UXD — Most Efficient Stablecoin on Solana: A Deep Dive
A Complete deep-dive into the Stablecoins, the need for them, problems with existing solutions, and how UXD protocol solves those issues.
Stablecoins are rapidly becoming crucial to the success of the crypto market. For a fact, its supply has increased from $5 Billion to a whopping $172 Billion in just 2 years ~35X growth🤯
The best part is, they have unlimited growth potential as the world currency market is very huge ~ $90 Trillion. But the present stablecoins are not very efficient and have their own shortcomings. On the other hand, Solana is making waves, being the fastest and most scalable blockchain on the planet, but it currently lacks a native robust stablecoin.
Who’s solving for all these?
Our spotlight for this article, UXD Protocol not only is trying to solve the shortcoming of existing solutions but also wants to increase the overall market of stablecoins!🔦
Let’s understand the basics of stablecoins, the stablecoin trilemma issue, and then straight jump to what UXD is aiming to solve, what are the different underlying financial instruments and what’s the future of UXD Protocol.
LFG🚀
Need for Stablecoins💁
In 2021, the price of Bitcoin increased 5X to reach a new high in April before losing half of its value and then rebounding. Let’s admit: cryptocurrencies are still highly volatile i.e they keep moving up and down, making them attractive for traders but risky assets for people who don’t want to take that much risk. This makes stability a rare feature in the world of cryptocurrencies.
Everyone needs stable crypto, but how can you make crypto stable?
Simple: make them tied to a nation’s currency, and what’s more dominant than a dollar? So, cryptos on blockchain were made and allegedly tied to the value of government-backed fiat currencies like the US Dollar.
By market capitalization, the largest stablecoins are Tether (USDT), USD coin (USDC), Binance USD (BUSD), DAI & Terra (UST). In fact, USDT, USDC & BUSD make up more than 80% of the total market cap of stablecoins. But the problem is, none of these coins are regulated & overseen like fiat currencies or commodities, hence, there’s not much assurance of what customers are sold in the name of stablecoins. Despite becoming an important fixture in modern finance, some even dip below the value of the currency to which they are supposedly tied.
Along with that, the coins carry an inherent risk. Most are backed by centralized entities that claim to have each and every invested dollar backed by real currency or asset with the equivalent value. If you want to know what these companies are holding actually, let us tell you, my friend, YOU CAN NOT. Although, they claim to publish reports but still, there is no real way to know what these companies are holding actually.
For instance, Tether (USDT) is run by Tether Limited, which is controlled by the Hong Kong exchange Bitfinex, USD Coin (USDC) is run by an association that was started by the payment company Circle and Coinbase, and the Binance USD (BUSD) by the exchange Binance. For example, businesses that wish to buy USDC must deposit the equivalent amount of USD into the circle account before receiving USDC. No regulatory authority guarantees their holdings.
Are centrally controlled stablecoins the only ones? Certainly, no. Let’s explore different types of stablecoins👇
Types of Stablecoins
Stablecoins largely fall into three categories:
1. Fiat: They are backed by the nation’s currency as discussed above.
2. Collateral Debt Position(CDP): They are generally issued by decentralized protocols that accept collateral and issue debt in the form of a stablecoin, so these stablecoins are backed by individual user deposited collateral which is generally cryptos like ETH or SOL.
3. Algorithmic stablecoins: They are controlled algorithmically. What does that mean?
Let’s understand👇
Algorithmic Stablecoins
The algorithmic stablecoins have no assets to back them. So, how are they then stable? Algorithmically! In most simple terms these coins don’t use any reserve/collateral but use an underlying algorithm that issues more coins when the price increases and buys them off when the price falls. This can be compared to a central bank printing notes to maintain the value of the fiat currency, but the only differentiation in algorithmic stablecoin is that it’s completely run by a smart contract on a decentralized platform in a way, it’s completely automated and most of them are being pegged to a reserve asset such as USD.
Algorithmic stablecoins represent true decentralization with no regulatory body oversight needed, as the code is responsible for supply and demand. These benefits offer a truly scalable solution that is not offered by any assets in the market.
