An article to understand the design highlights of superfluid mortgage stablecoin ESD

Editor's Note: This article comes fromChain News ChainNews (ID: chainnewscom), published with permission.

Chain News ChainNews (ID: chainnewscom)

Translated by: Lu Jiangfei

Chain News ChainNews (ID: chainnewscom)

• Written by: Complement Capital

• Robert Leshner, founder of Compound Finance, called it "a brand new algorithmic stable currency";

• Translated by: Lu Jiangfei

This article will introduce Empty Set Dollar (ESD) in detail and why it is a very important DeFi project.

In the ESD project documentation, they claim that ESD is a "decentralized self-stable dollar";

Robert Leshner, founder of Compound Finance, called it "a brand new algorithmic stable currency";

• In the ESD white paper, it is also called "elastic supply stable currency".

• So, what exactly is ESD? In our opinion, it is one of the most important components in the DeFi industry.

• ESD overview

• Before officially entering the topic, we first give a brief explanation of some of the parameters that will be mentioned below, such as:

"epoch" cycle

Coupon validity period

Bonded token holder supply allocation percentage

Guaranteed Liquidity Provider

These settings can all be affected by governance changes. Some of the parameter values ​​used in this article represent only those at the time of writing (November 4, 2020), and this article was updated accordingly on November 4 to reflect the debt approved by the ESD Governance Vote on November 3 Mechanism changes.

Now let's get into the topic.

What exactly is ESD?

ESD is an encrypted token with coding rules for supply expansion, so it can be regarded as an algorithmic token or an elastic supply token. However, none of these descriptions can accurately capture the basic core theme of ESD, namely: an anonymous, "self-interested" (self-interested) collection of individuals, ESD is a very reliable dollar mechanism that allows on-chain dollar representation The form is more stable, you can think of it as a "synthetic dollar" (USD "synthetic"), always consistent with the dollar. ESD does not need the support of a 1:1 anchor reserve, but a stable asset and a "by-product" based on a series of rules that motivate human behavior.

1.02+（1.05-1.02）\*0.75

Let's start with how it works and dig deeper.

Empty Set Dollar, or ESD for short, is a synthetic asset, like MakerDAO’s DAI or Synthentix’s sUSD. The goal of ESD is to maintain price stability by tracking the value of the dollar. In addition, there is a USDC-ESD liquidity pool on Uniswap that will be used as a price oracle for ESD. According to the design mechanism of ESD, the supply of ESD can be continuously expanded to ensure that the amount of ESD and USDC in the liquidity pool is always equal, so that the value of 1 ESD can be consistent with 1 USDC (or 1 US dollar legal currency).

Sidenote: ESD currently sets an "8-hour" cycle, that is, every eight hours is an "epoch". At epoch transitions, the ESD smart contract checks the ESD token price. It is important to note that the ESD price will not be evaluated at the moment when the "epoch" boundary is switched instantaneously, because doing so can easily lead to its price being manipulated. In fact, ESD uses the Uniswap time-weighted average price (TWAP) algorithm, so its measured price should be the average value of the previous eight hours multiplied by the weighted value of each price's dwell time.

To give you an intuition of how USD works, let's take an example: Suppose the ESD token price stays at $1.05 for the first six hours of a certain period, and then $1.02 for the next two hours, then According to the time-weighted average price algorithm, the time-weighted average price of ESD is approximately $1.0425, namely:

Even if a buyer bought a large amount of ESD tokens two minutes before the end of the "epoch" and pushed the token price to $1.50, the impact on the time-weighted average price was completely negligible.

If the value of ESD exceeds 1 USDC, the smart contract will think that the market demand for ESD tokens is too high, and the supply of tokens at this time can no longer meet the current market, so it will increase the supply by minting more ESD tokens ( We will explain in detail how the newly minted token supply is distributed later in this article). Then, in each subsequent "epoch" cycle, the ESD protocol will continue to increase the supply until the total supply matches the total demand, in which case the ESD price will fall back to $1. But when too many new tokens are minted or external demand falls, then the ESD price will drop below $1. Since the ESD protocol has no way of knowing if the supply is growing too fast, or if there is some external reason for the drop in demand, a unique mechanism called "coupons" is introduced to help the system return to a fixed exchange rate.

But before introducing the "coupon" mechanism, we need to introduce another related concept: debt.

"Debt" and "Coupons"

The ESD protocol creates debt when an "epoch" period ends and the time-weighted average price falls below $1. Debt builds up in the protocol over time, so if the ESD price falls below the peg for multiple epochs, the debt gets bigger and bigger. In this case, accumulated debt captures a lack of demand over time. No new ESD tokens can be distributed until the debt is paid off. When the ESD price exceeds the peg, any newly created supply of ESD tokens will pay off the "coupons" before being distributed to token holders, and then repay the debt.

