1 BTC不一定会到新高，更看好ETH 2 DeFi会有一波新的创新 3 Web3.0(存储，元宇宙，域名，DID，内容服务)会进入 top20 4 算法稳定币明年会有新的演绎 5 DAO领域（任何形式，捐赠DAO, Venture DAO）会群雄混战，有一个进入top 50 6 还有出现几个Layer1，Layer 1的竞争会非常激烈，但机会很多 7 各种链的互跨，以及集成互跨的钱包会开始出现

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1.宏观和市场

BTC难起来有三个逻辑，一个是明年加息，第二是目前市值太大了，就算有大玩家一直买买买，也很难买上去, Microstrategy已经不停在买了。第三个，其实传统投资人已经很深入到crypto的一线了，除非真的配置型投资人进来，才有比较大的利好，但会比较慢。明年的高通胀对于所有风险资产，仍然是一个制约。所以下半年加息缓和了，通胀稳定了，可能有机会，主要看供应链还能否缓解，毕竟憋了这么多年，成本太高全球增长都放缓了，总是有办法的。

但还是看好明年市场的，只是主要不在比特币这里，一个支撑就是以太坊可能会double，剩下的总市值增幅都是元宇宙，Web3，DeFi和新公链生态贡献的（可能担子稍微重了点，你们能行！逻辑在下面）

2. Web3和元宇宙

其实无论主流还是crypto native的人都开始意识到，再参加头部的项目，收益已经非常有限了。从做产品的角度，现在去参加以太坊可能有点晚了，直接进入红海。那一定会从其他一些生态出来，其他生态也会牟足了劲，因为今年再次证明，产品做得好，一样可以带动生态，即便社区弱一点，一个爆款产品的威力不亚于社区，爆款产品说白了就三因素能成功：1 真的好玩，2 能赚到钱，3 创造Web3声誉值，比如域名，DID，可以在社区累计威望，而且这样的威望就记在链上。（三者分别对应着七宗罪的怠惰，贪欲和傲慢，maybe）。一个Web3的个人积分，就像信用分一样，这就是Web3的通行证，让人一目了然。

我特别喜欢Web3，甚至多于元宇宙。Web3是一个真正的底层铺垫。元宇宙目前更缺的技术层面，如体验感的介入，以及更基层的VR/AR/5G/物联网等，这不是crypto能做以及需要做的。crypto要做的是Web3，Web3做好了，就是元宇宙的底层，信用，支付，资产，经济体系，都可以。不客气的说，没有Web3，元宇宙其实就是更好玩的游戏。

就像游戏只是Web2的一部分，那游戏也只是Web3的一部分，但是Web3可以让生活和游戏打通，我们需要借助游戏的技术，而不是游戏本身，这是一种解耦式的融合。可以说，技术就是Web2对Web3的最后馈赠。技术的东西，绝对不是Web3要解决的，但是没了技术支持Web3走不远。红白机也很好玩，但是还是更多人愿意玩MMORPG，而且红白机撑不起一个腾讯。

为什么现在的元宇宙即便很简陋，还有很多人去玩，从体验的角度就是因为开放性，不理解的可以参考Minecraft。元宇宙里，PGC还是太慢了，以后UGC一定会出来，UGC的同义词就是自由，是真正的平等开放自由。这里面的东西价值价值几何，会有公论。因此，做降低UGC参与门槛的产品，会非常有前途，那又将是一种基础设施。

3. DeFi

DeFi在2021是没有什么大的进展的，Uniswap的V3惊艳了一小下。DeFi在2020年创新buff加满，今年泄力了，微创新的路走不下去了。本质上在于各种场景下的收益率都被微创新满足了之后，已经见不到新的场景了。之所谓认为2022年DeFi会有新的变化，在于场景的边际在2021被扩展了，没错，就是元宇宙，Web3，或是其他未来的东西。Crypto发展这么多年，其实都是交易的空转，前几年做的实体支付、资产上链都是在找场景，这些场景的问题都是太低频了，很难让一个crypto native的用户产生兴趣。虚拟的金融需要虚拟的经济去支撑，个中道理就在这了。

另外为啥还看好算法稳定币，就是觉得各种crypto native的东西都有了，但是crypto native的支付通证却没有，这不科学。Gamefi里面的双通证的utitlity token还是不太稳定，需要脱离于一种应用的，纯粹的依靠共识的token出来，且稳定。价格稳定是一种稳定，共识稳定也是一种稳定，现在要从后一种向第一种迈进。（hats off to Liu Feng老师）

