Stable currency IOSG industry research | survey algorithm mechanism design, present situation and the stability of product performance

The original title: "IOSG industry research | decentralization of the central bank monetary experiment"

By Ray Xiao, Chief Investment Officer, IOSG Ventures

Summary of background

Stabilize the size of the coin market

From the market size, the general stable currency (decentralized & AMP; While centralised mortgages are absolutely mainstream, algorithmic stablecoin is a very niche product with only about 1% of the market.

Industry Demand: Why do we Need algorithmic stablecoins?

The secured stablecoin has been verified by the market, and the stablecoin model supported by collateral is also the simplest and most natural model that can achieve the stablecoin without decoupling from the target price. So algorithm stablecoins still need, there is a future?

Quite a few of the algorithmatic stablecoin teams we've talked to have a story about getting rid of central bank policy, but we don't think that's a real pain point. We believe that the demand and potential value behind algorithmic staboin lies in how to achieve low mortgage rate or even no mortgage step by step under the current DeFi excess mortgage, and finally change the money supply completely by automatic algorithm. This involves maintaining the relative stability of currency anchor price and market price based on the economic law of supply and demand and the arbitrage behavior of rational economic man. Therefore, it is indeed a very ideal monetary experiment at present.

Key factors to the success of algorithm stablecoin?

When we studied the algorithmic stablecoin projects on the market, we believe that the following four key factors determine the success of an algorithmic stablecoin:

Is there a mortgage mechanism (partially or completely unsecured)

Global Rebase (Globally adjusted Supply of smart Contracts)

Bond/Share Issue (seigniorage mechanism)

Target price anchoring or floating (strictly anchoring $1 or floating target price)

Industry Segmentation (mechanism design + Product status)

First of all, we need to clarify what the "algorithm" in the algorithm stabilization coin actually refers to. We believe that the "algorithm" in staboins means that the agreement sets a set of established rules in advance, and the market price of the staboins already issued according to the agreement and the price of the staboins to be anchored (i.e. The deviation of Target Price (Target Price) adjusts the total supply of staboin without human intervention and the protocol runs automatically, much like an automated central bank composed of various rules and algorithms.

In addition, it is worth mentioning that many friends think that the other side of "algorithm stablecoin" is "collateral stablecoin (DAI, USDC, etc.)", but in fact, from the perspective of development path, the algorithm stablecoin system can also have some collateral. In this breathtaking currency experiment, most of the algorithmically stable coins without any collateral support experienced a sharp rise and fall. In a practical sense, it is difficult to give users confidence in "stability". Therefore, after ESD and BASIS, we can see Terra, Frax, Fei, RAI and other algorithmic staboin projects supported by collateral, although the adjustment of their staboin supply is still completely dependent on automated algorithms, the stability performance of the system is relatively good because each issued staboin has a certain collateral support value behind it.

As mentioned above, it can be seen that all kinds of projects are adjusting token supply in the decoupling of stable currency market price and target price, and follow the following economic laws:

There is too much money in the market, oversupply, recycle/destroy the money in the market

There is too little money in the market, supply is less than demand, so send more money to the market

After staboins are issued (target price, issuance), "market price/target price fluctuation (imbalance between supply and demand) & GT; global control of smart contract/user spontaneous control & GT; influence supply and demand, transmission to market price" can be summarized to almost all algorithm staboins.

Although everyone is following this economic law from a High level, the specific means of maintaining stable currency price for different projects are varied, and we will classify them according to two groups: unsecured and secured.

Unsecured sent

The unsecured party does not need to put any collateral into the agreement when the currency is issued, so we will only discuss how the agreement is controlled by inflation/deflation.

First generation Rebase -- Forced increase or decrease in stabler supply

When it comes to Rebase, the first thing that comes to mind is Ampleforth, YAM. Although Rebase was not invented by Ampleforth, it was certainly promoted by Ampleforth (the mechanism was not well known until now). Even Ampleforth claims to be "Rebasing Cryptocurrency."

Representative project: Ampleforth

Regulation principle:

Inflation: when the market price of a stablecurrency < With a target price (currently around $1), the agreement reduces the number of stablecoins in the hands of all users in the system year over year.

Deflation: when the market price of a stablecurrency > With a target price (currently around $1), the agreement increases the number of stablecoins in the hands of all users in the system year over year.

It is worth mentioning that the number of staboins in this system is increased or decreased in the same proportion according to the decoupling between the market price and the target price (say 5%). The same proportion means that although the number of staboins in the hands of users increases or decreases every day, the corresponding proportion of staboins in the total circulation remains unchanged.

