Tokenomics of different stablecoins

How different types of stablecoins differ and how they function, why are they stable and are they even stable at all? Read this article to find out.

Initially, according to the idea of the creator of bitcoin Satoshi Nakamoto, cryptocurrency (bitcoin) was supposed to replace fiat money and become new money, free of the shortcomings inherent in the currencies of states. Those include unlimited emission and inflation, insecurity, centralized government regulation and so on.

Indeed, bitcoin has a limited emission, and consequently, it isn’t subject to inflation, and bitcoin also does not have a regulatory authority and emission. The same applies to almost all cryptocurrencies that followed Bitcoin.

In terms of providing real value to the cryptocurrency, after the abolition of the "gold standard" by President Richard Nixon in 1971, the dollar is no longer collateralized by any physical asset either.

In general, the collateralized factor is not so important for the mass adoption of money, since it’s replaced by the recognition of the monetary system as a whole. Recognition in this context means accepting the currency as money and giving it value by mass consciousness. It is like two scales: if there is no acceptance, it needs to be collateralized, for example, gold-collateralized (like a gold chervonets in the early years of Soviet power), if there is acceptance, backing is not so important. An example of this is right in front of your eyes - this is how Bitcoin has gained value over the years.

At first, Bitcoin was considered a cryptographic trinket, then people got interested, then more and more. People began to use Bitcoin and other cryptocurrencies for settlements, trade, until they gained almost universal acceptance.

The factor of acceptance or general consensus on what counts as money gives value to any money, including even gold. In fact, gold does not have any particular intrinsic value.

For example, in the Inca civilization (South America) there was no money at all and the economy functioned without it. There was no trade in general as a phenomenon, and not a single market or trader. At the same time, stone cities were built as well as stone-paved roads of a huge length, and gold was used as a convenient ductile metal that does not corrode, for example, for the manufacture of dishes.

When Francisco Pizarro conquered the Inca empire, the conquistadors found literally mountains of gold there, and the Incas could not understand why these people in armor were so eager to possess the yellow metal.

To function as a monetary system, in fact, it is necessary that money can fulfill two main functions: serve as a measure of value and be a store of value.

Here I don’t touch upon the rest of the "technical" requirements for money, such as divisibility, ease of use, storage, security against counterfeiting, etc. Since cryptocurrencies have all these qualities and wouldn’t even be able to claim to be money without these properties, since it is the basis that the monetary system should have as a matter of course.

As the past years of the existence of cryptocurrencies have shown, their rate (value) is subject to volatility within limits that prevent cryptocurrencies from fully (long-term) performing the function of storing value. And over the past decade, this problem has not been solved. If cryptocurrencies are quite capable of performing the function of a measure of value in transactions, then a solution in the form of stablecoins was found to perform another main function of money.

By the level of collateral, stablecoins can be divided into several groups:

It should be borne in mind that the lower the level of collateral, the bigger the role of another factor in the stability model should be. This can be not only acceptance, but also, for example, speculative interest in yield farming, which attracts users to algorithmic stablecoin projects.

By the type of collateral, stablecoins can be divided into several groups:

This type of stablecoin appeared before the others. USDT is the very first stablecoin, which was first released on the OMNI platform (built on top of the Bitcoin blockchain), and then on other blockchains, of which the most popular were USDT based on Ethereum and Tron.

Although there are already a large number of fiat-collateralized stablecoins (the most popular now USDC, BUSD, PAX), USDT still dominates among them.

USDT is collateralized by the dollar in a 1: 1 ratio and, in fact, it’s the same dollar, with all its advantages and disadvantages, which, however, has one more - doubts about the actual collateral of the entire USDT money supply by dollars. However, all the long-term lawsuits against the issuer Tether on this matter have so far come to nothing.

Therefore, in mass consciousness, USDT is perceived as a fairly reliable, and most importantly, a truly stable instrument for storing value. As a store of value, USDT is as reliable as the dollar. At least until it suddenly turns out that it’s not fully collateralized by dollars.

