Stable coins have long played a pivotal role in the crypto ecosystem. Tether made it possible for centralized crypto exchanges to interoperate, stabilizing the frequent disparities in across exchange prices. Now, a variety of stablecoins provide a solid foundation for the growth in the nascent DeFi space. It is arguable that without stablecoins as a safe, non-volatile asset, the massive price action in DeFi would have scared away many market participants, limiting the adoption rate that DeFi has experienced. However, to this day, we have yet to emerge on a stablecoin that fulfills the needed functionality for the DeFi space while reliably maintaining its peg.
Dynamic Set Dollar
DSD builds upon successful primitives from existing stablecoin projects — particularly ESD -, replacing suboptimal functionality to achieve what we believe is the perfect stablecoin model. In this article, we showcase some of the challenges experienced by other projects, and how DSD overcomes them. As an introduction, the following chart provides a simplistic overview of the major differences between DSD and other stablecoins:
A New Approach
Lately, the concept of elastic supply as a mechanism for achieving stability is advancing in the world of decentralized finance. Elastic supply in this context simply refers to a protocol where the token price is coaxed towards a defined peg (typically 1USD) by using price oracles in conjunction with token supply controls. Elastic supply protocols dynamically expand or contract the token supply through a mechanism called a rebase. An oracle samples the token price at specified intervals so it can decide if the total token supply should decrease or increase. Limiting the token supply makes the token more scarce, which increases the value of each token, so it can adjust to the 1 USD peg. If the price is above the peg, the total token supply is increased, making the token more common, and decreasing the value of each token. Almost all rebase tokens increase and decrease the token supply by directly adjusting the amount of tokens in every token holder’s wallet.
Rebasing is a clever mechanism to adjust the price of a token, however directly increasing or decreasing the total token supply has two significant problems, one technical and one psychological. From a technical standpoint, this form of rebasing does not strictly adhere to ERC-20 standards, making interoperability with the rest of the DeFi ecosystem difficult. The ability to inherently interoperate is called composability. Projects that lack composability will naturally be passed over for projects that require no extra effort to integrate.
From a psychological standpoint, it can be scary to see the number of your tokens decrease and an autonomously changing token balance does not promote confidence. Lowered confidence might provoke unnecessary volatility, which is an undesirable behavior for a stablecoin.
DSD incentivizes market participants to voluntarily increase or decrease the token supply, to provide liquidity to DSD trading pairs, and to positively contribute to the long-term success and adoption of the asset. Further, the protocol leverages a variety of mechanisms to incentivize token holders in a game-theoretic battle that is carefully designed to drive the token price to trade at or near its peg.
Voluntary Elastic Supply
To meet the optimal market demand, DSD’s total supply can either expand or contract. These mechanisms are mandatory in order to counteract the scenarios of having DSD trading above or below 1$.
DSD trading <1$
If the token price is below the peg, token holders must be incentivized to contract the token supply as doing so will help to get the spot price back towards the peg. To do so, the DAO issues so-called Coupons (debt). To purchase Coupons, users burn their DSD, thereby reducing circulating supply. This is incentivized as you always purchase Coupons with an added discount which depends on the debt ratio (Debt/Circulating supply) in the system. Once there is a positive rebase event, the DAO mints a programmatically sufficient amount of new DSD. In this case, an equal amount of Coupons will be redeemable for DSD. Important to note is that Coupons face an expiry of 360 epochs after purchase.
The debt ratio in DSD is capped at 35% which implies a max. premium of ≈46%.
DSD trading >1$
We must also consider what happens when the price of DSD goes above its $1 peg. As the token price moves above the peg, the token supply needs to expand in order to push it back down. In a positive rebase event, the DAO mints an appropriate amount of new DSD. In this case, the equal amount of Coupons will be redeemable for DSD and the remaining Coupons (debt) will automatically be cleared. If any DSD remains after all existing Coupons have been redeemed, the bonded DSD holders and liquidity providers (LPs) will be rewarded. After all existing Coupons have been cleared, the entire supply extension will go towards bonded DSD holders and LPs.