Ampleforth and Empty set dollar were among the earliest iterations of algorithmic stablecoins with AMPL starting in 2009 and running till this date. But, unfortunately, these stablecoins performed relatively poorly in maintaining the peg to their base currency, $USD as we can see from the ESD chart below👇
Some of the most popular Algorithmic stablecoins currently in the market include Frax (FRAX), UST (Terra), which have a way to redeem alongside Supply and demand to keep the price pegged. Redemption has become a key stability mechanism utilized by the current Algo stablecoins.
While Stablecoins are awesome with huge benefits, we can’t ignore the current problems with this growing ecosystem of stablecoins. Let’s now discuss that and how the spotlight of this essay, UXD comes to solving this.
The Stablecoin trilemma
This is a common problem in crypto, especially with stablecoins. It’s very difficult to find a stablecoin, at least to create one which has all the three characteristics of being collateralized, decentralized, and capital-efficient as well.
Tether is fiat collateralized, so stable, capital-efficient but it’s not decentralized.
DAI is crypto-collateralized, it’s relatively stable and decentralized but it’s not capital-efficient as you’ll need around 150 USD of ETH to mint 100 DAI. A
Basis cash(BAC) and some similar algo coins which tend to lose their bank so it’s not really stable.
Nowadays, everyone is either trying to find a stablecoin or to create one that solves all three, at least has fewer trade-offs.
Let’s now come to the focus of this essay, The UXD protocol.🎉
UXD: The Noble Solution?
UXD wants to create a stablecoin that is more crypto-native. With UXD, everyone will be able to do transactions and store money in a stable currency with censorship resistance. And the Vision is simple:
To Become the most widely used stablecoin in the world.
UXD solves an incredibly difficult problem in the crypto world: creating a stablecoin pegged to the USD. UXD is a stablecoin issued on Solana that solves the stablecoin trilemma it’s (i) stable (ii) decentralized (iii) capital-efficient, all at the same time.
Yes, I got it, but tell me why I should care?
It might sound complicated but it’s very simple how it works and what it does for you. You can deposit collateral such as SOL to the protocol and you will receive $1 of UXD in return for every $1 of SOL deposited. Also, you will receive 5–40% APY in interest from the funding rate just by hodling on to UXD.
Before going to key features and learning more about the protocol and the stablecoin, let’s understand what are derivatives, futures contracts, delta’s and what does it mean by Delta-neutral in a very simple way.🌎
What are Derivatives, Perpetual futures & Delta Neutral? : The Financial Gyaan
If we look at UXD’s homepage, it says “backed by delta neutral position”.
What’re Delta & Derivatives?
To understand Delta, let’s first understand derivatives. Derivatives in simple terms are a bet between two parties about an ‘underlying asset’ without actually owning that asset. Futures & Options are two major classes of derivatives, which derive their value from an underlying asset like stocks, commodities, or even cryptos!
Let’s understand with an example: Let’s say, you want to make a $100 bet with your friend by signing a contract, that Amazon will cross $500 in 3 months — this is simply a derivative (Today’s Amazon price being $250). You are not actually owning the Amazon stock, but you are exposing yourselves to a bet, which derives its value from Amazon stock. This was the simplest derivative, but they are a lot complex and can come in any form.
An interesting thing to note is that the price of the derivative keeps changing with the price of the underlying price. For instance, if 2 months have been passed, and Amazon stock is now near 450 USD, it has a high chance that it reach the target of 500 USD, would the price of the bet remain the same? Nope, instead, you can agree to receive just 50 USD and exit the contract. Now, how do we measure this change of contract’s price with the change in Amazon stock?
That’s “Delta”, my friend.
A delta is simply the amount a derivatives price changes depending on the price of the underlying asset. A delta of 0.5 means that for every $1 the underlying asset moves, the derivatives price changes by $0.50. This also helps determine someone’s exposure i.e if your exposure is 10 Delta, which means it’s equivalent to owning 10 Amazon stock, and if Amazon moves by $10, your derivative will move by $100. Wouldn’t be awesome, if the delta is zero altogether i.e the derivatives are unaffected by their underlying asset.
That’s now “Delta neutral”, folks! How do we achieve this delta neutral position?🧐
Perpetual Futures! But wait, what are Futures?