• If there is not enough capacity in the market to buy ESD for less than $1 and bring it back to the peg, a "coupon" can be used as a backup plan at this time. If the price stays below $1 for a long time, ESD will evaluate whether other methods are needed to solve the problem and ensure the continuous development of the project.

• "Coupon" can motivate token holders to voluntarily destroy ESD tokens, and it is also a voucher that can be exchanged for ESD in the future. These "coupons" can be purchased at a discounted price, and while the "coupon" holder is taking some risk, offering the discount is also a reward. During periods of low market demand, discounts on “coupons” are modest, as ESD token holders have little incentive to take the risk of buying coupons. But as the debt accumulates more and more, the discount of "coupons" will become larger and larger, which means that people who buy "coupons" can get more attractive returns. But there is one very important thing to watch out for: Coupons expire within 90 "epoch" periods (currently equivalent to thirty calendar days)! This means that "coupon" buyers have to be very confident in ESD and firmly believe that the undersupply of demand for ESD tokens is temporary, otherwise, their investment in "coupons" will all be wiped out. Therefore, "coupons" are not intended to be used by retail investors in essence, but are expected to allow professional investors to assume the role of purchasing. To understand this, it is necessary to take a step back and look at how an ESD system works.

We can think of accumulating debt as the "memory" of the system, and each debt is a "memory" of a difficult time. However, debt does not want to be a mechanism to stabilize the price of ESD. The real stabilization mechanism should be a belief in the ESD system in the market, that is, ESD should anchor the value of 1 dollar from the beginning to the end, as long as it falls below 1 dollar , traders can buy ESD tokens at a low price and sell them at the anchor price to make a profit. The take profit calculation is based on whether the difference between the current market price and $1 lasts longer than the trader expects that the ESD will not return to $1. The debt mechanism provides enough time for the system to calculate the lower demand so that the system can estimate how many "coupons" to issue. Once we go back to a fixed exchange rate, the debt will reset to zero, at which point no new "coupons" can be issued. If the ESD price falls below the peg again, the "coupon" cycle will start again, debt will accumulate from zero, and the "coupon" discount will also become lower.

On the other hand, the design idea of ​​"coupons" is actually to hope that ESD will restore the anchor exchange rate after it has been lower than the anchor exchange rate for a long time. Investors can buy debt on the belief that demand has increased or is about to increase. They will make a decision based on "game experience", and if they are wrong, failing to pay off the debt before redeeming the "coupon" means losing all the ESD they invested in buying the debt. If they're right, they stand to make a fortune, with benefits including:

(below par) the difference between the ESD transaction price and $1;

Additional ESD through "coupon" discounts.

Investors who buy "coupons" can also do some things that the ESD agreement itself cannot do, such as they can create their own demand. In fact, ESD believes that only those with a lot of money can effectively use the "coupon": they buy tokens to push the price up, and keep the price above the peg until the debt is paid off and the "coupon" is redeemed ——This is one of the main reasons why ESD is not a purely algorithmic stable currency. ESD is more like a system that combines algorithms with incentives for user behavior to achieve price stability. Therefore, it is not recommended for inexperienced investors to use "coupons", because if they cannot accurately judge the time to purchase coupons, they are likely to suffer huge losses.

"Coupons" also come into play in another typical situation, namely: ESD tokens are traded below the peg for an extended period of time. Assuming that ESD trades at $0.98 over a three "epoch" period, it may not seem like a big deal, but this situation will cause problems for some ESD users who need to close their positions but don't want to take the price shock, because the debt will Accumulated over three "epoch" periods, the "coupon" discount increases, allowing arbitrageurs to step in and make a profit. Some people have made a "small gain" by pulling the price back to the pegged exchange rate before, but obviously, the level of profit does not seem to satisfy arbitrageurs. However, the additional "coupon" incentive is enough to change the trading decision from "don't trade" to "do trade" for quite a few people. If it still doesn't attract enough people to trade, the "coupon" discount will continue to rise until the arbitrage opportunity becomes attractive enough for traders.

• Once the price stabilization mechanism kicks in and demand returns, the ESD token price could begin to climb above $1. Whenever the time-weighted average price ends each "epoch" period above $1, a new supply of ESD tokens is created and the debt is reset to zero. These newly supplied tokens will first fill the ESD liquidity pool and be redeemed for "coupons". At this time, "coupon" holders can redeem ESD on a first-come-first-served basis, and new ESD tokens will be minted only when enough minted ESD covers the redeemed "coupon". At this point, we are back to the question that was raised during token distribution, which users are lucky enough to get newly minted ESD tokens?