Differences with ESD
There are similarities between DSD and Empty Set Dollar. As explained in the ESD white paper, “[i]nstead of reinventing the wheel, we aim to construct [ESD] using already existing primitives where possible. This allows for minimal implementation with few unknown unknowns.” Just as ESD uses Basis, 0x Staking, and Rho, we use ESD to be a strong foundation from which to construct DSD.
There are crucial differences between ESD and DSD:
- Epoch Duration
- Rebase Amount
- Supply / Reward Mechanism
- Extended Coupon Expiry
1. Epoch Duration
ESD allows for 3 daily epochs (1 Epoch every 8hrs), while DSD changes this to 12 potential supply extension or contraction events per day (1 Epoch every 2 hours). This not only allows a faster response to price discrepancies, it allows DSD a more granular response to other matters. Smaller, incremental changes smooth transitions between rebase events unlike with only three rebase events per 24 hours. A small price difference should not trigger an outsized rebase reaction.
2. Rebase Amount
ESD features a maximum change to the token supply of 3% in one epoch. DSD removes the maximum percent limit since the token price difference can only ever move by 1/12 % every epoch. Scaling the price this way also prevents exploitation from attempts to manipulate the 2-hour epoch length.
In this context, DSD and ESD also differ in the way bonded token holders and LPs are rewarded. ESD rewards 80% to bonded holders and 20% to liquidity providers. It is our contention that liquidity providers are not rewarded enough for the risk they take, while bonded holders are comparably rewarded too much considering their low risk and capital efficiency. To incentives a deep liquidity pool that is more resilient against volatility, DSD rewards 60% to bonded holders and 40% to liquidity providers.
3. Supply / Reward Mechanism
Supply Elasticity in DSD is formulated in a slightly different way to ESD. The change in the supply of ESD is given as:
The amount of supply to change is determined by two main terms, the total supply multiplied by the price deviation from 1. If the price is lower than 1, then the supply difference will be negative, thus that amount of tokens must be subtracted from the total supply.
DSD modifies the change in demand formula to:
A positive number indicates supply should be increased by that amount. If the supply is 100 and the current token price is 1.20, then the supply difference will be:
1.67% of the total token supply is added to the total supply in order to devalue the high price.
This change will dampen the extension or contraction amount by a factor of 12. Since there are 4 times more epochs in DSD, it is not necessary to have a large token supply change in one event. Again, more frequent smaller changes help to reduce the likelihood of triggering token dumps. Due to these mechanics, we expect the price to stabilize as shown in the graph below.
4. Extended Coupon Expiry
Users that purchase Coupons play a fundamental role in the DSD ecosystem. By burning DSD for Coupons these users are willing to buy-off and reduce the underlying debt in the system.
In ESD, (Coupons in ESD = Coupons in DSD) coupons have to be redeemed within 90 epochs which bears significant risk as coupons remain worthless as they expire after 90 epochs without redemption.
To increase the chance of Coupon redemption, users can redeem them within the next 360 Epochs after their purchase.
Digital assets like ETH experience significant price volatility, necessitating high over-collateralization. This is capital inefficient and still subjects the user to non-trivial liquidation risks. The advantage of ETH is that it has equity-like characteristics. As DeFi grows, so too does the importance/value of ETH. ETH locked up as collateral cannot be used for other productive purposes, but it still creates a return.
Digital assets like USDT experience very little price volatility, but if you collateralize them they will not generate a return. Users suffer opportunity costs compounded by the necessity of moderate over-collateralization. The advantage is that there is a low possibility of liquidation.
DSD has the advantages of both while mitigating the disadvantages. DSD is a non-volatile digital asset pegged to the dollar, so the risk of liquidation through volatile price action is low. DSD can also have equity-like characteristics. If DSD becomes an important stablecoin in DeFi, then demand for DSD will increase. Bonded DSD will grow in value as the supply-demand for DSD increases. At the same time, sophisticated traders can profit from incentives that force the price of DSD towards its peg in a cleverly designed game-theoretical battle. It is as exciting as it sounds. A decentralized stable coin that grows more valuable in correlation with DeFi.