Seigniorage & Elastic supply. A case study on AMPL, ESD, DSD, Basis.
In recent months, we have seen a boom in seigniorage stablecoins: ESD, DSD, Basis.Cash, Mithril, DIGG. In this article, we will conduct a comparative analysis of the stabilization mechanisms of these projects, applicability and the effects of farming of these models.
The pioneers in the field of seigniorage were AMLP and Basis in the Ethereum community, which appeared back in 2017–2018, which is the same as the last century within the crypto space. At the same time, for a long time they remained “theorized”, because in practice these protocols did not work. We’re working on improving these mechanisms and making the stabilization and synthetics issuance model sustainable.
Let’s take a quick look at these models.
The project has one token — AMPL. The stabilization mechanics are quite simple: if the value of the token is p> 1, then the protocol mints (p-1)*token_supply and distributes it among the current holders of AMPL.
This model has proved to be viable, but this does not provide sufficient mechanical stabilization of prices:
- In the first moments of the system launch, the price can be very volatile
- Then, with scaling, the volatility range decreases, but nevertheless remains significant. Thus, we get an asset, the price of which is not correlated with the price of ETH/BTC, but it is not very convenient to use it as a means of payments — the volatility is too high
- There is no clear arbitrage cycle to move the price to peg
Basis Cash model
- Coupon (Bond)
- Seigniorage Share
How it works:
- stable > 1: stables are minted in the amount of (p-1)*supply and distributed to the share token holders (if there are system debts, then debts / bonds are paid off first)
- stable < 1: the user buys stable bonds at a discount, bonds are paid when the system returns to the state stable> 1
Reasons to fail:
- The model assumes rational users who will immediately take advantage of the arbitrage opportunity to make a profit, but because of farming, degens do not sell stables, but put them as LP in Uniswap to farm.
- As a result, the system mints more and more stables
- At some point in time, farming ceases to be profitable and everyone starts selling stable — the system falls like a house of cards
There are 2 tokens: stable and сoupon
- Supply growth is caused not by stable holders, as in the AMPL, but only by DAO members: those who have locked an ESD token or LP (ESD + DAI).
- Unlocking from DAO usually occurs within 3 days, which leads to the fact that the supply grows exponentially, since the increase in the supply is locked in the DAO.
- In the event of a price drop, the bonds mechanism is launched: the user buys out ESD at a discount, the coupon can be exchanged for ESD when its price > 1
In fact ESD / DSD — this model is largely identical to the basis model, only Uni LP tokens are used instead of shares. An important difference is the presence of a lock in the DAO, which creates a system that is very similar to various gambling MLM schemes: it distributes the system abruptly and grows the supply exponentially, but the reverse medal is that it will then exponentially increase the debt market. It is difficult to find now a person who is ready to provide 100 million in bonds
What’s the problem with seigniorage coins like Basis/ESD?
First of all, it is necessary to build confidence that the system will withstand peg < 1 and return to the growth phase. If we turn to the work of central banks and monetary policy, we can see that the Central Bank has a large set of instruments for managing the exchange rate, and not just issuing bonds. The fact is that they “developed” confidence in themselves for decades and even centuries. As we have seen with DSD and ESD recently which have struggled to get out of the contraction phase, coupon buyers are screaming for prolonging the expiry period.
Therefore, we propose to create additional peg management tools (primarily in the case of peg < 1). The first instrument presented by us: (see contract) is a stabilization fund.
Stabilization Fund Model
What is its essence? The stabilization fund is formed during the expansion of the coin and gathers 50% of the emission, which the pool sells on Uniswap. Thus, during the growth period, the protocol accumulates reserves, which can later be used at moments when the demand for a synthetic token falls.
The second problem with seigniorage coins is the bootstrapping of the debt market. This is quite hard and takes time. The bond format does not add attractiveness to such an asset: in cases where the bond payment date is fixed, for example, yield.is or UMA tokens, potential investors can predict the price and understand when they will exit the asset and calculate the profit.
In the case of the coupon mechanism, it is not clear to investors when they will be able to get a profit and whether they can. This adds risks to the bond as a debt instrument, makes it less attractive and, accordingly, the protocols are forced to pay higher fees when selling such debt instruments.
Liquid Debt Market
We propose to solve this problem by creating a liquid debt market — bonds will be freely sold in the secondary market (aka Uniswap) and we plan to increase the attractiveness of bonds by adding farming APY to bonds: this will make it possible to get profit when buying bonds even if the bond is not yet redeemed: you, as a potential investor, can buy a bond, wait a while, receiving farming yield for this, and then sell the bond at any time when you need liquidity. Thus, DeFi allows us to improve the properties of the bond due to composability.