAL treasury into Aura Finance to gain greater governance influence over Balancer. Currently, GHO’s minting cap stands at 35 million. Once the GHO yield-boosting flywheel gains momentum, we can expect a significant increase in the minting cap. Simultaneously, to reduce minting costs, AAVE staking levels will gradually rise. This development benefits AAVE, Balancer, and Aura Finance alike—though it may take time for the magic to fully ignite.
crvUSD
Although crvUSD is an over-collateralized stablecoin, its innovative design diverges from traditional CDP models, offering fresh inspiration for other DeFi protocols. Inspired by AMMs, crvUSD reimagines borrowing: just as AMMs allow swapping one token for another via algorithmic rules, borrowing involves depositing collateral and withdrawing another asset under specific terms. This AMM-like lending approach has already been adopted by protocols such as Timeswap and Instadapp’s sub-product 0xfluid.
crvUSD employs a gradual liquidation mechanism akin to AMMs. Traditional CDPs trigger full liquidation once collateral ratios hit a threshold. In contrast, crvUSD uses its LLAMA algorithm: whenever collateral prices drop, the price assigned by LLAMA is slightly below that on Uni V3. Arbitrageurs then buy collateral cheaply from LLAMA and sell it on Uni V3 for profit. Conversely, when collateral prices rise, LLAMA prices exceed Uni V3 levels, prompting arbitrageurs to sell collateral to LLAMA for crvUSD, then repurchase it cheaper on Uni V3—again profiting from the spread.
The benefit of this AMM-style gradual liquidation is that collateral ratios can be set much lower. Since liquidations occur incrementally with falling prices, the price elasticity buffer expands. Gradual sales recover more value than dumping all collateral at the lowest point, enabling safer operation at lower collateral ratios. While higher capital efficiency is crvUSD’s advantage, the trade-off is increased impermanent loss. If collateral prices crash sharply and later rebound, users’ collateral value diminishes due to external arbitrage extracting value via the LLAMA mechanism.
crvUSD maintains price stability through several tools:
- High minting rates
- Rich yield-generating opportunities for crvUSD
- Pegkeeper’s automatic mint-and-sell functionality
Based on earlier analysis of AAVE’s GHO, minting rate and yield farming returns are two key factors determining stablecoin scale. Despite the presence of numerous “cannon fodder” projects, crvUSD maintains one of the highest minting rates in the industry, yet still attracts widespread minting. To expand further, crvUSD could simply lower its minting rate to industry averages.
Currently, crvUSD shows tendencies toward positive de-pegging. High yield farming returns and elevated minting rates incentivize users to mint cheaper stablecoins elsewhere, swap them for crvUSD, and farm yields. This interest-rate arbitrage creates secondary market demand for crvUSD, potentially driving it above $1. crvUSD counters this simply and effectively: Pegkeeper mints crvUSD without collateral and dumps it into Curve V1 liquidity pools. Unlike MakerDAO’s PSM, Pegkeeper incurs nearly zero funding cost—a design consistent with crvUSD’s emphasis on capital efficiency.
crvUSD has begun building a “cannon fodder ecosystem.” Before Conic Finance’s hack, crvUSD established a three-layer Ponzi stack involving Curve, Convex, and Conic: crvUSD paired with other stablecoins in 3pool or 4pool, with yields funneled directly to Conic Finance. Early adoption via this method helped accumulate around $150 million in crvUSD supply. Prisma Finance was intended as a fourth layer, but following Conic’s breach, trust in that revenue chain collapsed, leading Conic to exit the crvUSD cannon fodder ecosystem. Prisma Finance now inherits Conic’s functional role for crvUSD, with a valuation logic mirroring Conic’s.
Theoretically, crvUSD can continue spawning more cannon fodder leveraging the Curve and Convex ecosystems—a potential unmatched by other stablecoins. AAVE’s collaboration with Balancer aims to replicate Curve’s ecosystem success, but still has a long way to go.
Abracadabra
Abracadabra emerged during a bull market, specifically designed for leverage—using poorly liquid yield-bearing assets as collateral to mint stablecoins, and maintaining price stability via secondary MIM-stablecoin pools. Most MIM liquidity resides on Curve. The MIM-Spell team maintains pool stability through two methods:
- Bribing veCRV holders to vote for the MIM-stablecoin pool
- Providing additional SPELL token incentives to MIM-stablecoin LPs
It’s highly likely that Abracadabra’s playbook from the last bull cycle will repeat in the next. During bull markets, users seek heavy leverage—they want access to highly liquid stablecoins without sacrificing yield on their assets, paying only a modest interest rate. They then use these stablecoins for various leveraged operations. This model faces two challenges: identifying popular, large-scale yield-bearing assets, and ensuring sufficient liquidity for the newly minted stablecoin.
At the end of 2021, Abracadabra’s strategy involved selecting widely demanded, high-cap assets as collateral and building secondary liquidity pools to enable fast leverage. At the time, Yearn Finance’s yETH pool was peaking, with massive TVL. Abracadabra capitalized by using yETH as collateral to mint $MIM, then establishing MIM-stablecoin liquidity pools to facilitate leverage.
Since users primarily interact with Abracadabra to leverage via MIM-stablecoin pools, deep liquidity in these secondary pools is critical. Abracadabra achieved this through aggressive incentive campaigns targeting MIM-stablecoin LPs, funded by SPELL emissions and broader ecosystem rewards.
Why did $SPELL’s value surge 100x in a short period? Two main reasons:
- All interest income was used for direct buybacks, creating strong buying pressure
- A sufficiently high SPELL price enabled rich secondary market depth, allowing the product to sustain operations
This means $SPELL had upward momentum both from active market-making and organic demand.
Abracadabra is a classic example of aligning with the DeFi ecosystem cycle—in a sense, this model can “win repeatedly” during bull markets. However, Abracadabra’s rise last cycle stemmed largely from capturing yield-bearing assets from Convex Finance and Yearn Finance. After enduring a full bear market, new asset classes may emerge in the next cycle, potentially weakening Convex and Yearn’s dominance. Therefore, for Abracadabra to maintain its cross-chain liquidity leadership, it must closely monitor shifts in yield-bearing assets and adapt accordingly.
Currently, Abracadabra maintains good relations with Yearn Finance while exploring opportunities with GMX and Kava Chain. Whether it can revive depends on whether MIM can identify newer, more promising market opportunities ahead of competitors.
Conclusion
Stablecoin design isn’t inherently dark—but once real money flows in, the financial game’s darker aspects surface. Beyond that, viewed through the lens of user leverage and liquidity needs, stablecoins genuinely fulfill real demand. Product-market fit is the authentic, legitimate side of stablecoin protocols in Web3.
For stablecoins, “maintaining yields in bear markets, increasing leverage in bull markets” may be the correct path. Lybra Finance’s rise during the bear market exemplifies this logic. But bear markets don’t last forever—protocols must proactively adjust to cyclical shifts. Having remained dormant too long due to capital constraints, larger DeFi and stablecoin protocols are poised for revival. With the return of the bull market, abundant liquidity and capital will inevitably flow back into today’s parched DeFi landscape. The gears of history will turn forward once again—we wait and see…
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