RAI: “In code we trust”

Original title: "Pantera Partner: Interpretation of "Non-Illegal Currency Anchored" Algorithmic Stablecoin RAI"

Original source: Chain News

Recently, Reflexer Labs announced the completion of a $4 million financing transaction, led by Pantera Capital, which aims to build a decentralized, stable and non-illegal currency-anchored stablecoin in the digital economy.

What is a "non-illegal currency-anchored stablecoin"?

Broadly speaking, a stablecoin is a token issued on a public blockchain that resists market fluctuations and its value is usually pegged to a widely accepted fiat currency. In the cryptocurrency market, there are always some subtle differences in the precise definition of stablecoins, but as regulatory "interest" in stablecoins grows, it is becoming increasingly important to accurately define stablecoins.

Basically, this broad definition I gave captures the essence of stablecoins.

Low volatility stablecoins are very important to the crypto ecosystem: stablecoins can fully utilize the advantages of public blockchains - immutable, decentralized, and secure - while providing a "bridge" to help crypto users connect with the "old world" of central banks and fiat currencies. Not only that, stablecoins have also played an important role in the "DeFi boom" in the summer of 2020 and the continued growth of the decentralized financial industry. Today, more and more large institutions are beginning to explore stablecoins, especially cross-border payments have become one of the most powerful use cases for stablecoins.

At present, stablecoins can be divided into two major "categories":

1. Stablecoins anchored to fiat currencies

2. Stablecoins based on algorithms

Stablecoins backed by fiat currencies are mostly issued by institutions, which need to bear economic and insurance responsibilities for the true value of each token issued. For example, USDC and Tether, the two most used stablecoins, are pegged 1:1 to the U.S. dollar. In theory, each USDC or Tether can be exchanged for 1 U.S. dollar - this logic also applies to other fiat stablecoins (such as TrustToken's fiat stablecoin matrix) and non-fiat stablecoins (such as the Venezuelan government's petro).

Although fiat currency is the main "anchor" of current stablecoins, fiat currency actually has a big disadvantage: trust.

First, you need:

Trust that the stablecoin issuer will not freeze your assets;

Trust that the stablecoin issuer always remains solvent;

Trust that the stablecoin issuer complies with complex regulatory requirements;

Trust that the stablecoin issuer actually owns the collateral reserves they claim to have (which is actually the root cause of Tether's long-standing controversy).

Secondly, and more importantly, when you hold a stablecoin pegged to the US dollar, it means that you will be affected by the monetary policy of the Federal Reserve (or other central banks), because the stablecoin is actually consistent with the "stability" of the legal currency financial system that manages it. In other words: crypto-USD is still USD.

Another type of stablecoin is an algorithmic stablecoin, which does not rely on reserves, but relies on the power of mathematical design to "anchor" the stablecoin near the value range. At present, many different algorithmic stablecoin solutions have been launched in the cryptocurrency market, but the complexity varies. If you want to learn more about algorithmic stablecoins, it is recommended to read This article.

What is DAI and how does it work?

DAI is the native token of the Maker protocol and the most widely used algorithmic stablecoin in circulation. The anchor price of 1 DAI is 1 US dollar. The Maker Protocol is a decentralized autonomous organization (DAO) that facilitates peer-to-peer lending (backed by the governance token MKR) and was released in late 2017.

To explain how DAI works, you also need to understand the Maker lending platform - DAI is minted when users lock ETH (and other Maker-allowed crypto assets) as collateral in smart contracts on Maker.

Like most DeFi platforms, the Maker Protocol requires loans to be overcollateralized; in other words, if you want to mint a certain amount of DAI, you need to collateralize more ETH, to be exact, currently the DAI collateralization ratio is 150%. DAI is subject to a stability fee, similar to the rate charged by banks, but usually the DAI stability fee is much lower than that of banks. When users wish to unlock the collateralized ETH, they need to inject DAI (including interest paid in MKR) back into the protocol, and then destroy these tokens.

If all this seems confusing, don’t worry, you’re not alone. The DAI mechanism is a true mathematical and economic achievement, so if you want to learn more, you can watch this explainer video or read the project whitepaper.

In short, DAI keeps the token stable by changing the stability fee, similar to how the Federal Reserve adjusts the money supply through interest rates. When the market price of DAI is above $1, Maker will reduce the stability fee to increase loan supply and bring the price back down; when the market price of DAI is below $1, the opposite happens.

