How Equilibrium’s Stablecoin Works
By now you’re familiar with the thinking and functionality that drives Equilibrium. We’ve taken a broad view at how our platform operates, why it’s an improvement over other solutions, and we’ve introduced you to our core system asset, the EQ token. Now it’s time to get into our USD-pegged decentralized stablecoin.
Equilibrium’s USD (we’ll share some exciting news about its proper name soon) is our figurative dollar on the blockchain. It enters circulation when users open a collateralized debt position on our platform. By overcollateralizing their varied and volatile digital assets within our interoperable smart contracts, DeFi platforms like ours can derive steady, intuitive value from a pile of varied and volatile crypto.
Decentralized stablecoins work as a kind of “smoothing agent” that makes it possible to manage predictable finances in the crypto world. Our decentralized stablecoin is a fundamental part of our price quotations for our built-in cross-chain DEX. It can even form the basis for an infinite liquidity pool where people borrow at an APR lower than regular stablecoins available on the platform — borrowing them brings costs to the liquidity providers who first brought stablecoins into their pools.
Furthermore, our stablecoin is running on top of the on-chain risk management system and the bailout mechanism, core system components that underpin the entire platform. You can learn more about these components in our previous article of this series, they effectively make our stablecoin stable.. We think DeFi developers seeking an easy way to represent USD values with crypto technology are really going to like it.
Let’s dig into Equilibrium’s USD, our decentralized cross-chain stablecoin, and explain what makes it so special.
The advantages of Equilibrium’s stablecoin
Don’t be taken by the notion that a dollar on the blockchain is simply a dollar on the blockchain. Not all stablecoins are created equally, and one stablecoin may operate completely differently from another despite representing the same value.
Our stablecoin enters circulation from the overcollateralization of multiple cryptocurrencies combined in a collateral basket that backs one position. This echoes a real strategy from the world of conventional finance, where collateral baskets are an established tool for mitigating volatility. Other protocols may restrict collateral positions to just one kind of currency due to technical congestions in the underlying blockchain platform, making our kind of varied basket impossible.
Our users can pledge a mixed pool of crypto at an overcollateralized rate, say Bitcoin, EOS, and Ethereum, in order to generate our USD-pegged decentralized stablecoins. For those people who have diverse crypto portfolios, they can more easily move some or all of it into a currency that holds stable, predictable value.
Secondly, our stablecoin is cross-chain compatible. As a Polkadot-based project, Equilibrium leverages an interoperable environment to serve a variety of blockchains at once. Consider USDT, the only major stablecoin to be widely represented across blockchains. It’s convenient to swap USDT between chains, but this calls for transacting via a third party. It’s less than elegant: transactions can take a long time to clear, other platforms take additional fees for withdrawals, there are risks stemming from a centralized counterparty, and the list goes on from there.
In our case, everything is decentralized. Users can easily juggle their stablecoins across multiple chains without interference from anyone. At the end of December, we introduced an integration with Ethereum-on-Polkadot project Moonbeam that makes our stablecoin fully compatible with Moonbeam’s Ethereum-enabled environment.
As other Ethereum-based DeFi protocols bring their projects to Moonbeam, our intuitive USD-pegged stablecoin can access niche blockchains with ease, gaining wide mindshare and utility throughout the ecosystem.
How does our stablecoin maintain steady value?
In a word, it’s algorithms.
Decentralized stablecoins maintain their value by mathematically monitoring a number of variables enabling certain incentives for users based on the given data. These variables include price data for the assets that comprise collateralized debt positions and the rate of collateralization — that data goes on to govern how debt is managed across Equilibrium user positions.
Our stablecoin users are like borrowers paying a very low APR to turn volatile, varied crypto into more manageable and intuitive value. As long as market forces don’t turn vengeful and as long as your collateralization ratio doesn’t flirt with our minimum threshold, Equilibrium’s stablecoins are actively protected in a trustless, decentralized manner.
