Now I know what you’re thinking, and you’re correct, several algo-stable experiments have crashed and burned (a la basis cash, empty set dollar, tomb, iron, etc.). To my knowledge, the only one that hasn’t imploded is FRAX v2. So what is this new experiment and what is it’s proposed “secret sauce” that will help it succeed where so many others have fallen?
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The mainnet beta launch article that I am going over can be found here. UXD is a new algo stable experiment that is being launch on Solana. They state that their goal is to make a stablecoin that is stable, decentralized, and capital efficient. The article states that the project’s primary goal is to become the most widely used stablecoin. In accomplishing their primary goal, they seek to set “a new standard for trust and usability in the Solana ecosystem”. The stablecoin is issued against a basket of tokens (BTC, ETH, and SOL at time of writing), which are then invested into delta-neutral strategies to help $UXD maintain its peg. Let’s delve into the docs to find out more
Before proceeding any further, in case any of my fellow degens are ready to dive right in, it should be noted that the protocol has chosen to geo-block US persons in addition to other restricted countries. Their Terms and Conditions can be found here. As such, I must rely upon the docs and not the website for the rest of this article!
It seems that one of the largest goals is to be capital efficient. Through perusing the documentation, it seems this stems from $100 of UXD being mintable by using $100 of SOL. This $100 of UXD represents the delta-neutral position, which is designed to always be worth $100. This $100 of UXD can be redeemed for $100 of collateral at any time.
Ok, so how are they creating these delta-neutral positions and what is a delta-neutral position. The projects doc page actually has a pretty good section describing this, but I will explain more here. Suffice to say, a delta neutral position can be created using both a combination of long (position increases in value as asset price increase) and short (position increases in value as asset price decreases) positions. What happens is that when a user deposits $100 of BTC, UXD takes that collateral and mints a long and short position (at current market price) on BTC perpetuals using an on-chain derivatives exchange. The first derivatives exchange that the protocol will be using is Mango Markets. What this means, is that if BTC goes up $50, the long position goes up in value and the short position goes down in value by the same amount (note this does not take into account funding rates). And actually it seems here that the funding rate is that “secret sauce” that I mentioned before. The docs say that when the funding rate of the perpetuals futures position is positive, the interest is distributed to stakeholders (presumably stakers of their gov token UXP?) and the insurance fund. When the funding rate is negative, the insurance fund is used to pay the interest on the positions instead of passing this cost onto the users. More info on the insurance fund here.
Please see the project’s documentation, linked below for instructions on how to mint and redeem $UXD.
https://docs.uxd.fi/uxdprotocol/tutorial/how-to-mint-uxd
This does seem to be a novel take on how to make an algo-stable. And I think the usage of perps to capture a portion of value and distribute to users is cool. Though, I’m not sure what the split on positive funding will need to be. In the event of massive nuke, where the long position of $SOL, for example, gains a funding rate of 100%, how long can the insurance fund pay for that? A day, a week, a month? I think one of the greatest challenges that faces the project is careful management of the insurance fund with constant worst-case analysis to determine the appropriate size. Other stablecoin issuers (DAI, for example) handle this downfall protection by requiring >$1 of collateral to mint $1 of stables. Maker (DAI’s issuer) also relies upon a series of bots and liquidation auctions to keep the project solvent in the event of a black swan event. Using overcollateralization and liquidation bots to protect a stablecoin is a tried and true method at this point. I am concerned that this novel approach may bring with it unforeseen risks, so proceed cautiously.
Another thing that I would watch out for is the amount of $UXP tokens that go to the team. Several of these Solana projects have relatively large % token allocations to the team and investors, with relatively little going towards airdrops. Their twitter account seems to hint that holders of $UXD will be getting a $UXP airdrop. I’d be cautious if the team ended up capturing 50+% of the portion of fees going to stakeholders.
The project’s choice to launch on Solana was most likely to save users on cost, and to access perpetual futures. dydX has on-chain perpetuals, but they are “stuck” on the Starkware rollup right now. This rollup is tailor-made to just support dydX and doesn’t support other smart contracts. The other option that I’m aware of is Perp protocol on Ethereum mainnet. The constant minting of long and short positions would destroy the users of $UXD with fees (but might be possible on rollups in the future as costs continue to go down). Solana has seen some prolonged periods of downtime in recent past. I would be mildly concerned about what happens to the positions if the insurance fund cannot get an interest payment back to mango markets due to transaction spamming. This is something that the devs could outline in the risk section of their docs. Supposedly a fee market is coming to Solana, and it may be based on the amount of stake that a given validator has. This might mean that $UXP would need to have their own validator with a sufficiently high amount of $SOL staked to get their transactions through when needed. (I’ll admit, my understanding of the proposed fee market could be wrong and is something I need to spend more time researching).
On a positive note, the project does say that it has complete an audit and is in the process of getting another one. The first audit was done by Bramah Systems and the second one is being done by Soteria (source). Always remember, that the presence of one or more audits does not imply that a project is safe to ape into. Auditors are still human and may not catch every security bug.
I think that there is a moderately high level of risk around using $UXD at this point in time, but is certainly something that could be experimented with using a small stack of stables (please please please don’t make it your majority position). As the algorithm becomes more battle-tested, I think those risks would go down. Plus, each moment that the project exists without there being a black swan event in the market, allows time for the insurance fund to grow. Right now, the only derivatives exchange UXD is partnering with is mango markets, so should there be any problem (hack, smart contract bug, etc.) with mango markets, that would propagate to UXD. Again, as more partnerships come online, that risk will be spread out amongst multiple exchanges.
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