Protocol design — the new approach for synthetic assets on Ethereum

Our goal is to create a platform for various synthetic assets based on an improved Basis stabilization model with the implementation of a stabilization fund supporting the peg in times of need. The fund and other features will be able to fix current price issues of similar protocols.

We’re going to use the mechanism to transfer the liquidity from other blockchains to Ethereum. See our vision here. This can also be applied to Ethereum-native assets for the sake of cross-composability of collaterals and more efficient use of trading on Layer 2 / sidechains. We will share these ideas in the next articles.

Klondike Design

We use the Basis.Cash stabilization model, but with some major tweaks. The main drawback of the Basis model, as it turned out, is the instability of the system caused by huge rapid increases in the supply with a subsequent price fall due to insane APY on farming. The reason for that, as one could argue, is misuse of the original Basis model which wasn’t supposed to expand in supply so quickly or be “farmed” at all.

The farming leads to the following:

1. The demand for BAS increases and the price goes to $100–1000 and the APY [false metric] growth together with it, attracting retail
2. Rebase starts and huge amount of tokens gets minted (they flood the market and supply increases x100–1000)
3. Because of farming, only part of these tokens are sold into the market, the other part goes to UNI LP BAC<>DAI and the price stays above 1 and it takes 3 to 5 rebases to stabilize the price
4. The supply increases dramatically and too quickly because tokens were kept by the public
5. Later, farming becomes not as profitable as it was in the beginning, and a huge amount of tokens is sold in a short period of time, this leads to price dump and destabilization of the model
6. Trust in the model gets lost, and it becomes a negative cycle into 0

These drastic fluctuations create dents in the market which are hard to fix both in mid- and short-term. Therefore, our focus was on introducing additional price stabilization mechanisms into the Basis model in case of a deviation from peg. We are introducing 2 additional instruments:

A Stabilization Fund and a Subsidized Debt Market

Let’s see how it all works together:

– An oracle uses uniswap to get the kBTC/wBTC price. If the price is above 1, then old_supply*(price-1) amount of kBTC is minted. After that, 50% (currently predefined and will be possible to change later via governance) goes to the stabilization fund, the other 50% goes to the KLON holders who stake them to the Boardroom.

– If the supply of a synthetic asset grows, the algorithm mints additional supply and distributes it between the stabilization fund and KLON token holders.

– In case of an excess supply, the bond market mechanism is launched, which is incentivized by switching the inflation of the KLON token to the bond liquidity market. This is a fairly known procedure.

– If the bond mechanism is not sufficient to stabilize the exchange rate, funds from the reserve fund are used.

What else?

The other feature that’s currently being developed is an internal exchange for swaps of one synthetic asset to another: our system does not have vaults and collateral, so no data on the positions of the “creators” of the asset need to be overwritten when swapping synthetic tokens. This makes the transactions cheap in terms of gas and it’s performed without slippage. We have more ideas on this topic getting into the realm of CRV<>SNX, which we will share later too.

The protocol token specification

We are introducing the Klondike Finance protocol token — KLON. Holders of the KLON token become the owners of the protocol. What the KLON token gives:

1. The ability to receive supply with growth [positive rebases]
2. The ability to adjust the strategy of the stabilization fund (now it is hard-coded, but governance will be implemented in the next stages)
3. The ability to list new types of synthetic tokens

Features & Advantages

1. Infinite scale of synthetic assets will allow meeting the market demand for synthetic assets without restrictions on the amount of required collateral — we believe that the volume of synthetic assets on air in the coming years will become much larger, similar to traditional finance ($1 Quadrillion derivatives vs less than $100trln of real assets)
2. Any synthetic asset can be implemented: it does not matter, a real asset, an asset on any blockchain or an ERC-20 token, as well as their derivatives (futures, options etc)
3. The ability to integrate with other exchange protocols to create no-IL pools: distribution of ideas for cross-asset swaps for Synthetix + Curve to any ERC-20 token
4. Flexible options for managing the debt market: subsidized debt market, stabilization fund

Conclusion

Synthetic assets are going to be one of the largest markets in DeFi. KLON is already here, and you have an opportunity to be a part of the major ever financial market remaking! We hope to contribute to the open-source DeFi developer community with new tools, ideas, and hopefully integrate with major products as Klondike Finance grows together with its community!