UXD Protocol — The perfect stablecoin?
Key Takeaways
$UXD stablecoin is issued by the UXD Protocol and solves the stablecoin trilemma — price stability in maintaining the USD peg, capital-efficiency since there is no need for over-collateralization, and $UXD is decentralized because $UXD is censorship-resistant.
The $UXP token is the governance token of the UXD Protocol.
Holding the $UXD is currently a risk-averse way of generating revenue through funding rates. Since funding rate revenues generated from perpetual futures will be regularly shared with UXD Protocol stakeholders, including $UXP holders and the insurance fund.
Introduction to $UXD and the world of stablecoins
Stablecoins have played a significant role in the growth and proliferation of cryptocurrency and DeFi. Global regulatory activities have made it difficult for cryptocurrency exchanges and investors to access fiat onramps. Thus, most of the buying and selling activities in the crypto and DeFi world are done with stablecoins.
Source: Coinmarketcap
Since stablecoins have become so crucial to the success of crypto markets, the leading stablecoin must be free of defects. I discovered the UXD Protocol in 2021, and I have been studying it to understand the methods and ultimate goal of the protocol. Using the protocol and reviewing details about the protocol and its stablecoin, I believe this is the closest stablecoin to perfection at the moment. UXD protocol essentially creates censorship-resistant, capital-efficient stablecoins backed by delta-neutral positions using perpetual swaps. However, before we do a deep dive into UXD and how it works, let's consider existing solutions and how they fall short.
Existing Stablecoin Solutions
Currently, there are four main methods for making a stablecoin:
Fiat-backed stablecoins.
Crypto-collateral backed Stablecoins.
Commodity backed Stablecoins
Algorithmic stablecoins
Fiat-backed Stablecoins
Fiat-backed stablecoins are the most popular form of stablecoins. These are stablecoins primarily backed 1:1 to the base currency. Before one unit of these stablecoins can be issued, the recipient of the stablecoin must give one unit of the corresponding base currency to the stablecoin issuer. For example, businesses that wish to buy USDC must first deposit the equivalent amount of USD into the circle account before receiving USDC. Thus, fiat-backed stablecoins are ultimately supposed to be redeemable at any time in a 1:1 ratio with the base currency they represent.
Fiat-backed stablecoins — Tether(USDT), USD Coin(USDC), and Binance USD(BUSD) make up the top three biggest stablecoins by market capitalization. Factually, these three stablecoins make up slightly more than 80% of the total market capitalization of all stablecoins.
Source: Coinmarketcap
While fiat-based stablecoins have become dominant and increasingly popular, controversies continue to beset the largest and most widely used fiat-based stablecoin, Tether(USDT). Issues regarding the solvency and integrity of the backing of these stablecoins continue to surface. Twitter user - Bitfinexed has helped shine the light on the opaque nature of the reserves of stablecoin issuer, tether.
Considering that fiat-backed stablecoins are centralized in nature and have a tendency to be opaque in auditing their reserves, they would hardly qualify as sound money. Moreover, in a situation where large swathes of users want to convert their fiat-backed stablecoins to the base currency, fiat-backed stablecoin issuers might not be able to honor every withdrawal.
Thus, the imperfection of fiat-based stablecoins is primarily because they are centralized and require high, unhealthy levels of trust.
Crypto-collateral backed Stablecoins.
These are stablecoins that are backed by crypto collateral. The most famous examples of crypto-collateral backed stablecoins are MakerDAO’s DAI and Magic Internet Money(MIM) by Abracadabra. To create 1 DAI, users must deposit blue-chip cryptocurrencies or liquidity provider tokens stipulated by Maker’s collateral requirements.
Source: Maker Oasis
Similarly, to create 1 MIM, users must deposit collateral as stipulated by Abracadabra.
Source: Abracadabra
Crypto-collateral-backed stablecoins are essentially capital inefficient since users must provide collateral above the amount of stablecoin they wish to create. For example, on Maker, to create $1 worth of DAI, users must provide about $1.7 worth of Ethereum.
Also, users can provide stablecoins as collateral instead of blue-chip cryptocurrencies like ethereum. This creates a centralization risk since the underlying crypto collateral is in part a fiat-based stablecoin.
While these crypto-backed stablecoins set out to be mainly decentralized and censorship-resistant, the underlying collateral base is increasingly becoming centralized fiat-based stablecoins. For example, looking at Maker’s asset types, we can see that stablecoins constitute a large percentage of the collateral provided. At the time of this writing, stablecoins like USDC comprise approximately 60% of the collateral supplied to mint DAI on Maker.
Source: Dune Analytics
Also, several crypto-collateral-backed stablecoin issuers rely on price oracles to determine the health of collateral supplied and liquidation thresholds. If the oracle is under malicious attacks, this will pose a risk, leaving users prone to liquidations or other financial losses.
Several Crypto-collateral backed stablecoins also poorly maintain the peg with their base currency. For example, looking at the DAIUSD chart, we can see significant variations in the price compared to the USD.
Source: Coinmarketcap
Thus, the problem with crypto-collateral-backed stablecoins is that they are capital inefficient, perform poorly at maintaining their peg, and are prone to re-centralization.
Commodity backed Stablecoins
Like fiat-backed stablecoins, these types of stablecoins are backed 1:1 with a commodity, e.g., Gold. Tether Gold($xAUT) from Tether is a prime example of a commodity-backed stablecoin. However, these stablecoins are highly centralized in their issuance and require an unhealthy amount of trust in the issuer.