So what kind of effect does this mechanism have? According to a new study in the Journal of Risk and Financial Management, DAI is the least volatile collateralized stablecoin and can compete with multiple stablecoins pegged to fiat currencies - a new technological achievement.

What are the disadvantages of DAI?

Although DAI has many advantages, it also has some problems, mainly concentrated in the following four points:

Fiat currency anchoring: Due to the "anchor" to the US dollar, DAI owners are forced to have a certain degree of trust in the US dollar. But now, more and more people are questioning the "stability" of tokens pegged to the US dollar, mainly for the following reasons:

The US dollar money supply has seen unprecedented growth

Growing concerns about inflation

Many companies are starting to add Bitcoin as a hedging tool to their balance sheets

MCD: MCD refers to Multi-Collateral DAI, which means that the collateral can be selected not only ETH, but also a variety of other cryptocurrencies. By switching to MCD, the counterparty risk of some off-chain assets on MakerDAO that make holders dissatisfied may increase.

Custodian: Maker's organizational structure may bring the risk of "malicious collusion". Ameen Soleimani (co-founder of Relexer Labs) imagined an unlikely but terrifying scenario:

For example, MakerDAO currently has at least four custodians, each of which can "steal" 100% of the ETH collateral deposited in MakerDAO at will, mint 100 trillion DAI, and then use these DAI to steal all ETH liquidity provided for ETH/DAI pairs in all decentralized exchanges (such as Uniswap) and lending protocols (such as Compound). Before having a chance to respond, the custodians, the Maker Foundation, a16z, PolyChain, and Dragonfly could theoretically execute the entire "heist" in a single atomic Ethereum transaction.

Negative interest rates: DAI is at risk of "runaway anchoring", which Ameen Soleimani also explained:

The DAI anchor rate is: 1 DAI = 1 US dollar, which also brings a limitation to MakerDAO, that is, it is difficult to impose negative interest rates. When the price of DAI rises above $1, MakerDAO cannot offset the incentives by implementing negative stability fees and repay more DAI debts to borrowers. If negative interest rates can be implemented, it will help restore the anchor rate. Instead, Maker relies on arbitrage opportunities between different forms of collateral to meet excess demand for DAI.

What is RAI and how is it different?

RAI is a new algorithmic stablecoin launched by Reflexer Labs that attempts to solve some of the problems facing the current stablecoin market. Relexer Labs, co-founded by Ameen Soleimani and Stefan Ionescu, recently announced a $4 million round of financing led by Pantera Capital.

After months of testing, RAI officially launched its mainnet on Ethereum last week. You might ask, how does it perform?

First, let's take a look at how RAI works. In fact, RAI is similar to DAI in many ways and is a hard fork of the MCD system. The DAI code itself has been tested for a long time, and RAI not only benefits from it, but also implements some important optimization improvements. One of the biggest differences is that RAI is completely separated from the "fiat currency world".

The Defiant once commented on RAI:

RAI is not pegged to a fiat currency, nor is it backed by a fiat currency, but is run entirely by a computer program. If RAI issues physical coins, it is estimated that a line of words will be printed on it: "We trust code."

This is very important, and RAI is undoubtedly a pioneer in the field of algorithmic stablecoins.

While using a "floating peg" may make some users uncomfortable, Reflexer Labs has minimized price volatility through optimization. RAI has an arbitrarily set initial target price (the initial target price at the time of issuance was $3.14), and as long as the market price is different from the target price, RAI will algorithmically adjust the interest rate - the "redblockquoteption rate" to respond to price changes. The price of the RAI token may fall back to the initial level, but it may also stabilize at a new equilibrium position. For RAI, this mechanism is undoubtedly successful - because their goal is not to have a price that never fluctuates, but to prevent price fluctuations, because the RAI mechanism is also different from other stablecoins.

The RAI protocol uses a similar lending system to Maker, except that it only accepts deposits of ETH to mint RAI, thus solving the counterparty risk mentioned above. When the redemption rate is adjusted, people will choose to mint or destroy their RAI, and by changing the token supply, the RAI price can be kept stable.

It is important to mention that the biggest difference between RAI and DAI is that it allows negative interest rates. RAI is still in its infancy and has not yet suffered the huge impact of Ethereum's price fluctuations, but without affecting decentralization, the founder of the project believes that RAI can be more resilient to emergencies such as the short-term plunge of Ethereum on "Black Thursday" compared to many other algorithmic stablecoins.