The stability of USDT in this case is that USDT = $ 1 always, with small fluctuations, unlike, for example, uncollateralized stablecoins. The fact that the dollar itself is subject to inflation does not affect the stability of the USDT in terms of its collateral.

By the way, even gold has experienced inflation in its monetary history. If the inflation of gold coins in the ancient world was always associated with the "spoilage" of money by the ruler (an increase in the percentage of copper in gold coins, a decrease in the weight of coins), then in the Middle Ages there was a real inflation of gold in Europe for the first time after the already mentioned Francisco Pizarro, Cortes and other conquistadors began to send galleons with gold and silver to Spain.

Up to this point, the main money in Europe has always been silver, and gold was scarce and highly valued. When Europe was flooded with gold from the Incas and Aztecs, food prices skyrocketed, followed by everything else.

Benefits of fiat-collateralized stablecoins:

Disadvantages of fiat-collateralized stablecoins:

This type of stablecoins is also called decentralized stablecoins, since the issue (release) is carried out by a smart contract, independent of the state financial regulator.

The most famous of such stablecoins is DAI = $ 1. The stability of its value is ensured by excessive collateral crypto assets deposited by users into a smart contract in exchange for issuing stablecoins for them. In case of an increase in the rate of the collateral asset, users can receive significant profits. When the rate of the collateral asset falls, users can be left at a big loss.

In essence, this whole model is very similar to a pawnshop, where a smart contract plays the role of a usurer. Indeed, all the characteristic points coincide: the collateral of each client is served individually, the amount of collateral is much higher than the value of the stablecoins issued against it (the proportion depends on the type of collateral asset), if the collateral value falls below a certain threshold value, the collateral is sold for stablecoins issued by the service, which are burned by the smart contract.

This is done to match the value of the emission volume of all stablecoins to the value of all collateral. However, the threshold value is always higher than the rate of the underlying asset, that is, the overcollateral of the decentralized stablecoin is almost always present.

Thanks to this mechanism, cryptocurrency-collateralized stablecoins are quite stable and reliable. By these parameters, they can be put in second place after stablecoins collateralized by fiat.

Over-collateralized by cryptocurrencies stablecoins have a serious flaw from the user's point of view - excessive collateral. What's good for stability is bad for the user. That is why what works great in a growing market can hardly repeat its success in a falling one.

Benefits of over-collateralized  stablecoins:

Disadvantages of over-collateralized stablecoins:

The main difference between fiat-collateralized and over-collateralized by cryptocurrencies stablecoins is that the stability of the former is ensured by the issuer, while the stability of the latter is ensured by the users of these DeFi services.

The DeFi sector has spawned the next type of stablecoin - uncollateralized, called algorithmic. These stablecoins are the most interesting - in order to understand how they function, you need to learn in detail about the system of each of the projects.

Algorithmic stablecoins differ both in terms of the stabilization model of the coin value and in the degree of (un) collateral. Unlike stablecoins collateralized by fiat currencies and over-collateralized by cryptocurrencies, algorithmic stablecoins differ significantly in their stabilization mechanisms and function in different ways.

If all protocols of fiat-collateralized stablecoins can be called “the same dollar, just from the other side”, the systems of super-secured cryptocurrency stablecoins can be described as “pawnshop”, then algorithmic stablecoins have only one thing in common - handling the money supply to stabilize the exchange rate.

Conditionally, the stabilization mechanism can be divided into two types: seigniorage and rebalancing. Algorithmic stablecoins are still few in number, so it is easier to understand the mechanisms of their functioning on specific projects.

Ampleforth (AMPL). Price stabilization is carried out through the rebalance of the money supply. This stablecoin has no collateral at all. There is a certain AMPL money supply in circulation. Depending on supply and demand (and, accordingly, rate fluctuations), the time-weighted average price (TWAP) is determined daily, and if it goes beyond the established allowable rate range, then the number of coins in the wallets of all coin holders either decreases or increases proportionally.

