“By my hand DAI will die.”
So tweeted Do Kwon, the co-founder of the Terra ecosystem on March 22.
Kwon‘s vow of doom for DAI, the U.S. dollar-pegged stablecoin supported by MakerDAO, is a rare case of unalloyed competitiveness in DeFi. True to his word, the Terra co-founder on April 1 introduced “4pool,” an amalgam of four stablecoins on an automated market maker (AMM), Curve Finance.
This four-headed beast will include Terra’s UST, Frax Finance’s FRAX, USDT (Tether), and USDC. Users will be able to deposit one of the four stablecoins into the pool to earn a yield as other users trade between the pooled assets.
The key to making this pool function: Terra and Frax will work together to incentivize users to deposit into the forthcoming 4pool. The bigger the incentives, the more users deposit any of the four stablecoins in the pool. Or more succinctly, the bigger the incentives, the deeper the liquidity.
And liquidity is the lifeblood in DeFi — especially for stablecoins because liquidity is what makes prices, well, stable.
This is because when there’s a lot of value in a given pool, individual trades don’t change the relative prices of the assets very much (a phenomenon called slippage). A pool of stablecoins with deep liquidity means that you can reliably move between these dollar-pegged assets at a nearly one-to-one basis (low slippage between like-kind assets).
If relative newcomers like FRAX and UST can be reliably exchanged one-to-one with established dollar-pegged coins like USDT and USDC, which are in theory backed by an equivalent amount of fiat dollars in the traditional banking system, that makes them easier to trust.
As for algorithmic stablecoins, which are driven by software programs instead of reserve assets, trust is especially important.
At $3.29B as of Apr. 7, the pool with the deepest liquidity on Curve appears to be “3pool,” which contains USDT, USDC, and DAI, the MakerDAO stablecoin Kwon has in his sights. The Terra co-founder is explicit about his plans — “[the] goal is to starve the 3pool,” he tweeted when announcing 4pool.
The Curve Wars
More specifically the plan is to use the large amounts of CVX, the token for Convex Finance, a behemoth built on top of Curve, to incentivize users to deposit stablecoins into 4pool.
At a very high level, there is a battle to get users to deposit in specific curve pools, driven by token incentives. This battle has come to be known as “The Curve Wars,” and CVX is generally accepted as the kingpin to victory as the token can control which pool the incentives go to.
Frax has the most CVX tokens while Terra has the third most, according to the DAO CVX Leaderboard. The plan for 4pool also has [REDACTED], which has the fourth most CVX, also throwing its governance weight behind 4pool.
How Swapping and Staking on Curve Drives High User Engagement
While Kwon has tweeted that “the curve wars are over, all emissions are going to the 4pool,” some, like the analyst who goes by Average Joe’s Crypto, think differently.
“Terra, Frax, and Redacted control a lot of CVX, but they don’t control enough CVX,” Average Joe wrote in their article outlining the next iteration of the Curve Wars. “Their 12% control will certainly drive large emissions to 4pool, but most likely not enough to kill off 3pool.”
The analyst does believe Maker will need to enter the Curve Wars however — so far, DeFi’s most venerable lender has steered clear of the incentivization game and still enjoyed deep liquidity on Curve.
With Frax and Terra teaming up, Maker may be forced to jump into a more active role to defend its DAI stablecoin.