Value: Ampleforth's greatest value lies in its bold first Rebase, a mechanism to regulate the amount of money issued, and then rely on arbitrageurs' arbitrage to drive the price of the currency in the direction desired by the designers. All of the improvements to algorithmatic staboin since Ampleforth have been more or less around Rebase (whether it's smart contract global regulation or issuing bonds and shares to motivate users to complete supply regulation). Take additional issuance as an example. After each additional issuance of Rebase, the number of stablecoins in each user's hands will increase. Short-term arbitragers can carry out arbitrage by selling stablecoins, and eventually promote the price of stablecoins to fall.

Design defects: Ampleforth controls the supply of stablecoin in a straightforward and brutal way -- increase or decrease in the same proportion. In the case of ignoring more complex factors (market environment, psychological factors, etc.), in theory, the same proportion split is really just a slice of the cake and does not change the size of the cake. However, in actual operation, external market factors and psychological influence of users (decrease in the number of assets in hand) will bring negative impact on the system, which led to drastic price fluctuations of the stable currency.

Second generation Rebase -- first introduction of the practice of Seigniorage Shares

In the first generation of Rebase projects, protocol regulation was only a means of adjusting the total supply of smart contracts globally (users woke up every day to find more/less staboins in their hands and could only passively accept them). So economists, seeing the inadequacy of this design, added a new instrument, Seigniorage, ushering in a second generation of Rebase.

Robert Sams was the first to think of applying the traditional currency economy concept of "seigniorage" to the Cryptocurrency system in A 2014 paper he wrote. In Seigniorage Shares, he describes a two-token stablecoin model: one token is a stablecoin, and the other token is like an equity share that can share Seigniorage. For example, when the market price of stablesoin is higher than the target price and the supply of stablesoin needs to be increased, the newly issued stablesoin will be distributed to the holders of the "agreed shares".

Representative projects: ESD, BASIS

Regulation principle:

Inflation: When the market price of a stablecurrency; With the target price (currently about $1), the agreement will issue bonds to recover stablesoin in the market, thereby reducing the liquidity of stablesoin in the market, and users can obtain interest income by purchasing bonds (Coupons in ESD and BASIS Bond of BASIS are bonds issued by agreement).

Deflation: when the market price of a stablecurrency > Target price (currently about $1), the agreement will issue additional staboins, and the additional staboins will be issued to users entitled to seigniorage (ESD is issued to pledgers of staboins, BASIS is issued to pledgers of BASIS Shares)

Value: Do careful friends see the difference between the first generation and the second Rebase? Yes, the most important innovation is the introduction of the agreement of equity, bonds these two important macro-control means. While the second generation of Rebase will still adjust the total supply globally, it will only be used in times of deflation, and the extra staboin will be given to the holders of the agreed shares for seigniorage. In the face of inflation, stock awards user agreement is through sale active destruction in the hands of a stable currency arbitrage opportunities, with the first generation of Rebase users passively accept the stability of the currency supply increase or decrease in there is a huge difference, and then many algorithm stable currency project also introduced a bond agreement, is also used when inflation to repurchase/destruction of a stable currency, These are huge improvements over the first generation's simple and crude "increase in price on a rise, destroy on a fall" approach.

Design flaw: The unsecured group believes that people's optimistic expectations for the system (stable development, stable price, steady increase in supply volume) are enough to support a stable system, but the actual situation proves that only expectations can not succeed. Although projects represented by ESD and BASIS have introduced the design of seigniorage of agreed stock sharing, their performance is far worse than that of projects with collateral in terms of price stability of stable coins at present. Since the system is not backed by collateral, these expected NPV values are the underlying value of the agreed shares. From the current development of the "unsecured party" project, it is always the situation that the users leave the market to sell stocks when the staboin price falls, resulting in the failure of stock regulation by agreement alone and the system collapse.

Mortgage sent

At present, the projects of the mortgaged party perform better than the projects of the unsecured party both in terms of the stability of the stablecoin price and the valuation of the protocol governance token. The main reason is that collateral was placed at the time of issuance to support the stablecoin value.

Regulation 1 Elastic Seigniorage Shares

The important thing of the third generation Rebased is the new design of the function and supply changes of the protocol stock, which enhances the protection of the protocol stock against the price fluctuations of stablesoin.

Representative project: Terra (Although Terra stated in its official white paper that its stable currency, TerraUSD, has no collateral, in fact we think LUNA is part of the collateral behind it, so we temporarily put Terra in the collateral group)

Principle of regulation: The first thing to be clear is that Terra is a Zone side chain on Cosmos. This side chain uses PoS consensus, and the transaction packaging rights on the chain need to be secured by the miner pledging $LUNA. Terra algorithmic stabbcoin is a project running on Terra chain. $LUNA is also an equity token in the algorithmic stabbcoin, which has dual functions.

