Five minutes to understand the ESD operation mechanism of the algorithmic stable coin nova

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ESD realizes the adjustment of circulation supply through incentive measures without collateral. At the same time, it draws on the popular trends of DeFi such as liquid mining and DAO governance.

Recommended reading: ” Selected Chain News | Understanding Algorithmic Stable Coins: Ampleforth, Basis Cash, ESD and Terra

Original Title: “One of the Duo of Algorithmic Stable Coins: ESD”
Author: Blue Fox Notes

Stable currency is one of the most important tracks in the crypto field, because it can solve the problem of excessive volatility of cryptocurrency, and it has become more and more widely used in DeFi. This is also reflected in the market value. Since 2020, the overall market value of stablecoins has grown very rapidly, and now exceeds $26 billion.

The overall market value of encrypted stablecoins exceeds US$26 billion, Coingecko

Five minutes to understand the ESD operation mechanism of the algorithmic stable coin novaCounting AMPL and ESD, there are already 10 stablecoins with a market value of more than 100 million U.S. dollars. Coingecko

Stablecoin is the holy grail in the crypto field, and it is the crypto track that has the opportunity to keep pace with Bitcoin and Ethereum in the future. This is destined to have a steady stream of projects to participate in to realize the ultimate encrypted stable currency dream.

Stablecoin iteration: risks and opportunities

The first generation of stable currency experiments was to tokenize legal currencies, for example, to tokenize USD, which gave birth to a series of USD stable currencies such as USDT. The first-generation stable currency is an important bridge between fiat currency and cryptocurrency.

The second-generation stablecoin experiment was originally intended to build a decentralized stablecoin, but with the evolution of MakerDAO, the early ETH collateral was too volatile, which may lead to liquidation, and the liquidation caused the price to continue to fall, and the price fell further Lead to more liquidation, which has a knock-on effect. After the black swan incident on March 12 this year, in response to market risks, MakerDAO introduced some centralized assets as collateral, such as USDC, wBTC, etc. For stability, MakerDAO made certain trade-offs in terms of decentralization.

The third-generation stablecoin test is a crypto-native stablecoin, such as the flexible stablecoin test of AMPL and YAM. These stablecoins do not need to use collateral, and are mainly regulated by algorithms and mechanisms.

The fourth-generation stablecoin experiment is a cryptographic native algorithm stablecoin experiment, such as ESD and BASIS. They refer to the previous design of the prestigious Basecoin and combine the experience of liquid mining and flexible stablecoins to design a new stablecoin mechanism.

It should be noted that the first and second generation stablecoins have been widely adopted, while the third and fourth generation stablecoins are still in the experimental stage and there are many uncertainties. However, this is the direction of future stablecoin exploration. This uncertainty itself is extremely risky, but also an opportunity.

Today, Blue Fox notes mainly talk about ESD, one of the duo of algorithmic stablecoins. The algorithmic stablecoin design originated from basecoin, but due to pressure, the basecoin project did not continue. If it was able to continue at the beginning, it may now have a chance to shine.

ESD inherits the design idea of ​​basecoin, realizes the adjustment of circulation supply through incentive measures, without collateral (USDT and MAKERDAO require collateral), but it also borrows from the popular model of DeFi today, such as no token pre-mining, liquidity mining Mine and DAO governance these new trends. In addition, in terms of composability, it is easier to integrate with other DeFi protocols than AMPL and YAM.

ESD stabilization mechanism

ESD is decentralized, but the biggest problem facing decentralization is: how to ensure its stability?

The first importance of stablecoins is stability, not decentralization. It would be better if both stability and decentralization are achieved, but it is not easy to achieve. So far, there is no stablecoin that has really successfully achieved this. Whether it is DAI, AMPL, YAM, or ESD, BASIS, they are still on the way, and they have not really achieved this goal. But on this road, there is a steady stream of exploration in the field of encryption.

USDT and USDC are the tokenization of USD. They need to mortgage USD and trust custodians. They are stable but not decentralized. DAI currently has an overall market value of more than 1.1 billion U.S. dollars, which is the closest to decentralization among stablecoins with a market value of more than 1 billion U.S. dollars. However, there are many centralized assets (USDC and wBTC, etc.) in its collateral, which makes it unsatisfactory The ultimate vision of the encryption field. In addition, DAI and sUSD need to be over-collateralized, and the solvency of their collateral needs to be guaranteed. Once there is a risk of market fluctuations, their stability will also be affected. This is also reflected in the 3.12 Black Swan Incident in 2020.

AMPL uses a new elastic adjustment mechanism called rebase (re-adjustment of supply). If the price of a coin is higher than the target price, additional tokens will be issued and automatically distributed to the token holders, which will cause the price of the coin to fall through inflation; if the price of a coin is lower than the target price, the coin will be reduced and the coin will be changed. To be scarce, so as to increase the price of tokens and make them tend to the target price. AMPL re-adjusts its supply every twenty-four hours. Through this elastic mechanism, the price is close to the target price.

Unlike AMPL and YAM, ESD’s token adjustment is not a global adjustment through smart contracts, and ESD’s token supply adjustment is done actively by users. What stimulates user behavior is the ESD incentive mechanism.

This incentive mechanism is the key to ESD different from other stablecoins. When the price is higher than the anchor price (1USDC), users can choose to pledge their ESD to have a chance to get more newly issued ESD rewards. Due to the increase of ESD, the circulation of ESD is increased, thereby reducing the price of ESD. When the price is lower than the anchor price, the ESD agreement issues debt and token holders can buy it. ESD will issue coupons, and ESD holders will get coupons by destroying ESD.

