Over the past few weeks, we have been steadily establishing Ukiyo Finance. As we gear up to launch the protocol, it's critical to offer users a preview of its initial state and its potential for growth. This article aims to provide a fundamental introduction to the protocol's core mechanisms and a glimpse into its promising future.

Ukiyo, a derivative of Staked Ether, enhances composability, utility, and yield, reflecting the founding principles of blockchain and Ethereum: decentralization, permissionless nature, and utmost immutability. This article delves into the foundational elements of the protocol, serving as the building blocks for future developments.

Ukiyo, being a derivative of Ether, essentially wraps Ether to facilitate custom logic implementations. At its core, it incorporates two primary functionalities and one utility feature: minting, burning, and loans. Understanding these functionalities—controlling the system's inflows and outflows—is vital, as they generate revenue for the protocol through loans. While Ukiyo's core mechanics may seem simple, they have nuanced facets worth discussing.

Users wishing to enter the system have two options: buying from the market or minting new tokens. The former is a straightforward process involving a decentralized exchange or aggregator to swap one token for another.

However, minting new tokens involves several steps. Initially, the core smart contracts calculate the current price to mint a new token, which could be higher, lower, or equal to the current market price, depending on the market conditions. When a user mints a new token, they send Ether to the contract, which is then bifurcated. One part is transferred to the protocol-owned liquidity pool, while the other is staked and added to the loan pool. The deposit-splitting ratio remains constant and will be discussed in greater detail in the fees section of this article.

Upon successful completion of these steps, the user receives their tokens, giving them the flexibility to use these tokens as they see fit—whether it's for arbitrage or to secure a loan. However, if the user loses interest in the protocol, they can choose to exit the system, which introduces the protocol's second aspect—burning.

When a user decides to leave the system, they can either sell on the open market or burn the tokens for the underlying backing.

Each Ukiyo token is backed by a certain amount of underlying Ether, effectively giving the token's owner the right to that Ether. When they opt to exit, they can burn the token, and in return—with a small fee—receive the underlying tokens, a combination of staked Ether and Weth. This ratio is contingent on the liquidity pool's current state.

The process might seem simple, yet it involves components requiring further clarification, such as fees.

The protocol levies three primary fees during minting or burning. First, there's a team fee—2.5% on newly minted tokens, which supports the team's ongoing project development and expansion. The second is the variable liquidity fee, designed to decrease over time for reasons we will discuss shortly.

Ukiyo socializes liquidity, meaning that any new Ether entering the system contributes a certain percentage (15%) directly to liquidity, enabling Ukiyo's liquidity to scale with the protocol itself. This mechanism applies in reverse as well, scaling down when users reclaim their initial Ether deposits from the liquidity pool.

The protocol aims to increase the yield on Ether over time, thereby gradually elevating the backing. Given that Ukiyo tokens are backed by an increasing amount of Ether, it stands to reason that the price within this liquidity position would rise over time, consequently altering the position's ratio. This results in a smaller fee for newly minted Ukiyo, granting a larger percentage of tokens back to the user while still ensuring sufficient liquidity.

Finally, there's a burn fee. Upon exiting the system, users are entitled to the underlying assets for their tokens. As the owed amount is calculated from two distinct pools, a minor 2.5% fee is deducted from the loan pool amount, which, instead of being sent to the user, remains in the loan pool, contributing to the backing's increase over time.

Now that we've tackled fees, let's discuss the pools, an essential component of Ukiyo's operation.

The liquidity pool, managed by a smart contract, fluctuates depending on the protocol's state. While the protocol does not have direct access to this liquidity, it can utilize the generated fees.

These fees serve two primary purposes: any Ether earned from the liquidity pool is staked and added to the more stable loan pool, and any earned Ukiyo tokens are burned. Both actions aim to increase the backing. This pool's characteristics enable it to adjust according to the protocol's size, accommodating both growth and contraction phases.

The loan pool forms a vital part of Ukiyo's core functionality and serves as the foundation for several products currently being developed. It allows users to borrow against their backing for various purposes.

Consisting of the staked Ether underpinning the protocol, the loan pool uses a decay function to generate interest, thereby augmenting the backing of other tokens. Rather than charging interest like other protocols such as Aave, Ukiyo effectively "sells" the collateral in exchange for interest, leading to token burn over time. There's no liquidation as the necessary fees are handled automatically. Users can retrieve their collateral upon loan repayment. The backing growth and interest rate dynamics could potentially enable users to borrow more over time.

Note: users can only borrow staked Ether; they don't have access to the weth portion of the token backing, except during burns.

This article serves as a concise introduction to the foundational elements of the Ukiyo system. With a firm understanding of the core mechanisms, users can interact more intelligently with the system. While this article merely scratches the surface, it provides a foundation that allows the team to expand in various directions, introducing different functionalities catering to diverse user interests.

Despite these technical details, our mission is rooted in maintaining the core principles that propelled Ethereum and blockchain to their current stature. As we continue to grow, we commit to retaining our foundation, ensuring maximum decentralization, introducing immutability, and permitting access only when absolutely necessary—always with stringent measures in place to prevent malpractice.