It’s an agreement between two parties to buy or sell some asset at a pre-determined date at a pre-determined price. If let’s say, you agree with your friend to buy Amazon stock at $500 after 3 months, that’s a future contract.
Why do we even enter this contract? Simply, to lock in prices to avoid any fluctuation in price 3 months later, or speculate by not owning the asset. In a futures contract, after the 3 months — the settlement takes place. Perpetual Futures take it a step further, there isn’t even any settlement.🤷♂️
What are Perpetual Futures?
Perpetual Futures are the purest form of price speculation because they (i) remove the Expiry Date (never expires) (ii) replace Pre-determined Prices with Market Price and (iii) remove the need for settlement. How does this exactly work?
Let’s understand that with an example: Let’s say you want to gain 5X leverage exposure to the price of SOL on Mango Markets (a derivative platform on Solana). To buy a perpetual contract like SOL-PERP, you have to first deposit some collateral margin ~0.5 SOL (acts as a safety net in case SOL crashes). Since you have a leverage of 5X, you will be able to buy a contract worth, 2.5 SOL (5X your margin of 0.5 SOL). So you basically get an exposure of $250 at the price of $50 (Assuming 1 SOL = $100).
Remember, it’s a perpetual future, which means no expiry date, so how do we exit the contract?
- If SOL goes down by 20%, you will lose ($250*20%) = 0.5 SOL and lose your margin collateral.
- Sell this perpetual contract to someone else
Now it’s not all simple, each time someone buys or sells on this virtual market, the price of SOL on this virtual market will change. With many people buying or selling, this could cause the price of SOL-perp on this virtual market to deviate from the actual market price (since it relies on supply and demand to determine the market price, just like any other market)
How can we solve this?
Enter Funding Rate:
It’s simply a periodic payment from the more popular position (buying, for example) to the less popular position (selling).
Funding Rate payment = Virtual Price — Market Price
The frequency of this payment varies by derivatives exchange. Let’s say, it’s 4 hours. If the virtual price of SOL is $101 and the market price is $100, then anyone who “bought” Solana on this virtual market will pay anyone who sold, a sum of $1 for that 4-hour period. The idea of the funding rate is to incentivize people to take the opposite position on the exchange for collecting that sum of $1 and bring the virtual price in order with the market price (Think of it as arbitrage).
It’s obviously a lot more complex, but this simplified version would be enough for understanding.Okay, enough of gyaan, let’s check how’s all this relevant for UXD Protocol🧐
$UXD is a stablecoin backed by a 100% delta-neutral position. What this simply means is that when you give collateral to the UXD protocol to mint the $UXD, automatically, a short position is opened on a derivative trading exchange like Mango Markets. The change ratio between the long spot and the short perpetual futures position is always equal to 1 (which makes it delta-neutral).
What makes UXD unique?
- Decentralization: UXD protocol does not hold users deposited assets. Users can use mint or redeem it in a permissionless way.
- Stability: As it’s 100% backed by a delta-neutral position and uses derivatives to make that happen, you can redeem 1 UXD for 1 USD worth of assets. (To know more about Delta-neutral position see above explanation )
- Efficiency: You’ll need $1 of crypto assets to mint 1 UXD stablecoin. Unlike other stablecoins where you might need more than $1.
How UXD maintain its peg?
UXD is pegged 1:1 to the US dollar via an oracle (a framework to share reliable data to the smart contract from the external world) provided by the Mango market. For example, When a user deposits $100 worth of SOL, UXD opens a short in a Perpetual futures contract on a derivative exchange like Mango markets. So if SOL goes up by $1, UXD now owns the SOL which is now worth more than $1 and now the short position will lose $1. So the value of the asset or the portfolio hasn’t been changed it’s still worth $100 even though the SOL price has moved up. The vice-versa also holds true.
Tl;dr: When a user mints UXD the protocol puts a Delta-neutral position and when a user redeems UXD the protocol unwinds the position.
This is what we discussed in the Delta-neutral position, that the value of the position is unaffected by the value of the underlying asset. As a result, the price of stablecoin becomes stable.