Why are users willing to buy coupons? This is because there are discounts for purchasing coupons. When the future ESD price is higher than the target price (1USDC), more ESD can be redeemed with coupons. When the amount of ESD agreement debt is greater, the amount of ESD that users can redeem is greater because the original discount is greater. As debt increases, discounts increase, which will incentivize token holders to burn more ESDs and buy coupons, thereby reducing the supply of tokens and increasing the price of tokens.

Under this mechanism, ESD will encourage arbitrageurs to make arbitrage. Users have the opportunity to get more ESD by pledge their ESD or purchase coupons. Staking ESD can passively gain income, while purchasing coupons can gain income through arbitrage. Of course, buying coupons is also risky and not suitable for everyone.

It should be noted that: the current Coupon has set a validity period, and the coupon will expire after 90 epochs, which is equivalent to 30 days. This is a risk of it, so ordinary users must be cautious when buying Coupon. If they fail to complete the exchange within the validity period, it will cause losses. Coupon is more suitable for professional players.

The advantage of this mechanism is that it can reduce user panic to a certain extent, and it is not easy to produce a death spiral. In the rebase mechanism of AMPL and YAM, when the price of the token is lower than the anchor price, people will have greater psychological panic. Even if the user knows that the proportion of tokens they own is constant, they see the token in the wallet. The number of coins is decreasing, and the price is also falling, which will cause some users to sell, which will further cause the price to fall, and the number of tokens in the wallet will further decrease. Of course, so far, in practice, AMPL and YAM have resisted the death spiral to some extent. In ESD, the tokens in the wallet of the holder of the currency will not decrease, so there will be no visual and psychological impact caused by the decrease in the number of wallet tokens.

The oracle of ESD

The price predictor of ESD comes from Uniswap’s liquidity pool USDC/ESD. In essence, ESD is also a synthetic asset, similar to DAI and sUSD.

Five minutes to understand the ESD operation mechanism of the algorithmic stable coin nova (The oracle of ESD uses Uniswap’s TWAP, ESD)

ESD has an Epoch (epoch) every 8 hours. When the epoch changes, the ESD smart contract will get the ESD price through the oracle. ESD uses Uniswap’s TWAP (Time-weighted avaerage Price). It is the weighted average price of the past 8 hours, so it is difficult to manipulate the price of its oracle. The current TWAP price is 1.2286USDC, which will trigger additional issuance.

ESD can be integrated

Among the current stable currencies, USDT, USDC, and DAI all have ERC-20 standard tokens, and it is easier for developers to integrate them into their protocols. AMPL and YAM are not easy to be integrated because of the automatic adjustment mechanism of tokens. ESD does not directly change the number of tokens in the user’s wallet, but stimulates the user’s response through additional issuance or coupons, thereby adjusting the supply, and is also easy to integrate into the DeFi protocol.

Distribution of additional ESD

The new issuance of ESD must first repay the debt to satisfy the redemption of the Coupon. Coupon holders can redeem their ESD on a first-come, first-served basis. After completing the ESD coupon redemption, more new ESDs will be generated.

Then, after the coupon redemption is completed, to whom will the new ESD be issued?

First to users who pledge ESD in DAO, these users will receive 80% of the newly issued tokens, and the remaining 20% ​​will be allocated to those users who provide liquidity for ESD/USDC on Uniswap.

The liquidity provider pledges LP tokens from its Uniswap token pool to ESD. Currently, in order to unlock the user’s LP token, it is necessary to wait for 5 epochs, which means that it can withdraw its liquidity after 40 hours. Participating in the DAO pledge ESD will also be locked. At present, the withdrawal of the DAO pledge needs to wait 15 epochs, that is, it takes 5 days. The design of this unlocking period will reduce the market circulation of instant ESD. This will help expand the overall market value of ESD in the early stage, increase the rate of return, and increase the attractiveness of the agreement. Although, this is not the original meaning of stable currency.

How ESD holders get benefits

As a stable currency, ESD does not have room for appreciation, but holders of ESD tokens also have the opportunity to gain income. The reason is that holders of ESD tokens have the opportunity to obtain new ESD rewards by staking their tokens. Of course, the premise is that the market value of ESD continues to grow. The current market value of ESD is 237 million U.S. dollars. Assuming that its market value has the opportunity to grow to 1 billion U.S. dollars, hundreds of millions of U.S. dollars will be distributed to ESD liquidity providers and token pledgers.

As of the writing of Blue Fox’s notes, ESD has run 310 Epochs, which is approximately three and a half months. The current price of the TWAP oracle is 1.2286USDC, and the next ESD will issue 5,664,897.87 ESD.

Five minutes to understand the ESD operation mechanism of the algorithmic stable coin novaCurrent earnings of ESD liquidity providers, Coingeco

Five minutes to understand the ESD operation mechanism of the algorithmic stable coin novaESD state lock, ESD

In addition, holders of ESD tokens can also purchase coupons for arbitrage, but coupons have a validity period and also have certain risks.

When the account is in Frozen or Fluid state, ESD users can Bond or Unbond, but only in Frozen or Locked state can they store, retrieve or vote. This state design supports its safety model.

The risk of ESD

If the ESD mechanism fails to operate as expected, and the long-term price is too high or below the target price, it may prevent it from becoming a real stable currency. It also faces competition from stable currencies such as USDT/USDC/DAI/AMPL. If it cannot maintain relative stability, it will be difficult for other DeFi protocols to adopt (for example, as a loan collateral). In the long run, how the ESD mechanism evolves needs to be observed. In addition, the ESD protocol also faces the same risk of hackers as other DeFi protocols.