If the rate exceeds the threshold value (the upper limit of the acceptable range of fluctuations), the number of coins in circulation increases. If the rate is below the threshold value (the lower limit of the acceptable range), the number of coins in circulation decreases. This is done with the expectation that as a result of these manipulations with the money supply, the balance of supply and demand will change, and, accordingly, the exchange rate will level out in the right direction and return to the established price corridor.

As you can see, the model of stabilization of this coin, which by its purpose should be stable, is initially based on the speculative component. That means, in fact, that the model implies that the rate must be unstable in order to be stable.

Instead of changings in the value of each coin, the number of coins in the wallets changes. Logically, the capitalization of this coin on the chart should represent an almost straight line, and the rate chart should not, or, even better, vice versa. However, in reality both graphs are very far from this.

Ampleforth is designed to be more stable the more users it has. If the interest in the project disappears, it will just "eat" all its coins, since the exchange rate will constantly fall and the money supply will continuously shrink, i.e. it will enter the phase of "death spirals". So far, however, the project is doing well. AMPLs can be staked across multiple pools, providing liquidity to automated market makers (AMMs).

In order not to confront users with the fact of their voluntary and compulsory participation in the manipulation of the money supply, projects using seigniorage to stabilize have appeared.

Empty Set Dollar (ESD), just like AMPL, uses the supply and demand balance to stabilize based on the time-weighted average price (TWAP) received by the oracle from the ESD-USDC stimulated pool on Uniswap. But instead of forcibly changing the amount of money supply for all coin holders, the system encourages users to do it themselves.

If the ESD rate exceeds the target value, the smart contract issues additional money supply, which is distributed as rewards to those users who have “frozen” their ESDs in the DAO (this is called bonding). If the rate is below the target, then users can burn their ESDs in exchange for debt coupons, which will be redeemed (redeemed with interest by contract for ESD from users) in the next phase of money expansion.

The time-weighted average price (TWAP) periods in the contract are 8 hours long. The term for coupon redemption is limited and represents 90 epochs, that is, 30 days. If, after 30 days, the money expansion phase does not occur, then the coupon cannot be redeemed.

Thus, users have an incentive to bond their coins based on the reward they receive during the expansion phase, when the contract issues money supply, as well as to burn their coins in exchange for coupons when the coin rate is low, so that later (in the next emission phase) receive a debt on coupons with interest from the contract.

The maximum amount of debt is 20% of the total supply, but over an epoch it can only grow by a maximum of 3%. The coupon bonus percentage, called the Debt Ratio, can accumulate and grow over several epochs. The current debt ratio can always be seen on the coupon sales page in the app. For example, now (March 19) Debt Ratio = 19%, which is not surprising given the current ESD rate, which is at $ 0.13. The maximum interest on coupons is 56% and is calculated using the following formula:

(1 / (1-R ^ 2)) - 1, where R = debt / money supply

However, the stability of the coin rate leaves much to be desired. If you look at the charts, there is the same "stability" as in the AMPL. As you can see, the coin stabilization model is practically one of the varieties of yield farming, but the user's participation in operations to compress the money supply or expand it is voluntary.

Indeed, it’s highly doubtful that the project had any users at all who wouldn’t have been involved in bonding, coupons, and the supply of liquidity to the ESD-USDC pool. Naturally, achieving stability through instability, at best, leads to fluctuations around the target rate. But the amplitude of such fluctuations is important. Here, users are interested in always having a larger amplitude. At the same time, it runs counter to the goal of creating a stablecoin.

Basis Cash (BAC) uses data from the BAC-DAI pool on Uniswap to stabilize its BAC stablecoin. Every 24 hours, the time-weighted average rate serves to trigger price stabilization mechanisms. If the rate is higher than the target value by more than (1 + ε) DAI, where ε was initially set at 0.05, the contract issues additional BACs, which are distributed as a reward to holders of Basis Shares (BAS), another token of the system. This increases the money supply and increases the BAC supply.

