Financial stability: AMOs, BLR, AMMLR & The DeFi Trinity
Last updated
Last updated
Automated market operations are a set of autonomous contract that implement specific monetary policies within USDFI's cryptoeconomy and Universal Banking Protocol. The contracts perform a series of actions to enforce given monetary policies within the confines of the protocol's rules to reduce the supply of USDFI on the open market. USDFI's AMOs can only decrease the market supply of USDFI, but they can never increase the supply. This automation is crucial for maintaining efficiency, transparency, and trustlessness of the decentralized stablecoin design.
The foundation and primary value of the design is a decentralized cryptoeconomic system based on the universal DeFi banking model. USDFI leverages an existing decentralized finance (DeFi) economy to mature and achieve price stability long-term. A sustainable decentralized bank-like architecture in DeFi requires a protocol implementing a central bank's core financial stability instrument, engaging as the lender of last resort. For DeFi, the concept of lender of last resort is adapted from the traditional monetary system and introduced as the buyer of last resort ("BLR") to the stablecoin design.
During times of downward price instability, the protocol acts as a buyer of last resort and buys back (“burns”) unlimited USDFI on the open market at a higher price, in perpetuity, until price stability/true value is restored. With the introduction of a buyer of last resort to the stablecoin design as a buffer, unlimited USDFI buy back transactions (and the resulting reduction in coin supply along with increased liquidity) help to restore confidence, attract new users and reduce extended periods of downwards price pressure. In this manner, the protocol plays the buyer of last resort in a manner that renders it no longer individually rational to sell USDFI[1], thereby anchoring the price to USD $1 over time.
A successful stablecoin design must be able to reduce the supply overhang and eventually correct the downward instability of the stablecoin into a new equilibrium; it’s an intentional and inevitably user-experience flaw that the stablecoin temporarily no longer tracks exactly one USD.[2] However, this flaw is mitigated by the fact that every user can have the confidence that over time, he will be able to trade USDFI at the peg again.
To be able to act as a perpetual buyer of last resort, the protocol operates a cash-flow generating, automated on-chain treasury along diversified revenue streams from liquidity and lending activities. For each USDFI minted, the equivalent of USD $1 flows into the treasury and gets locked on-chain in smart contracts for yield operations (liquidity pools, “LPs”) on decentralized exchanges (“DEXs”[3]). These LPs replace centralized exchanges to define the price of digital assets and provide liquidity for automated trading. In return, the protocol’s treasury is rewarded with a fraction of the trading fees generated.
Here we introduce the second interlinked element to the stablecoin design: the automated market maker of last resort (“AMMLR”). Only the revenues from the yield operations are allocated to the AMM operations, avoiding recursion in the design. The AMM operations generate additional revenues for the treasury, which get routed back to the yield operations, steadily compounding revenues and perpetually dollar-cost averaging into new tokens, generating more liquidity.
Combined, these buffers both reduce the likelihood of instability arising in the first place and improve the user’s ability to deal with instability when it occurs. The dedicated liquidity pools act as stability pools for the USDFI ecosystem during periods of temporary downward instability and help smoothen the effects of such periods as instability gets distributed over time.
A DeFi Trinity is the triangle between the fundamental core elements of DeFi consisting of stablecoins, liquidity and lending. Different protocols may offer different designs, but fundamentally everything in DeFi is a variation of one of these core elements mirroring decentralized banking functions.
USDFI captures and controls the whole value proposition and powers the entire financial stack with its own stablecoin. The design of USDFI aims for integration, utility, and ultimately demand for its stablecoin. Lending and liquidity support stability, and in turn, this triangle enables mutual growth in a perpetually reinforcing and demand-generating relationship between the core elements. This symbiosis is the main differentiator to other designs, where protocols aim to expand its ecosystem by adding siloed, supplementary services to the crypto stack. Unlike other designs, there is a native, protocol-based interdependent relationship powering the USDFI ecosystem.
By creating this native, protocol-based interdependent relationship, USDFI aims to create a more holistic and integrated ecosystem, where all the core elements work together to enhance the stability and liquidity of the stablecoin, and drive the growth and adoption of DeFi as a whole.
[1] Hockett, R. C. (2015). Recursive Collective Action Problems: The Structure of Procyclicality in Financial and Monetary Markets, Macroeconomies, and Formally Similar Contexts. Journal of Financial Perspectives, 3(2). 27: The price follows a self-fulfilling prophecy dynamic.
[2] See Buterin, V. (2022), Two thought experiments to evaluate automated stablecoins, https://vitalik.eth.limo/general/2022/05/25/stable.html. The process resembles supply/demand dynamics and the necessity of having the possibility of implementing negative interest rates in an automated stablecoin design like RAI: Negative interest rates pay borrowers to borrow, driving borrowing demand and RAI supply up and help to resolve the instability of the RAI’s peg. The other alternative is to manipulate user token balances. However, it is not a feasible approach. A stablecoin cannot be considered a stable asset (even if the price of the stablecoin is fixed) when the quantity of stablecoins owned by the user fluctuates. This design abandons the stability of asset value for the sake of price stability. Different opinion: Kuo, E., Iles, B., & Cruz, M. R. (2019). Ampleforth: A New Synthetic Commodity. Ampleforth White Paper.
[3] A decentralized exchange is a peer-to-peer marketplace where transactions occur without an intermediary.