Inflation: When the market price of a stablecurrency; Target price (currently around $1), system print stock & AMP; To recover money, arbitrageurs can exchange staboin for newly issued shares (for example, at the current Terra staboin market price of $0.9, the system allows arbitrageurs to exchange 1 Terra staboin for $1 LUNA. Arbitrageurs get the equivalent of a new LUNA $0.1 cheaper than the market price.)

Deflation: when the market price of a stablecurrency > Target price (currently around $1), system prints new money & AMP; By retrieving the shares, arbitrageurs can exchange the equity token LUNA for new money (for example, the current market price of Terra staboin is $1.1, and the system allows arbitrageurs to exchange $1 LUNA for a Terra staboin. Arbitrageurs receive the equivalent of a newly issued Terra stabler $0.1 cheaper than the market price.)

Value: First, Elastic Seigniorage Shares are designed to Rebase the supply of contract Shares and stablecoins in times of inflation and deflation, and then rely on arbitrageurs to pull back the price of the decouped stablecoin market. Essentially, a redesign of the supply of agreed shares provides better absorbability to fluctuations in the stablecoin price.

Second, in this case, $LUNA is itself a native token for the side chain, and a PoS staking scenario for The Terra chain actually assigns new functional value to $LUNA itself. So if Terra blockchain can be developed, theoretically we think Terra's algorithmic stablecoin project will be more stable.

Design bug: Miners in Terra staking are exposed to the risk of stablecoin price fluctuations. Systematic printing of new equity in times of deflation diluts the power of a stablecoin miner, but Terra stablecoin prices are currently among the most stable in stablecoin projects (see section 3.1 below).

Control method 2: Protocol Controlled Value

Representative project: Fei

Issue: FEI is created based on Bonding Curve. Users invest in ETH and get FEI. The ETH invested by the user actually goes into the vault controlled by the PCV as an asset that supports FEI value.

Regulation:

PCV regulation: The core is that smart contracts use the collateral in the vault to continuously increase or decrease liquidity in the stablecoin trading pool issued by agreement in the market, so that the price in the stablecoin trading pool is always stable at the target price of $1.

User penalty/incentive: when stabecoin market price < When the target price is $1, users will automatically discount when they sell staboins. Buy stablecoins and get extra stablecoins

Value: The protocol Treasury composed of collateral assets is used to control the stablecoin liquidity pool in the market. PCV can be regarded as an interesting idea related to algorithmic stablecoin after the emergence of AMM liquidity pool.

Design defects: Project parties use intelligence to the collateral of the agreement to the automation control of the market price, in most cases are effective, but if face extreme prices sharply lower collateral value (FEI, collateral is ETH) at present, the regulatory mechanism will face a serious test, but this is all low mortgage rates DeFi common fault of the product.

Control means 3: introduce engineering PID control system to adjust the proportion of target price and market price

Representative project: Reflexer

Issue: users are required to overpledge ETH (mortgage rate is no less than 145%), and the system also has a clearing mechanism.

regulation

When the market price (suppose 4) > At the target price (currently $3.14), the control mechanism is activated (using PID control system) to continuously increase the redemption rate of RAI (the ratio between target price and market price), which is equivalent to raising the target price. Higher redemption rates will encourage those locked in ETH (RAI borrowers) to buy RAI now as their liquidation costs become higher. In theory, this would bring the market price of RAI into line with the redemption price.

Value: Reflexer's system is relatively robust; it inherits MakerDAO's mortgage and liquidation mechanism, and collateral can be redeemed at any time (Fei can't redeem collateral directly). The novelty of this project lies in the use of PID algorithm to control the target price and interest, so as to change the market price based on arbitrageurs' arbitrage behavior. We believe Reflexer is one of the most stable prices of all and is better positioned to withstand a death spiral in the event of extreme mortgage price declines.

Design defects: No obvious defects, excess mortgage also means that it has low capital efficiency, which is not a subversive innovation compared with MakerDAO (is the stable price of stabler mainly due to MakerDAO's mechanism, PID algorithm seems not the main cause?) .

Control means 4: mortgage rate control of compound collateral

Representative project: Frax

Issuance: Two types of collateral are placed in the issuance of staboins -- external assets (currently USDC) and agreed shares, FXS. The ratio of the two assets (mortgage ratio) is controlled by the protocol algorithm. For example, 50% collateral means that $1 staboins need $0.5 in USDC and $0.5 in FXS.

Regulation: The specific mechanism Haseeb Qureshi, Alexis Direr and others have written articles that provide an easy-to-understand analysis.