During the period when the BAC rate is below the target value, one should buy from the Basis Bonds (BAB) contract with BACs at a discount, which are subsequently always settled by the contract in a ratio of 1: 1 to BAC. The BACs received from users for bonds get destroyed by the contract. This shrinks the money supply and reduces the BAC supply.

In the phase of the BAC emission, which occurs during the period when the rate is higher than the target value, it’s possible to redeem these bonds (BAB)  in the contract and receive a profit from the discount (somewhat remotely similar to promissory note sold at a discount). Moreover, the validity period of the BAB is unlimited, unlike coupons in the Empty Set Dollar. By the way, during the emission, the contract first buys out bonds, and only then distributes rewards to BAS holders. This mechanism works if the BAC balance, which was not bought out for bonds, is higher than 1000, then there are either no bonds to be repurchased by a contract, or the BAB holders don’t want to sell them now.

The stabilization model contains an implicit flaw - the greater the discount for bonds, the less their sale squeezes the money supply, since less BAC is required to buy them. And there comes a time when it’s necessary for additional liquidity to enter the system through the purchase of BACs on the exchange, and then the bonds would be bought out using these BACs.

Given that at the moment (March 19) holders already have 48.29 million bonds in their hands, they expect to buy another 900,000 bonds (BAB) at a price of $ 0.08, that is, with a discount of more than 300%, since the current BAC rate is $ 0.28. However, so far no one seems to be willing to redeem them, and thereby slightly squeeze the money supply, even with an estimated profit of more than 1180%. And if, in the case of the Empty Set Dollar’s debt coupons at 19% the absence of buyers can be somehow explained by the fact that coupons can expire in 30 days with the risk of never seeing the phase of money emission and debt repayment, then in the case of perpetual bonds the situation looks like "death spirals", only in reverse. Perhaps the bonds will be bought at an even lower rate with an even greater discount. However, in this situation, you can forget about the stability of the coin, since the whole project is primarily about yield farming.

It’s also possible to draw parallels between BAC and ESD: ESD bonding rewards are similar to BAS bonding rewards, debt coupon redemption premium is similar to bond discount margin. As you can see, BAC and ESD are very similar in terms of the stabilization model, and accordingly BAC is as “stable” as you can see on its graph.

It should be noted that Empty Set Dollar and Basis Cash are considered uncollateralized stablecoins, but that’s not entirely true. We can say that these stablecoins are indirectly collateralized by liquidity providers to pools on Uniswap: ESD-USDC and BAC-DAI, respectively. Since without these pools, projects would not even be able to launch. Providing liquidity to pools (namely, in terms of USDC and DAI) can in some way be considered collateral.

Only Ampleforth from all the stablecoins listed in the article can be classified as absolutely uncollateralized. However, over the past three months, AMPL has been much closer to the target rate of 1 dollar than ESD or BAC.

A stablecoin, which is indeed partially collateralized and not indirectly or imaginary like ESD or BAC, also uses the seigniorage model:

Frax (FRAX), unlike the projects listed above, is partially collateralized and is built on a fractional collateral mechanism: part of the collateral is USDC, and the other part is Frax Shares token (FXS). The ratio of the collateral parts changes with a small step (0.25%) in one direction or another, depending on the current stablecoin rate. If the exchange rate falls below one dollar, the share of USDC in the collateral required to issue FRAX increases and the share of FXS decreases. If the FRAX rate is higher or equal to one dollar, the share of USDC in collateral decreases hourly, while the share of FXS increases. Upon issuing FRAX, the contract burns out FXS's share of the collateral.