• To answer this question, we have to delve into Decentralized Autonomous Organizations (DAOs).

ESD Governance System

ESD is decentralized and based on on-chain governance from day 1, that is, the protocol can only be upgraded after a quorum of token holders votes. Those who participate in decentralized autonomous organizations need to invest in token binding. If the supply of tokens expands in the future, then:

80% of newly minted tokens will be distributed proportionally to those participating in DAOs;

The remaining 20% ​​will be allocated to those who provide liquidity in the Uniswap ESD-USDC fund pool.

Of course, liquidity providers (LP) must bind their own Uniswap liquidity pool tokens to earn rewards. However, by bonding ESD and Uniswap liquidity pool tokens, these token holders are subject to some restrictions. For example, after unbinding, users who pledge tokens in decentralized autonomous organizations and users who provide liquidity on Uniswap must wait for the end of an "epoch" cycle before transferring their tokens. Decentralized autonomous organization member-bound tokens will also be locked until the voting result is determined.

Are ESD protocols working as intended?

Are the design mechanisms of the ESD protocol so far working as intended? The above is a very typical diagram of a decentralized self-stabilizing system, which you can see in any book related to "self-stabilizing" systems. The idea of ​​this graph is that many control systems may be slow to respond initially, in which case the system will overshoot and then decrease the target value. In fact, the "self-stabilizing" system generally responds to fluctuations by adjusting some internal states to reduce fluctuations until the final control mechanism controls the system target value within a small range.

Lianwen Note: Overshoot is also called maximum deviation. Deviation refers to the difference between the adjusted parameter and the given value. For a stable fixed value regulation system, the maximum deviation in the transition process is the difference A between the first peak value of the adjusted parameter and the given value. The indicator B of overshoot is often used in the follow-up regulation system. When y(∞) is not equal to the given value: overshoot=[Y(Tm)-Y(∞)]/Y(∞)×100%, (A—maximum deviation; B—overshoot).

ESD is currently in the process, so we don't know what the outcome of it will be in the future, but ESD is entering the end of its second full cycle. Here's the system history so far: As you can see, the "hit value" peaked at $24 in the first cycle. In fact, during the bootstrap phase, before CoinGecko added support for ESD tokens, ESD tokens traded even higher (a reasonable valuation based on high inflation during the bootstrap period, by the way). And in the second cycle (which looks like a small wave compared to the first cycle), you will see the ESD token price closer to $1 than the first cycle.

Let's take a closer look at the second cycle to gain a deeper understanding of what's going on:

We can see that in the second cycle, ESD tokens peaked at around $2.40 and dropped as low as $0.43 (actually, ESD tokens could have dropped even lower all at once, but that’s not in the CoinGecko data records), and then reverted to the peg on 3 November 2020.

So far, we can see that ESD tokens are trending as expected, and the initial design of the protocol seems to be working well. The protocol can also be adjusted appropriately, while hopefully suitable governance decisions can be made to change certain system parameters and adjust incentives.

But it is foreseeable that as we go through more cycles, the ESD system will build enough market confidence so traders can price against the peg for expected returns, so they may be more inclined to trade below the peg Buy ESD and sell above the peg. In fact, the predictability of ESD systems will attract more professional arbitrageurs. Over time, the competition among arbitrageurs will gradually weaken, making the ESD token pegged exchange rate more stable.

Premium Superfluid Mortgage

While we've also seen a variety of interesting decentralized stablecoin designs (e.g. Terra, Celo, MakerDAO), centralized "players" such as USDC, Tether, and Binance still have a huge amount of market share. Advantages (as shown in the figure below). Centralized stablecoins can be subject to regulatory and potential censorship risks, so the cryptocurrency market needs a truly decentralized stablecoin.

But why can ESD tokens become one of the key components of the emerging DeFi economy? The main reason: ESD tokens have the potential to be a great form of collateral.For most DeFi projects, high-quality collateral is crucial. When users borrow encrypted assets on DeFi lending platforms such as Compound, Yield, Mainframe, and Aave, or mint synthetic assets on MakerDAO, Synthetix, and UMA, the quality of collateral will have a significant impact on user experience and user revenue. In order to let everyone understand this better, the following will compare ESD with the "DeFi mortgage king" ETH.When we use ETH as collateral, price volatility is a major problem that everyone needs to face. The price of ETH can fluctuate wildly over time, sometimes even falling sharply, which can lead to a sudden drop in the value of the collateral, which in turn triggers a forced liquidation. Therefore, when users use ETH as collateral, they have to put in more ETH (sometimes even need to exceed the minimum requirement of the system) for collateral, which will cause a very serious problem of inefficient use of capital. To make matters worse, borrowers/traders are now also required by the trading platform for margin calls. If they do not provide more collateral or fail to repay the loan within a short period of time, their collateral will be lost in just a few minutes. Liquidated by the trading platform. For collateral providers, this is a very bad user experience, but what is even more frightening is that this method is likely to trigger a panic sale of collateral, which in turn will cause irreversible systemic risks. The price drop will also cause a chain reaction, and other ETH holders will also choose to sell, thus triggering more margin calls, resulting in a cascading effect of continuously lower prices. On the other hand, the current Ethereum blockchain also has certain limitations, and network congestion will further aggravate this problem.