In general, Frax designed a dual-collateral system where staboins could always be redeemed at $1, so arbitrage could be relied on to bring the market price of staboins back into a range.

Inflation: When stable currency market price < With a target price (currently $1), arbitrageurs would buy stablecoins in the market and redeem the collateral in Frax agreements, eventually selling the agreed equity (FXS) in the collateral at a profit. Arbitrageurs have more demand for stablesoin, so the market price of stablesoin will go up.

Deflation: when stable currency market price > The target price, the arbitrageur would go into the Frax protocol and put collateral into the stablecoin, and sell the stablecoin in the market for a profit. As the supply of stablecoins increases, the market price of stablecoins decreases.

Value: Frax is one of our favorites on the track right now.

Its design has the taste of learning from the failures of previous algorithm stablesoins. For example, the initial collateral was stablesoins rather than other volatile assets. Abandoned Rebase> for system global supply increase/decrease. Arbitrageur behavior & GT; The price rises/retracts while the new design is set at any time at a fixed exchange rate bi-directional casting/redemption & GT; Arbitrageur behavior & GT; A rise/correction in price.

Judging from the current system asset mortgage rate, its performance is also the first project to complete the algorithmic stablecoin without excess mortgage and keep the stablecoin price stable.

Design defects: There are no obvious defects, and the stability of the system in the early stage also has a lot to do with the fact that the collateral is USDC. It still needs time to prove whether the collateral can withstand the test when the Crypto assets fall sharply when the collateral is changed into other volatile assets in the future.

Control means 5: agreement Treasury Dutch auction

Represents the project: Float

Issuance: Similar to Frax, stablecoins are issued with two types of collateral -- external assets (currently ETH) and an agreed share BANK

Regulation:

Means one: agreement Treasury regulation

Method 2: user arbitrage behavior regulation

Value: Float combines several factors that make algorithmatic staboin systems better able to withstand death spirals: Composite collateral, the use of seigniorage tokens, bond, protocol issued Treasury regulation + Rebase arbitrage relies on the user behavior regulation and agreement on the changes in the price target also has its own innovation, therefore personally think that this project has better robustness and innovative, although the current liquidity is not high, but we think it has good development potential.

Design flaw: Since there is no clearing mechanism and no excess collateral, this DeFi system also faces the test of a fall in vault collateral in an extreme market.

Calculate the actual performance of the project

Existing algorithms stabilize the price stability of coins

As for the price performance of the current mainstream algorithm staboin, we compare the standard deviation of their daily price fluctuations, and it can be seen that Frax and Terra perform relatively better:

How to face the death spiral

Death spiral is a problem facing all algorithm stable currency (or, more broadly all synthetic asset class DeFi agreement have this problem, the stable currency also belongs to a kind of synthetic assets), we observed the currently on the market performance of the project, summarizes several possible coordination factors can help to better cope with the extreme market project:

There must be speculation in the early stages, but the point is that the speculators will eventually bring a lot of money to the agreement, which will turn the economic flywheel.

Collateral gives users more confidence. The larger MakerDAO, Synethetix adopt overmortgaged, providing a price shield to the system. Therefore, from the perspective of the price stability of the current algorithm, the overall performance of some mortgaged projects is better than that of the unmortgaged ones.

The design of contractual equity and seigniorage is critical, and here we see Terra's flexible contractual equity and Frax's equity casting/redemption arbitrage design making their economies more robust.

The use of bonds in deflation can also absorb a lot of selling pressure.

Investment Logic - What does a successful stabilization look like?

Based on the various algorithmic stabler designs and their actual market performance, we believe that the following points will support the steady growth of stabler projects:

Almost a must:

Compound collateral: external collateral such as ETH and other stablecurrencies; Agreed equity tokens as collateral

Elastic Seigniorage Shares, the supply of agreed equity tokens, is also designed to absorb the volatility of staboins

In addition to governance and seigniorage, protocol equity tokens are more stable in value if they have additional functions (for example, $LUNA, the protocol equity token of Terra Staboin, is also the native token of Terra blockchain.

Possible:

Use of bonds

The target price is not anchored at $1, and a new floating target price mechanism is designed to automatically adjust the target price according to market supply and demand to create arbitrage opportunities

Use the system Treasury (collateral) to control the liquidity of the stable currency trading pool in the market

Thanks to John Wu for his help in the writing process

The original link

Welcome to join the official BlockBeats community:

Telegram Subscription Group: https://t.me/theblockbeats

Telegram Discussion Group: https://t.me/BlockBeats_App

Official Twitter Account: https://twitter.com/BlockBeatsAsia