At any time a user can return FRAX to the contract and receive a collateral for it in the current ratio of USDC / FXS, which corresponds to one dollar. At the same time, the contract mints the share of FXS in the collateral that must be paid to the user for FRAX. The amount of USDC's share in the amount of collateral as a percentage is called the Collateral Ratio. The project started with Collateral Ratio = 100%, it is assumed that over time, the share of USDC in collateral will decrease, while the share of FXS will increase. At the moment (March 19) Collateral Ratio = 86.75%, which clearly indicates an increase in the algorithmic share in FRAX collateral.

The system is based on arbitration between the marketplace and the contract. In the contract, the FRAX price always corresponds to one dollar, the only thing that changes is the Collateral Ratio in the collateral that the arbitrage specialist receives when he or she returns FRAX to the contract (for example, if he or she bought FRAX on the exchange for $ 0.98, then he or she always sells to the contract for $ 1). Likewise, the reverse is also true: having issued FRAX for collateral worth $ 1, the affiliate then sells FRAX on the exchange, for example, for $ 1.02. In the next version of the project, it is planned to add one more element to the Frax Bonds system.

Although this system is rather complex, it works much better than other algorithmic systems. This is clearly seen on the FRAX rate chart. However, despite the finely tuned complex system of the project, perhaps the main contribution to the stability of the coin is still made by partial collateral.

Seigniorage Shares (SHARE) is a kind of hybrid of all the models described above, as it consists of two parts: x-series and f-series. In the first one, the USDx stablecoin is stabilized based on the time-weighted average price (TWAP) of the USDC-USDx pool every 12 hours. If the rate is 0.05 higher than the target value, then USDx is issued, and it goes to all holders of the SHARE governance token.

If the rate is below the target level by 0.05, then the USDx balance is reduced proportionally in all wallets where USDx is not tied in bonds. xBond is something like a debt coupon to be redeemed during the emission phase. However, this element might not be functioning now. Until March 2021, SHARE could be earned for supplying liquidity to the SHARE-ETH pool, now it is no longer possible.

Actually, there is a connection between the termination of SHARE mining and the fall in the capitalization of both SHARE and USDx, which just confirms the decisive role of yield farming in the functioning of algorithmic stablecoins. It seems that when people create projects of algorithmic stablecoins, this goal is primarily pursued, and the stability of the coin becomes a secondary concern. As you can see, the behavior of the stabilization algorithm in the x-series is similar to Basis Cash and Empty Set Dollar in the emission phase, and to Ampleforth in the phase of money supply contraction.

In its turn, the f-series in Seigniorage Shares, just like FRAX, uses fractional collateral. The USDf stablecoin collateral consists of the USDC / Gaia proportion, where the Gaia token represents the algorithmic share of the collateral. The Gaia price is determined hourly, based on the time-weighted average TWAP price from the USDf-Gaia pool. According to TWAP data from the USDf-USDC pool, the collateral ratio changes in 0.5% increments. If the USDf rate exceeds one dollar, the collateral ratio decreases (the share of USDC in collateral decreases), if the rate is lower than the dollar, then vice versa. The Gaia token can be earned by providing liquidity to the USDf-Gaia pool. At the moment, the coverage ratio is 100% since the f-series launched very recently, in mid-March.

Benefits of Unsecured Algorithmic Stablecoins:

Disadvantages of algorithmic stablecoins:

The main feature of algorithmic stablecoins is that their stability is based on trading and arbitrage, which means they can’t be truly stable (within reasonable limits, like fiat-collateralized or super-secured ones). At best, stability in this case implies small fluctuations with a high frequency around the target value.

Is it possible to combine the advantages of different types of stablecoins in one project and at the same time avoid the disadvantages inherent in each of those coins? Is it real to achieve independence from the central regulator, avoid over-collateral, while ensuring high stability of the coin rate? There are plans to develop a project of such a stablecoin called LibreCash on the Free TON project.

The goal of this project is basically to create a stable coin that can perform not only the function of a measure of value and unit of account, but also a more complex function - to serve as a tool for preserving value.