So what happens if instead of ETH we use stablecoins as collateral? The most direct result is to eliminate people's worries about collateral price fluctuations, and there is no need to worry about huge losses caused by forced liquidation. When a trader loses money on a synthetic trade and cannot meet a margin call, they can approach the situation in a calm and cautious manner, rather than panic selling, because at this point everyone believes that the collateral will continue to hold its value. Even if the stablecoin falls below the peg, this may only be temporary. Therefore, the protocol/lender/trader — that is, the counterparty to the synthetic transaction — also knows that the trader can sell the stablecoin collateral at the appropriate time. But the problem is that stablecoin collateral also has disadvantages, one of which is that users cannot earn returns when their stablecoins are locked, so using stablecoins as collateral is also very capital inefficient, which in turn leads to unsatisfactory returns on investment.

Dan Elitzer in his book "

superfluid mortgage

"(Superfluid Collateral) article proposes a solution to the capital efficiency problem. In the model given by Dan Eritzer, the collateral is secured, but at the same time the collateral is liquid. In a sense, the guaranteed collateral can be retained for mortgage transactions, and it is possible to have liquidity in a short period of time. From another perspective, the secured collateral is liquid, but at the same time, it can be used for lending transactions and earning income in some way. Doesn’t this effectively solve the capital efficiency problem mentioned earlier? Well, it is, but maybe we can do better -

When I use ETH as collateral, it means that I take a position in an asset whose price may grow with the overall growth of the DeFi ecosystem. In this model, ETH acts somewhat like a stock in that it captures value through the growth of the cryptocurrency market, and this growth is also strongly correlated. Holding ETH is a bit like buying a DeFi "exchange-traded fund", so this is actually what users can get from ETH collateral. will exceed the rate of return they earn, so people need to be able to act as superfluid collateral for "DeFi exchange-traded funds"-and this is the problem that ESD hopes to solve.

As the market demand for ESD Tokens continues to increase, so will the value of ESD Secured Tokens. Therefore, if ESD becomes one of the leading decentralized stablecoins in DeFi (yes! it is very likely!), then the market demand for ESD tokens may keep pace with the growth of DeFi. And, if ESD tokens can demonstrate price stability (yes, more likely!), then the volatility problem goes away, the overcollateralization problem goes away, and the resulting systemic risk ends, Collateral providers are no longer subject to margin requirements. You will find that the DeFi user experience has become better after the introduction of ESD tokens.

When an agreement accepts ESD tokens as collateral, the agreement understands that the stability mechanism of ESD can ensure that the value of tokens can quickly return to the pegged exchange rate state, so even if the price of ESD tokens is sometimes lower than the anchor price, the agreement will give some tolerance Spend.

In fact, ESD has the same characteristics as "DeFi ETF" like ETH, but while having the characteristics of DeFi value capture, the price volatility of ESD tokens is lower-these two characteristics undoubtedly make it a A high-quality superfluid collateral, which is also more market attractive than other collaterals.

What risks need attention?

Finally, we have to discuss a question, are there any disadvantages of ESD tokens? Well, ESD does have some issues, mainly three:

• First, the biggest competitors of ESD tokens are MakerDAO and centralized stablecoins. At the same time, the decentralized stablecoin market is heating up, with a large number of new competitors entering every week, so the market competition will become more and more fierce. ESD may not be able to grow with the growth of the DeFi market, which brings some risks.

• Second, whether ESD tokens can continue to maintain a "stable" state in the long run is still unknown, but as ESD token holders gradually adjust the system dynamics, the stabilization mechanism may be further developed. But it should be noted that the stabilization mechanism may not work, especially considering that the DeFi "hacker army" has been trying to undermine the stability mechanism.

• Third, ETH price volatility may also decline over time. In this case, ETH can still maintain its market dominance as the "king of mortgages". These are real potential risks.

However, we remain optimistic about ESD's vision for the future and can't wait to see how the project develops further. With ESD tokens:

When users need to spend ESD tokens, they can benefit from its stable price;websiteIn our opinion, this is an amazing innovation!here。

If you want to experience ESD, you can find it at