Algorithmic Stablecoins
Algorithmic stablecoins do not have any collateral backing. Instead, the most popular algorithmic tokens rely on arbitrageurs and algorithms to maintain their peg. There are several popular algorithmic stablecoins. However, Ampleforth and Empty set dollar were among the earliest iterations of algorithmic stablecoins. Unfortunately, these stablecoins performed relatively poorly in maintaining the peg to their base currency, $USD.
Source: Coinmarketcap
Some algorithmic tokens introduced arbitrageurs into the ecosystem to help maintain a more decent peg to the base currency. The Terra ecosystem took this approach. As a result, Luna effectively acts as the stabilizing crypto asset for the Terra stablecoin ecosystem and aids arbitrage activities between Luna and the basket of stablecoins in the Terra ecosystem. Luna also represents the mining power of the Terra network. Of the several stablecoins issued by the Terra Network, the $UST is the most widely known and used.
Source: The Tie
The problem with the approach taken by Terra is that during extreme price contraction of the $LUNA token, a death spiral can occur, forcing the $UST or any other Terra stablecoin to lose the peg to the base currency. Also, a decreased demand on the $UST can be very harmful to the peg and health of the $LUNA token.
Thus, while algorithmic tokens are decentralized, they can be volatile. Another problem with Algorithmic stablecoins is that they rely on price oracles underneath the hood. Any exploits or malfunctions in the price oracle can lead to de-pegging or other forms of financial losses.
How does $UXD work
Source: UXP Protocol
$UXD is a stablecoin backed by a 100% delta-neutral position. What this simply means is that when you give collateral to the UXD protocol to mint the $UXD, automatically, a short position is opened on a derivative trading exchange. The change ratio between the long spot and the short futures positions is always equal to 1.
Source: UXP Protocol
Thus, since the rate of change between the spot and futures position is always equal to 1, the stablecoin is said to be backed by delta-neutral positions.
Since there is no need for over-collateralization, the $UXD effectively becomes one of the most capital-efficient stablecoins in existence. Also, the issuance of the tokens is fully decentralized and censorship-resistant, allowing for anyone to transact freely.
$UXP is the governance token of the UXD Protocol. $UXD token holders earn a share of revenues generated from positive funding rates revenues that accrue from the futures position.
When interest rates are negative, the UXP Protocol pays through the insurance fund created. At the time of this writing, the insurance fund is valued at $57,086,131. This means that the protocol can cover annual funding rate fees that are slightly more than 10% for one year on $500 million worth of $UXD. The protocol can then replenish the insurance fund with the $UXP token auctions upon depletion.
The $UXD is a near-perfect stablecoin because it is censorship-resistant, adequately maintains its peg to the United States Dollar, and is capital efficient since you only need $1 worth of collateral to generate $1 worth of $UXD. Furthermore, users can mint or redeem $UXD in a permissionless way, at all times.
Source: UXD Protocol
Source: UXD Protocol
Currently, the only acceptable collaterals to mint the $UXD are Bitcoin ($BTC), Ethereum($ETH), and the Solana token ($SOL). However, the UXD Protocol would open up a broader spectrum of collateral as time goes by. The UXD Protocol currently has a $7.5m $UXD cap that is increased based on demand.
Tokenomics
Source: UXD Protocol
The total supply of the $UXP token is 10,000,000,000 UXP. However, only 300,000,000UXP or 3% of the total supply has been dispensed at the point of the initial token sale.
Of the total supply of the $UXP token:
20% has been allocated to the team,
15% is allocated to investors,
57% is assigned to the UXD Protocol community,
5% is allocated to the Treasury to enable future growth of the UXD protocol,
while 3% of the supply is assigned to the insurance fund.
UXD Protocol raised a total of $57,086,131.8292 from 3,676 investors during the initial token sale, and the entire amount raised has been allocated to the insurance fund.
Currently, the $UXP token price is $$0.08319, bringing the market cap of the UXP protocol to $24,986,065, with a fully diluted market cap of $831,883,773. Currently, you can purchase the $UXP token on Raydium, Serum, or Dexlabs.
Risks
While the $UXD is bold and innovative, you should note several risks associated with implementing the $UXD. Some of the most likely risks include:
Smart Contract Vulnerabilities - The implementation of the $UXD is natively done on a smart contract. Also, the decentralized derivatives exchange(DEX) — Mango Markets is run on smart contracts. Therefore, any failure in the UXD Protocol smart contract or the smart contract of Mango Market can lead to financial losses that would cause the $UXD to become under-collateralized.
Prolonged periods of negative funding rates - If the funding rates stay negative for long periods, this can deplete the UXD protocol insurance fund. If there are no redemptions of $UXD for the same period, holders of $UXD can become under-collateralized.
Also, if the DEX used by UXD protocol to manage the insurance funds suffers from illiquidity, it might be difficult for $UXD holders to retrieve their crypto assets.
The insurance fund will be deployed to safe investments such as providing liquidity to stablecoin pools. However, there may be a minute chance that other stablecoins in the liquidity pool lose their peg. This kind of loss of the insurance fund can cause the $UXD to be under-collateralized.
Final Thoughts
Stablecoins happen to be the crypto product with the most significant market fit. Since there is a scarcity of reliable fiat-onramp, there is a need to create a stablecoin that cannot be censored and is very capital efficient. I believe $UXD can become a crucial stablecoin in the Solana and broader crypto ecosystems. While the tokenomics of the protocol can be significantly improved, I think that the $UXP token can present a good investment opportunity as the UXD Protocol continues to grow and as demand for the $UXD increases.
Reach out to UXD Protocol
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Thanks.
great overview, thanks for sharing