Welcome to EntropyDAO, a future exploration of stablecoin.
This is the first article of EntropyDAO, where we explain what EntropyDAO is, and why we want to build an undercollateralized algorithmic stablecoin protocol.
Stablecoin, as defined by Investopedia are tokens in which their price stability is attained via collateralization (backing) or through algorithmic mechanisms of buying and selling the reference asset or its derivatives.
Many stablecoin protocols (fully on-chain ones) have entirely embraced one spectrum of design (Over-collateralized by digital assets like DAI from MakerDAO) or the other extreme (entirely algorithmic with no backing) and like BASIS.
How are they? What are the pros and cons about them?
As one of the most successful stablecoin that are collateralized by digital assets, Maker’s dominance in the Ethereum ecosystem is no secret. They have always been proud of their protocol and over-collateralized system that secure DAI to be safe and stable. But others argue the fact that DAI relies on unstable digital assets to remain stable is like a pseudo-proposition.
Back in March 2020, ETH’s sharp drop in price caused a large number of Maker’s vaults to default and even be available for liquidation. About 5.67 million DAI was being uncollateralized. MakerDAO’s protocol was intentionally designed to withstand massive drawdowns in the value of the collateral. They have this role called keepers who may participate in auctions as a result of liquidation events and help DAI maintain its Target price ($1). This brilliant idea actually caused Maker big trouble. Numerous problems that happened by that time, such as gas fees dramatically raised, and ETH’s price kept going down, causing panic for most of the regular keepers. Lack of competition gave a tiny number of keepers a great opportunity to profit.
There are many arguments to support or reject the idea of Maker being the gold standard for stablecoin design. In the meantime, they have to face the issue of capital inefficiency since the bulk of their assets are locked up as collateral.
Different from over-collateralized stablecoin, other project attempts to improve low funds utilization through algorithms.
Basis, who wants to build the algorithm central bank, borrows the idea of the Quantitative Theory of Money, in which the Central Bank will use different kinds of tools to calm inflation and deflation to stabilize the money supply. Fancy right? A central bank on the blockchain, easily maintains stability by expanding and contracting the availability of the tokens. No collateral is needed at all. This sounds like the perfect approach to solve the problem of capital inefficiency.
However, it is not that easy. Without the social credit system and government endorsements like most of central banks do, a blockchain protocol can’t serve as a central bank and guarantee its coins price stability. The simple way to put it: Not everyone can be the central bank.
There is another name for how Basis worked called seigniorage supply which is a term describing the profit that banks make between printing money and what the money is actually worth. This kind of algorithm normally works when it expands, but when people start to trade the coin for other things, the price would plunge. So in the contraction cycle, the protocol needs the speculators to pay the real cost to help the protocol back to normal, while the speculators will show more concern for the protocol and stop their investments, leading to further price plummets, then entering the death spiral. That's what happened a few days ago to Luna and UST.
None of this kind of algorithm stablecoin has survived until now, and we don’t know exactly why, probably just human greed.
So, neither over-collateralization nor algorithmic stablecoin seems to be the best solution. Is there a better one? Does it have to be one way or the other? The answer is: No!
An innovative, fractional-algorithmic stablecoin protocol, Frax was announced in May 2019. It was known as the world’s first decentralized stablecoin with parts of its supply backed by collateral and parts of the supply algorithmic. Starting from entirely collateralized, the ratio of collateralized and algorithmic depends on the market’s pricing of the FRAX stablecoin. This way, it gives the market more time to adapt to the undercollateralization, and slowly solve the problem of low funds utilization of over-collateralization.
Inspired by Frax, we think that fractional-algorithmic is probably the only solution to stablecoins. The only problem is on what ratio. This has also been one of the big things that Frax is trying to figure out. Despite how much we admire Frax, we do believe that there is a better way to do this fractional-algorithmic, to find the perfect balance. Therefore, we proudly introduce EntropyDAO to you.
Entropy is a scientific concept as well as a measurable physical property that is most commonly associated with a state of disorder, randomness, or uncertainty (Wikipedia). It has been adapted in many other subjects. It represents a measure of disorder, and explains why life seems to get more not less complicated as time goes on. The total entropy of the universe can never decrease. The energy just tends towards a less useful, more disordered state, and so do businesses and other organization systems. To achieve entropy reduction, rearranging the molecules, or systems into an ordered state, injection of outside energy is required.
The reason why we want to introduce the entropy idea is that we believe that, just like the law of entropy, any isolated or closed system will lead to serious chaos and then death. The only way to make the stablecoin stay stable is to add more energy to the system, not play it safe. Frax has been in the markets for years, as fast as the blockchain world goes, Frax seems quite conservative on both of its collateral ratio and way of governance. Its collateral ratio hasn't decreased much, which means the problem of capital inefficiency still remains. In the meanwhile, its governance remains stuck in a curve model without much innovation.
EntropyDAO is aiming to build a protocol that is capable of maintaining its normal operation of the system while transiting to the algorithmic stablecoin. We must admit that the establishment of EntropyDAO has been inspired by many amazing projects, and has absorbed many of their excellent ideas. Especially from Frax Finance and OlympusDAO.
The dual-token model from Frax and their insightful fractional-algorithmic stablecoin opened up a new window for us. In the meantime, we believe the bond mechanism from OlympusDAO might be the perfect solution for the lack of liquidity that lots of stablecoin projects have faced. Based on it, we also want to be bold and step forward to give our members more power in actual governance.
A comprehensive system should need at least two types of tokens to divide the functions of stabilization, appreciation, and governance. Therefore, we got: Energy ($NRG), which is the stablecoin of the protocol, and it will always be pegged to $1 Entropy ($ENT), which is the governance/utility token of the protocol, and also for value capture and appreciation
To ensure the stabilization of price and steadily expansion under-collateralized, the protocol has the following mechanisms:
Mint & Redeem
$NRG can always be minted from the protocol for 1 USDC of value. This allows arbitrageurs to balance the demand and supply of $NRG in the open market.
Bond
EntropyDAO sells Bonds at a discount which will attract people to invest and provide liquidity to the protocol. Users can buy Bonds NFT matured in 7 to 365 days with $USDC, and redeem $NRG and $ENT after maturity. The protocol will use the $USDC to increase the Reserve of EntropyDAO, and the $NRG-$USDC liquidity in the secondary market.
To guarantee its governance, value capture, and long-term price increase properties, the protocol has the following mechanisms:
Bond
Buy LP Bonds NFT matured in 5 days, and redeem $ENT through NFT bonds after maturity. The LP BOND NFT of $ENT will only be purchased by $NRG.
Stake
Stake $ENT with a different lock period (10 days to 4 years) to receive the governance token $gENT, and get the weekly governance token rewards.
Vote
Vote for the specific parameter adjustment of bond, stake and other functions to get the corresponding governance rewards.
We hope this article was enjoyable and gave you a brief introduction to what EntropyDAO is and what we are trying to achieve. There will be more articles to follow on the specifics of $NRG, $ENT, and the changes we want to make on DAO. As more people learn about EntropyDAO and more energy is added to the ecosystem, the act of entropy reduction will keep on going.
If you still believe in DeFi and want to make something new, Please follow and join us :)
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