Algorithmic stablecoins have continued to evolve over the last year. We’ve seen many designs emerge and achieve varying degrees of success, ranging from uncollateralized stablecoins like Ampleforth, Empty Set Dollar, and Basis Cash to partially collateralized models including Frax and FEI. Olympus DAO’s OHM and Reflexer’s RAI employ yet another approach where they target a market-based floating peg instead of the US Dollar.
While the Ubiquity protocol has multiple core features and design attitudes that distinguish it from other algorithmic stablecoins, one of the most compelling elements of the protocol is the unique debt system which acts as one of the primary algorithmic stability mechanisms.
In this article, we will be taking a closer look at how debt can be leveraged to control and stabilize the price of money, what exactly makes Ubiquity's debt system so interesting, and how this can be related to future developments to the protocol.
Historically, one of the major impediments to collateralized borrowing was the risk that the lender would run away with the pledged asset. This is probably why some of the earliest recorded shadow lending systems in 7th century China were run by Buddhist monks who were widely regarded as trustworthy.
When debt is able to be mediated through smart contracts, with everything transparently on-chain and formalized in a trustless manner, counterparty risk is eliminated. This is precisely what many algorithmic stablecoins are taking advantage of by leveraging debt as a major stability mechanism.
The most influential early design in debt stability mechanisms was Basis protocol's bond tokens. These tokens were to be pieces of debt issued for future Basis printed by the protocol, sold at a discount in comparison to their redeemable value (the difference being the premium), which expire in 5 years. Following the basics of monetary policy mentioned above, if the price of Basis were to fall below its peg of $1.00, debt would act as an algorithmically deployed incentive to remove circulating Basis from the money supply. The project raised $133M in a 2017 ICO but was ultimately shuttered after pressure from US regulators and so the system was never tested in the real world.
Fast forward to 2020 In the DeFi space:, Empty Set Dollar (ESD)previously issued debt 'coupons' in order to stimulate demand for ESD when it traded below $1. Basis Cash, a lightweight implementation of the aforementioned Basis Protocol, attempted to do the same with its Basis Bonds. A litany of clones followed, from MithrilMITH Cash on Ethereum to bDollar and Midas Dollar on Binance Smart Chain. All made minor adjustments to the Basis Cash mechanism in attempts to achieve stability, including shorter epochs, vested rewards and a large portion of seigniorage retained in the protocol treasury to be used for buybacks. Ultimately, the market showed that a completely uncollateralized model is highly susceptible to a ‘bank run’ situation when there is a concerted rush for the exits by liquidity providers and token holders. ESD coupons and Basis Bonds proved to be ineffective at stimulating demand when the respective stablecoins started trading far below their intended $1 peg.
FRAX Finance pioneered the partially-collateralized stablecoin model. Their FRAX stablecoin was 100% collateralized by USDC at launch, and the collateral ratio was slowly reduced as the circulating supply increased due to user demand. It has since stabilized around 85% USDC with the balance made up of the protocol’s governance token FXS. It is noteworthy that FRAX has managed to hold its $1 peg extremely well even during bouts of extreme volatility in crypto markets, implying that the market can and does maintain confidence in the system despite being only partially collateralized by a proven stablecoin like USDC.
Other algorithmic stablecoins utilize debt in an entirely different manner to stabilize the price, RAI for example adjusting the redemption rate of debt taken out by users (in a Reflexer Safe lending pool) to reach its target price. FEI protocol has done away with debt tokens altogether, instead choosing to maintain its peg through regular ‘re-weights’ in which the protocol withdraws liquidity from the FEI-ETH pool on Uniswap and purchases FEI with ETH until the target peg of $1 is achieved. They have been able to do this successfully since the majority of FEI-ETH liquidity is owned by the protocol itself and not in the hands of individual LPs.
The Ubiquity Dollar protocol (uAD) was designed after a thorough analysis of existing and proposed algorithmic stablecoin designs, integrating the insights gathered into a scalable protocol with multiple levers that can be utilized to stabilize the price of uAD around its intended $1 peg.
Ubiquity is distinct in that it will utilize multiple forms of debt, each with their own properties, in order to stabilize the price of the Ubiquity Dollar (uAD). When uAD trades below $1, the protocol will algorithmically issue two forms of debt tokens:
uDEBT - An ERC-1155 NFT issued at a discount to uAD, redeemable at $1 upon uAD supply expansion, with an expiration of 6 months.
uAR - An ERC-20 token also issued at a discount to uAD that has a continually depreciating redemption rate for uAD. uAR does not expire and the discount offered is lower than that of uDEBT.
