Reflective Bonds: A New Building Block for the Ethereum DeFi Ecosystem

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Translator's Note: Based on the original design of the anchor currency DAI, the original author, Stefan Ionescu, proposed a hedging strategy-like reflection bond (Reflex-Bond), which can "wash" the volatility of its own collateral and use it as a The collateral of stable coins such as DAI can greatly reduce system risk, thus laying a stronger foundation for the DeFi ecology.

(picture from: tuchong.com)

Here is the translation:

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(picture from: tuchong.com)

Here is the translation:

Time to let an old idea shine.Over the past few years, the term "stablecoin" has come to mean "anchored coin" whose value is closely tied to a specific asset or basket of assets in the long run. However, recent market dynamics have shown that the narrative style of anchor coins has brought problems to stablecoin projects with collateral. That is, it limits the economic incentives the system can use to influence the stablecoin market price, one of which is the imposition of negative interest rates on all token holders. If the system had a built-in rate, the stablecoin would be de-pegged, breaking the original "peg" argument.One notable example is that MakerDAO’s DAI is currently struggling to maintain its peg. During the "Black Thursday" period on 312, the market price of DAI was more than 10% higher than the predetermined anchor price of $1. In response, holders of its governance token (MKR) must reduce stability fees and savings rates to zero, and even with these drastic measures, DAI’s market rate remains above the peg to date. Then, there are many people in the Ethereum community who will ask why the DAI rate cannot go negative, so that governance can put more pressure on the market. The simple answer is that the 1 DAI = $1 meme must be kept alive at all costs, so the system was not designed to support negative interest rates.

At least that's not the current system. In Maker's

In (as mentioned in the purple paper), DAI does have negative interest rates, but more importantly, the design shows that the market price of DAI does not always return to the redemption price of $1. Instead, the redemption price itself is floating. To put it bluntly, a stablecoin here is defined as a low-volatility asset (compared to its own collateral) whose redemption price and interest rate are determined by the market, not by "decentralized" governance.

The original motivation for floating the redemption price was for a "Black Thursday" scenario, and if the system had been designed according to the original specification, it would have reacted more decisively to offset the sharp rise in market prices. Sadly, this robust mechanism design was abandoned.

Well, it's been abandoned until now.

Enter Reflex-Bonds

In the next sections, I describe the overall mechanics of a new system that incorporates the original ideas from the Dai Purple Paper. The assets created by the system are not pegged to anything, but are designed to remove much of the volatility present in their underlying collateral. I will refer to this new asset using the term “reflex-bond,” coined by early MakerDAO contributor Nikolai Mushegian.

The purpose of reflective bonds is to represent their collateral more stably while maintaining a high degree of trustlessness. If used in other protocols, reflective bonds can protect their users from major and sudden changes in the cryptocurrency market. For example, if Maker used “reflective bonds” as collateral before Black Thursday, CDP creators would have more time to avoid being fully liquidated.

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2. "Reflex Bond" ETH = Delicious ETH

3. Before we go through a few examples of how "reflection bonds" keep volatility low, let's familiarize ourselves with the terminology you'll encounter in the rest of this article:

4. Reflex Bond: A collateralized, non-pegged asset with lower volatility compared to its own collateral;

5. Redemption price: the price that the system wants the reflective bond to have. For example, the goal of DAI is to always remain at $1, while the price of the reflective bond is variable;

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Figure 1A

Figure 1B

1. Figure 1A

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3. Figure 1B

4. Until day 30, the reflex bond has a call price and a market price of $1. Because the deviation between the two prices is zero, the redemption rate is 0%. Furthermore, the average collateralization ratio across the system is 190%, and for simplicity we assume that the collateralization price is always $100 and the liquidation ratio is always 150%.

5. Between 30 and 40 days, its market price rises to $1.1 as people start paying more for the reflex bond (e.g. they want to pay off their debt, but there is not enough liquidity in the market). To lower the market price, the system needs to create more bonds. To encourage bond issuance, the redemption rate is -10% per year (Figure 1A), while the market price surges by 10% (note: a redemption rate of -10% will result in a redemption price of $0.9 after one year);

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Figure 2A

Figure 2B

Figure 2Aimage descriptionFigure 2BFor the sake of simplicity, I have deliberately left out some details. Most of the time, there will be a small deviation between the market price and the redemption price, and the controller can be set to noise classification. Also, ideally, you should useimage description

Figure 3A

Figure 3B

Figure 3A

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Controllers can be launched with specific parameters and then be fully autonomous, in which case the system is less dependent on governance, or their parameters can be manually tuned over time. One caveat here, though: choosing the fully autonomous option from the start may prove ineffective due to lack of real-world data to base your arguments on.

Finally, even with a negative redemption rate, the system can still charge stability fees. When reflex bonds are repriced due to redemption rates, the amount of stability fee charged (in reflex bonds) does not change. But that's not all: a version of the system could charge a fixed stability fee while only modifying the redemption rate. Fixed fees and redemption rates estimated based on market/call spreads give CDP creators greater predictability in terms of costs and risks associated with their open positions.

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You can always predict the direction of the redemption rate as it is the exact opposite of the bias

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2. How do reflective bonds become trustless?

3. In order to create a reflection bond, we need to combine multiple parts together:

4. A reliable oracle system that provides price information for bonds and their collateral;

5. Changes to the rate-setting process for redemption rates;

a lending facility;

a clearing mechanism;

Components for setting the lending rate (stabilization fee procedure);

The hard part comes when designing the oracle and the redemption rate setting program. One option for collateral price feeds is to build an aggregator for the different oracle networks, store the results from each network in a sorted array, and choose the median. Part of the stability fee can be used to pay for oracle calls by using Uniswap v2 to exchange bonds with each oracle’s specific fee token. Bond price feeds can be obtained from the bond/COL Uniswap v2 pool. COL is one of the collateral types backing bonds, and can also be provided through governance whitelist oracles until the oracle network provides bond feeds.

As for the rate setter, a simple implementation is a PI controller, where the smart contract automatically calculates the ratio, and the governance only sets the integral item. A more complex implementation is to use a PID controller, where the integral and derivative terms are calculated by the contract using a market price deviation accumulator. With PIDs, governance may still require tweaking some parameters, although overall their impact on the system is minimal.

And the end result is that you don't need to trust the governance to handle most of the components of Reflection Bonds after it's started.

Once the system is launched, anyone will be able to atomically deposit ETH to create reflective bonds, and then deposit reflective bond ETH in another protocol to borrow or create other crypto assets, as well as synthetic gold, synthetic oil, synthetic stocks, and even Synthetic dollars are currently popular, and reflective bonds act as middleware between the initial crypto asset and the final agreement. The main benefit of using these bonds as collateral is that they mitigate volatility.

Summarize

To encourage the use of reflective bonds in other systems, they can be set with a default positive redemption rate. The upside is that these bonds will be more expensive to redeem over the long term. On the other hand, reflective bond CDP creators will gradually need to add more collateral to their positions to avoid liquidation due to bond repricing. Of course, the default redemption rate may be small enough that liquidation is not an imminent threat.

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Summarize