How stable is RAI?

The real heart of RAI (and what makes it so exciting) is that it uses a PID controller to stabilize the underlying asset, and the idea of PID controller comes from "Control Theory".

As stated in the RAI white paper, PID controllers have been used in "more than 95% of industrial applications and a wide range of biological systems". At its core, it uses a feedback loop to adjust unstable changes - the first practical application of this stabilization system is to help ships achieve automatic steering functions. Although it is not clear whether PID controllers have been applied in the financial field, researchers have found that many central banks may have accidentally come close to using PID controllers.

But with the emergence of RAI, this concept is becoming clearer.

Is RAI a true "stablecoin"?

No, at least not yet. According to the RAI team:

RAI, on the other hand, is not pegged to anything. The system behind RAI only cares about ensuring that the market price is as close to the redemption price as possible. The redemption price almost always floats (in this way, RAI is not pegged to any fiat currency) to force system participants to keep the market price close to the redemption price.

The above paragraph may still be difficult to understand, but in fact, you can think of RAI not as a stablecoin similar to an "external currency" (like those stablecoins pegged to the US dollar), but as a currency that optimizes itself for reduced volatility. RAI has its own monetary policy and governance model, which means that when its price changes, it has nothing to do with system problems, but is just a "system function". If you look at the price changes of the RAI/USD trading pair, it may be like watching the Zimbabwean dollar depreciate against the US dollar; they are two completely different systems, and for some users, RAI is an asset, not a responsibility.

Its own currency optimized for low volatility. It has its own monetary policy and governance model, which means that when its price changes, it is a feature, not a bug in the system. Watching the price change in the RAI/USD trading pair is the same as saying that the price of the US dollar is surging uncontrollably relative to the Zimbabwean dollar; they are two completely different systems, and for some users, this is an asset, not a liability.

Some people call RAI a “gentlecoin”, a term I really don’t want to catch on, but unfortunately, it does a good job of describing the fact that RAI is a completely different stablecoin.

What value does RAI add to the crypto ecosystem?

The launch of RAI is significant for the crypto community both symbolically and pragmatically.

The core tenet of “cryptoeconomics” is to break free from the shackles of central banking institutions, and while Bitcoin and other stores of value have played the role of alternatives to fiat currencies, volatility has always been the Achilles’ heel of cryptocurrencies. For risk-averse members of the crypto community, stablecoins backed by fiat currencies have always been a “safe haven” for high volatility events and long-term financial contracts. However, RAI now offers a completely new alternative that does not rely on, use, or focus on the fiat currency “world”. There are also some members of the crypto community who are "against the idea of fiat currency". If they don't want to be affected by volatility risks, RAI is also a compelling choice because it is a "volatility-resistant" token that does not rely on fiat currency to maintain its stability.

From a practical perspective, the RAI team has launched two direct use cases.

First, RAI may be an asset for investors who want to invest in ETH without holding the underlying asset. Since RAI uses a floating exchange rate mechanism and all collateral of the protocol is insured by ETH, it means that it pays more attention to the price trend of ETH. For certain types of investors, this may be a more attractive component of their diversified portfolio.

Secondly, RAI may become the next "ETH standard" for collateral in DeFi projects, especially synthetic asset platforms (such as UMA, Synthetix) can regard RAI as an alternative to low-volatility collateral assets. On March 12, 2020, the ETH crash "Black Thursday" incident broke out, which had a huge impact on some DeFi protocols. In order to avoid similar situations from happening again, some DeFi protocols may be looking for alternatives to ETH and other crypto assets.

RAI's next development plan?

Since the successful launch of the RAI Ethereum mainnet, $250 million worth of ETH has been locked in the first week, and more than 30 million RAI have been issued. If you want to know more about RAI's real-time indicator data, you can view it here.

This is just a brief summary of RAI’s philosophy and principles, and we still have a lot to learn! If you’re interested in getting involved, you can check out their documentation and join their Discord community. If you want to mint RAI by locking up ETH, the protocol has already opened up leverage services to hundreds of users.

In short, RAI is a new type of crypto asset: a volatility-resistant stablecoin that does not rely on fiat currency for stability. RAI is the first token of its kind, but it may not be the last, and we are excited to continue to watch RAI’s future development direction.

Original source

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