What's wrong with CDP stablecoins on HyperEVM?

In the ever-evolving landscape of decentralized finance (DeFi), the pursuit of stable and efficient digital assets has led to the creation of various innovative protocols. Among these, collateralized debt position (CDP) ‘stablecoins’ have emerged as a promising category, aiming to provide decentralized alternatives to dollar-backed stablecoins like USD and USDT or centralized synthetic dollars like USDDe.

However, recent attempts to emulate Liquity's success have encountered difficulties, with projects like feUSD, USDXL, and KEI struggling to maintain their $1 anchor prices and facing issues related to scalability and incentive design flaws. This article delves into the problems that these projects face and provides insights into why they are more than just growing pains—they are structural problems that will continue to plague the Hyperliquid ecosystem.

First, let's clarify that these CDP 'stablecoins' are not true stablecoins or 'USD' tokens, which is why DAI is called DAI and not USDD or anything else. It's also incorrect to name these tokens with the 'USD' prefix, as this may mislead new DeFi users. These tokens have no arbitrage mechanism or direct guarantee, and each token is minted out of thin air and may be worth far less than $1.

To mint one CDP token, users must lock up more than 100% of the value of collateral in order to borrow tokens, which reduces capital efficiency and limits growth. In order to mint 1 token, you need to lock up more than $1 in value. Depending on the loan-to-value ratio, this ratio can be higher.

Without adding heavy-handed mechanisms like Felix's redemptions (where arbitrageurs can steal someone's collateral if the borrowing rate is too low) or Dai's PSM module, these CDP tokens simply cannot maintain a 1:1 peg to the USD, especially when their main use case is leveraged trading.

In essence, in DeFi, CDP is just another form of lending. Borrowers mint CDP stablecoins and exchange them for other assets or yield strategies that they believe can exceed the protocol's lending rate.

Everyone swaps their CDP stablecoins for other assets, usually more stable centralized assets like USDC or USDT, or for more volatile assets like HYPE for leveraged trading. There is no point in holding these tokens, especially if you have to pay borrowing rates: 7% annualized yield (APY) on feUSD on Felix and 10.5% APY on USDXL on HypurrFi.

Take USDXL as an example: it has no local use case, and users have no reason to hold it. That's why it can fluctuate at prices like $0.80, $1.20, etc. - the price is not anchored by any real arbitrage mechanism. Its price simply reflects the demand of users to borrow HYPE. When USDXL is trading above $1, borrowers can borrow more USD; when it is below $1, borrowers can borrow less - it's that simple.

feUSD is slightly better. Felix provides users with a stable pool where users can earn 75% of the returns from borrowing fees and liquidation bonuses, which is currently about 8% APY. This helps reduce price volatility, but like USDXL, there is still no strong arbitrage mechanism to keep feUSD firmly at $1. Its price will still fluctuate based on borrowing demand.

The core problem is this: users who buy feUSD and put it into the stability pool are essentially lending their USDC or HYPE (via Felix) to the people who minted feUSD. These CDP tokens have no intrinsic value. They only have value when paired with valuable tokens like HYPE or USDC in a liquidity pool.

This introduces third-party risk, and without airdrops or other incentives, there is really little reason for DeFi users to borrow illiquid, unpegged tokens like feUSD or USDXL, or to buy them as exit liquidity for borrowers. Why would you do this when you can just borrow stablecoins like USDT or USDDe directly? The stablecoins you borrow will eventually be converted into other tokens anyway, so you don't need to care about the decentralization of the borrowed assets.

Another reason why CDP did not succeed in HyperEVM is that leveraged trading is already a native feature of the Hyperliquid ecosystem. On other chains, CDP provides decentralized leveraged trading. On Hyperliquid, users only need to use the platform itself, take advantage of leveraged perpetual contracts (perps) and excellent user experience, and do not need to rely on CDP stablecoins.

To summarize, here are the reasons why CDP ‘stablecoins’ on HyperEVM perform poorly:

* Lack of strong arbitrage mechanism

* Weak demand for CDP products in Hyperliquid

* Low borrowing costs and no reason to hold CDP tokens

As a result, CDP ‘stablecoins’ like feUSD and USDXL are trading below their soft pegs of $1