Because each debt token has distinct features and parameters, Ubiquity's protocol is able to engage multiple fronts of incentives to better control and differentially tap into the economic factors involved with the valuation of uAD. Each token comes with its own potential premium, its own form of expiration, and thus its own set of risks and potential value. When uAD trades below $1, users have the option to burn their uAD for either uDEBT tokens, which have a higher potential yield but a fixed expiry, or uAR tokens, which offer a lower redemption premium but remain valid in perpetuity. The continual depreciation of uAR vs uAD is intended to incentivize users to redeem their debt at the earliest opportunity, thus clearing the protocol’s debt load in an expeditious manner.
Secondary markets will be used to trade the debt tokens and further hedge risk, which allows for the determination of the value of depreciating or differentially expiring pieces of debt. This permits Ubiquity's internal economy to remain efficient and functional, while at the same time providing insights to the valuation and stability of the debt itself in a way that can be used to inform further adjustments to debt issuance.
A complete cycle can be seen below:
To be added - note from HristoP?
Money is defined as any commodity that is generally accepted as an economic medium of exchange. Historically, that has usually meant monetary policies set by the ruling elite and foisted upon the public. Money is a primary social construct, as everyone needs it in order to thrive. At the same time, fiat money only retains its value because market participants have confidence in the underlying authority that issued said currency.
Political control of the money supply is always fraught with the risk of excessive money printing, as the temptation to simply inflate fiscal problems away often overweighs responsible financial decision making. This solution tends to work up to a point until price inflation spirals out of control and the system collapses into hyperinflation. We are currently seeing this play out in Venezuela, where Bloomberg’s Cafe con Leche index, a measure of inflation, has registered a 2,575% rise over the past year. Years of fiscal irresponsibility resulted in a total loss of confidence in the Bolivar, and the nation has been battling hyperinflation since 2017.
History is full of such examples, from Weimar Germany post WW1 to Zimbabwe in 2007-09.
Even the mighty Roman Empire was ultimately brought down by hyperinflation that left it unable to pay its soldiers.
While the debasement of the Denarius is readily apparent from declining silver content over time, the devaluation of fiat is more insidious as wealth has gradually been transferred from savers to speculators since the gold standard was abandoned in the 1970s. Prolonged near-zero interest rates in pursuit of a Keynesian ‘growth at all costs’ approach have fueled a financial system prone to spectacular boom and bust cycles.
Debt is a cornerstone of the modern global financial system. Equity markets may capture the headlines but debt markets are an order of magnitude larger and far more critical to the smooth functioning of the global economy. The reason for this is quite simple. Let’s say you are the owner of an asset like a watch or a car and are in need of liquidity. You can either sell the asset to raise the necessary funds or borrow against it. While there are certainly markets for used cars and watches, they are likely not efficient at price discovery. A sale requires two parties to come to an agreement about the value of the asset, a process that can be time-consuming with no guarantee of success. Borrowing is usually the easier option, as lenders can retain an adequate margin of safety through over-collateralization, thus obviating the need for exact price discovery.
Under the fractionalized fiat banking system prevalent around the world, the power to manage the money supply lies in the hands of global Central Banks who adjust these levers and utilize the worldwide network of commercial banks as a transmission mechanism.
Similar to monetary policy dictated by central banks - which leverages debt in the form of bonds - the Ubiquity Dollar protocol issues debt as a mechanism to stabilize the price of uAD by decreasing the circulating supply of uAD.
Debt also instills confidence in Ubiquity's monetary system by increasing financial stake (and ideally subsequent further involvement) with the protocol. When users decide to effectively lock their money into Ubiquity's debt system, this reflects a certain level of confidence in future repayment.
Decentralization is an important issue for the digital currencies and stablecoin space, not only because it allows users to access financial tools anywhere in the world in a trustless way, but also because it enables them - through DAOs - to have a direct say in the issuing and control of the money they use (and thus have a direct stake in.)
The future of digital currency development is pointing towards increasingly controllable systems of money which may fall on either side of centralization or decentralization.
What follows may be an implementation of monetary policy that corresponds not only to the formal algorithmic oversight and control of the economic parameters of money itself, but a monetary policy effectuated by both indirect and formalized behavioral engineering and control practices which dictate what you can, cannot, or are compelled to do with your money.
Much like how private banks have historically issued money in a semi-independent or autonomous manner, there is a way for these digital currencies to be issued and conducted on a non- or extra-state basis, while also remaining compliant and politically agreeable to other forms of sovereignty. Multiple different currencies, digital or otherwise, can co-exist and be complementary to one another, assuming each currency is able to establish a niche that ties it directly to some substantially productive economies.
What some people have referred to as the "layer 0" of decentralized systems, social consensus, is an important reference point here. This is not only because it is what actually determines and implements the creation and ongoing life of digital protocols, but because it also reflects the stake involved in the relation that people have to money, and the way this is reflected in the continuity between consensus, governance, protocol-level implementation, and usage. When money is decentralized, and when the users of money are able to dictate what this money is and how it behaves, the control and formalization offered by digital currencies also presents the opportunity to build upon and enrich a layer 0 that has its own kind of sovereignty and its own interests in mind.