The project is a synthesis of the benefits of all types of stablecoins:

The system is simple and somewhat resembles a currency exchange. To issue stablecoins, the user deposits an amount in TON into a contract called Libre Bank (hereinafter referred to as the bank) and receives an equivalent amount in LibreCash at the dollar exchange rate.

Collateral in TON tokens goes to the bank's capital balance (there is no individual service for collateral for each user). The user at any time can redeem his or her LibreCash from the bank by exchanging them for TON at the current exchange rate at the time of exchange. The bank burns the funds received from the user of LibreCash. If the TON rate has increased by this time, the user will receive less Сrystals for their LibreCash, but if the rate of crystals has decreased, he will receive more of them. Thus, there is no concept of collateral at all, since it just doesn’t exist. Therefore, nothing is ever liquidated for the user, there is no commission for liquidation and there is no stabilization commission either.

On the contrary, in case of a decrease in the rate of the collateral asset (Crystals), users will receive more of them, that is, through LibreCash, they will retain the value of their capital. Ensuring the stability of LibreCash rests entirely with the bank, in contrast to the protocols of over-collateralized by cryptocurrencies stablecoins, where the stability of the coin is maintained by users with their excess collateral.

As you can see, the bank is always in a long position at the rate of Crystals, that is, it’s interested in its growth and is not interested in its fall.

At the start of the project, its goal is to quickly reach a critical money supply of the capital, that is, to achieve a ratio of the bank's capital in Crystals to the capitalization of issued LibreCash > 1 relative to the dollar (due to the growth of the collateral asset rate).

The stabilization tool is LibreCash's floating issue and redemption rates, which represent commissions for the respective transactions.

The LibreCash redemption rate is a commission that is deducted from the TONs paid to the user when LibreCash is redeemed. Depending on the current rate of Crystals (received from oracles), the redemption rate changes - the higher the exchange rate, the lower the redemption rate, and vice versa, the lower the exchange rate, the higher the redemption rate.

The redemption rate increases (according to the formula) with the fall of the Crystal rate, and slowly decreases with its growth in each period between the receipt of the oracle data, if the rate increases. This rate behavior algorithm is explained by the need for a quick reaction to a fall in the rate of the collateral asset.

The LibreCash issue rate is a commission for the operation of issuing stablecoins by the bank and is charged from the amount of collateral deposited in Crystals into the bank's capital. It’s vice versa for the repayment rate. The algorithm of its work will differ in the start phase of the project (accumulation of a critical mass of capital by the bank) and in the operating phase of the system.

In the operating phase, the output rate rises when the rate of Crystals rises, and decreases when the rate falls. Moreover, the range of its values ​​lies in the positive zone, including the minimum value of 0%.

The value of the issue rate decreases to 0% (according to another formula) when the crystal rate falls and gradually increases with its growth in each period between the receipt of the oracle data, if the rate increase happened.

In the start phase, the output rate also grows with an increase in the exchange rate, but remains unchanged when it falls. At the same time, its values ​​are in the negative zone and it grows from a negative value (starting value) to 0%. Since the issue rate remains unchanged when the exchange rate goes down, it can only grow with each rate increase towards 0%, that is, take values ​​from cashback to "quid pro quo". When the rate reaches 0%, its algorithm switches to the operating phase, and, accordingly, the rate never goes into the negative zone.

Thus, during the operating phase, both rates take only positive values, increasing as well as decreasing, and the issue rate can take on a value of 0%, but the redemption rate does not. The issue rate takes on values ​​in direct proportion to the TON rate, and the redemption rate in reverse.

Since the project is still in development, there are many possible changes in the final version.

In the Free TON project, not only stablecoins are developed, but also many other original DeFi and NFT projects.

The DeFi community at Free TON invites developers interested to participate in the creation of a new DeFi world in the Free TON project. Join → DeFi