The “threat” to a decentralized stablecoin’s value can only really come from the market or the user. The market may decline to the point that the overcollateralized position becomes insolvent, and that bad debt gets liquidated. There can also be trouble if the user doesn’t sufficiently overcollateralize their position from the outset. Just a small downward market move can turn these barely-collateralized positions upside-down before you know it. This comes with significant risk: in a steep market decline there will be forced actions required to wipe out the bad system debt and it may turn out that there will be no counterparties willing to liquidate it.
That’s why we’re so proud of our bailout model for liquidations. Auctions are the DeFi norm for handling this task, but these are too passive and depend on other people taking action after the fact.
We’ve designed a more reliable mechanism to protect our stablecoins from black swan market events — our so-called “bailsmen” provide liquidity in advance. As positions go insolvent, debt obligations are simply transferred to bailsmen, no immediate auction involved. Bailsmen can cover accumulated debt anytime they want, but they can withdraw their initial deposits only after making repayments.
How does Equilibrium calculate the interest rate for its stablecoin?
Output from our risk model makes good input for our pricing model. We are effectively looking for a feedback loop here: if there is more excess debt than there is stressed bailsman liquidity, the borrowers’ interest rates scale higher. If there’s extra bailsman liquidity remaining after covering all debts, then borrower interest rates decline. This market mechanic ensures there’s enough capital in the liquidity provider pool for covering any borrower losses.
The problem of pricing a collateralized loan comes from the realm of traditional finance. Under the Black–Scholes model for pricing an options contract, Xia and Zhou in 2007 derived a pricing formula for an infinite-maturity stock loan by solving the related optimal stopping problem. We adapt this approach with our own pricing solution that depends on borrower portfolio risk and that portfolio’s collateralization level.
If you want to compare Equilibrium’s interest rates against the average interest rates for borrowing stablecoins via DeFi loans, you’ll notice that Equilibrium is quite competitive in this arena. Only MakerDAO offers comparable interest rates right now.
You can learn how interest rate reflects collateralization level, as well as the proportion between the values of liquidity pool and collateral pool from the table below:
DeFi use cases between Equilibrium’s stablecoin and Curve Finance
The meta pool that can support Equilibrium’s USD along with the most major stablecoins — USDT, DAI, USDC, and so on — is poised to cement itself as most relevant. That’s why our recently announced collaboration with Curve Finance is especially interesting.
Curve provides a multitude of use cases to DeFi users who want to minimize their fees and interest rates. Since Equilibrium offers fairly cheap loans via our native stablecoin, you could consider the following sequence of events. Please keep in mind this is just a hypothetical example, not investment advice:
Curve’s automated market maker software can drive a multi-asset exchange in this scheme that offers tight spreads for exchanging between stablecoins and other homogenous assets. Initial liquidity on Polkadot will be limited, and Curve’s market-making algorithms are in perfect position to minimize slippage during trading.
The popular notion of money and how it works seems to be in flux. It’s too easy for people to be frightened away by major cryptocurrencies like Bitcoin and Ethereum, with their values changing from one day to the next. If crypto is going to start meaning something to everyday people, then it needs to behave a lot more like paper cash, worth the same amount of money every day.
It should furthermore be mathematically protected from negative market impact. Then, if you want to kick your stablecoin up a few notches beyond that, make it cross-chain interoperable and let people generate them from multiple forms of collateral.
We have imbued our stablecoin with some state-of-the-art characteristics worth talking about. If you want to try generating your own, just head over to our testnet and get started at this page:
A good stablecoin is hard to come by, but we think we’ve really got something that crypto users are going to enjoy. What are you waiting for? Go get your hands on Equilibrium USD!
Read the previous article “The Advantages Of Equilibrium”.
The outline of our series:
- The Fundamentals Of Equilibrium
- Advantages of Equilibrium
- How Equilibrium’s Stablecoin Works
- Key Functionality of The EQ Token
- Bailouts vs. Auctions (Bailout Mechanism)
- Equilibrium’s Risk Model
- Equilibrium DeFi Parachain & the Initial Parachain Offering
- Liquidity Farming