Risks
Tackling these problems comes with inherent risks. The following are the primary risks out there with UXD protocol:
1. What if the Funding rate is negative?
The insurance fund created, pays out the negative funding rate so that the holders of UXD do not have to pay. The insurance fund is funded by the token sale, part of the Positive funding rate, and the Liquidity mining rewards(UXD will become LP in other AMMs)
UXD will also have an insurance fund staking program so that the insurance fund is well-capitalized. Users will be able to stake UXP (Governance token of UXD protocol) and receive UXP in return this way they will be actually taking the risks of the Insurance fund.
2. Insufficient Liquidity:
If the market is very volatile, UXD can also lose money on the future perpetual, and if the insurance fund also dries up, then the protocol will lose stability (very extreme case).
Apart from these market risks, other technological risks include Smart contract risk & Risk of Managing the Insurance Fund.
How to mint and redeem UXD: a short tutorial
Minting is a process of creating a new UXD in exchange for a USD- equivalent value of a crypto asset such as SOL. For example, you can mint 100 UXD for $100 of your crypto assets.
The minimum mint size is .01 SOL (~$1.5 as of January 2022) due to the functionality of the underlying derivatives exchange(s).
If you want to mint UXD or redeem, visit app.uxd.fi.
- Firstly, as UXD is on Solana you will need an SOL wallet(e.g. Phantom). Connect your wallet to the UXD web app and make sure it’s on the mainnet.
2. Enter the SOL amount you would like to exchange for UXD and click on MINT. Once your transaction completes you will receive a notification indicating UXD has been successfully minted/sent to your wallet.
3. To redeem UXD, go to the REDEEM tab and enter the UXD amount you want to exchange for SOL, and click on REDEEM. This time you will also receive a notification stating the update about the transaction. And Boom! you have got the SOL in your wallet for that UXD.
$UXP token and Governance
The governance token of the protocol UXP will have the following functions in the UXD ecosystem:
- Voting rights: You will be able to vote on proposals that make UXD protocol better like choosing, which derivative DEX to integrate with or the asset to use.
- Cash flow from the delta-neutral position can flow to UXP (can be voted through governance). So will be able to get the portion of revenue as interest that UXD generates if you hold their governance token.
- Interest in Staking: you can stake UXP in the insurance fund and earn more UXP on that UXP. In this way, the protocol benefits because the protocol has more money in the insurance fund and the users get to receive the interest in UXP.
Therefore, UXP will gather value both as a governance token and as a beneficiary of the yield generated by the delta-neutral position. And by generating yield, the overall protocol per UXP token may grow quite large.
Community and Backers
As more people in the Evolving Solana ecosystem get to realize the value of Algo stablecoin like UXD, more and more people are getting involved and the UXD community is continuously growing and will continue to do so. Currently, on their Discord server, there are already more than 7.4k+ members. They usually post product updates, take product feedback and host a bunch of community events echoing their own motto of censorship-resistant, transparency, and true Decentralization.
UXD is backed by the most prominent investors in the ecosystem like Multicoin capital(seed round), DeFiance capital, Solana, and many more. All of them are pretty active in the Solana ecosystem and with this strong backing of the community and investors, UXD plans to become the most dominant algorithmic stable coin on Solana.
Future Roadmap
Beginning this year on Jan 14th, UXD mainnet beta was launched on the Solana mainnet. UXD integrated with Saber and Mercurial Finance upon Mainnet Beta Launch, to ensure liquidity for stablecoin swapping.
As UXD minting continues to increase its cap, it aims to integrate with major Solana platforms for different DeFi functions and continuously strengthen the network. UXD will try to cultivate the adoption of UXD as the default USD-pegged collateral for the DeFi applications.
Conclusion: UXD to the moon🚀
Stablecoins was genuinely one of the products, which has found a true market fit and already capture ~5% of the overall crypto market. With the rise in DeFi and crypto market in general, the market is only going to increase. The Solana Ecosystem is ripe now, with the rails of DeFi already being built, and we genuinely believe $UXD can become a crucial stablecoin not only in the Solana but also in the overall crypto ecosystem.
That’s all folks!
If you have any suggestions or just want to have some interesting conversations around web3, we would love to connect — Sitesh Sahoo and Yash Agarwal