4 DAO

我为什么把DAO的图放在最上面，因为我真心喜欢，哈哈，这就是改变世界的东西！相信People，SOS已经让DAO开始显性化了，以及乱七八糟的各种DAO，现在都有点DeFi summer仿盘频出的味道。这些DAO的出现，可以说都是试错，当然试错成本可能就是用户，但是总能试出来各种奇奇怪怪的东西。其实一些正经的DAO也可以尝试扩大自己的边界，DAO没有那么严肃，DAO就是兴趣小组、行业协会、自己维护自己人，以后一定会山头林立，山头林立了就会划地盘，就有经济的聚集，就有机会。

5 其他

商业场景的拓展对于技术的创新肯定是最有影响的。Layer2起来以后，跨链可能更加成为必须。各种互跨还没有实现，但是很重要。反过来说，跨来跨去需要钱包去承接，一个链开一个钱包太麻烦了，所以多链钱包如果可以去做跨链，那真是太方便了。这里我没有想的特别清楚，但感觉也是机会挺大的。

总而言之，2022年可以期待的东西很多，虽然2021年的发展令人瞠目结舌，however there are still more to come.

Blockchain technology enables the mapping of currency in the digital world, and has resulted in the creation of a series of fungible cryptocurrencies, which has sparked a surge of cryptocurrency investment in recent years. The emergence of non-fungible tokens (NFT), on the other hand, allows us to envision the prospect of mapping the entire real world.

Apart from the currency, most objects in the real world are one-of-a-kind with distinct characteristics and values.. The characteristics of NFT can perfectly adapt to this circumstance and realize the tokenization of different objects in the digital world. By leveraging the qualities of blockchain to be tamper-proof, open and transparent, and traceable, NFT maps the real world into the digital world, and builds up the long-awaited Utopia – the Metaverse.

However, because of existing technical limitations, NFT has not been able to achieve the above-mentioned idea perfectly. Due to congested communications, limited scalability, high gas expenses, and other reasons, the metadata and media data of NFT are not entirely stored on the blockchain, but off the chain instead. Without the protection of blockchain technology, this component of the data is not completely safe and reliable, which implies that the current NFT has not yet achieved the same level of trustworthiness as Bitcoin does. But this flaw is masked by the enthusiasm for NFT and receives little attention.

According to data from coingecko, as of press time, the current market cap of the NFT market has totaled $22.97 billion, accounting for 1.2% of the global cryptocurrency market cap. It has a 24-hour trading volume of $3.25 billion and is still rising with a strong momentum. The security behind the huge number is, however, very fragile. Due to the uncertainty of off-chain storage, there have been missing cases for NFT from time to time. Once the corresponding metadata and media data become invalid, Certificate of ownership for NFT stored on the blockchain is just a worthless check without an acceptor. William Entriken, the author of ERC721, which is the most widely used NFT standard, once said: ” Your ownership of assets on a ledger is only as valid as your trust in the custodian who has physical control of the assets.”

As of now, NFT is still not secure. Unlike Bitcoin and other cryptocurrencies whose transaction information is completely stored on the blockchain, NFT has a different approach. While its transaction is also completed on the blockchain, its storage is often done off the blockchain – in the centralized server of the project, third-party cloud server, IPFS, or Metastorage and other NFT storage projects. This is due to the fact that the metadata involved is often complicated and that the media data requires a larger storage space. These intricate “Keepers” are all somewhat riskier than storage on the blockchain.

NFT storage has become the weakest link in the current NFT system, yet as a key infrastructure of the Metaverse, it is bound to play an important role in the new social ecosystem in the future. This article will explain the underlying architecture of NFT, summarize the status of NFT storage, and also delve into the opportunities and challenges faced by NFT storage.

1 The Basics of NFT

1.1 Basic Concept

NFT refers to “non-fungible token”, a type of token originally created through the Ethereum smart contracts. As a special digital asset, it is indivisible, tamper-proof, irreplaceable, and one-of-a-kind.

The concept of NFT is relative to FT, which stands for “fungible token”. Bitcoin is a typical example of fungible tokens – each Bitcoin is identical to one another and can be divided into smaller units. Each NFT, however, has a single unique identifier, which cannot be interchanged with any other one or split into smaller units.

NFT can empower creators in various fields with its unique attributes, providing a more convenient and reliable way to authenticate digital assets. With NFTs, creators can easily prove the existence and ownership of digital works in the form of pictures, videos, artworks, tickets, etc. In addition, creators can also earn royalties every time the NFTs are traded.

1.2 Technological Elements

Blockchain. Blockchain is a technology  was first known as a distributed ledger for Bitcoin. Blockchain is a distributed and tamper-proof database. In essence, it is a list of recorded data and information that is protected by encryption protocols. Blockchain provides a viable solution to the long-standing Byzantine Generals problem.

Smart contract. The smart contract accelerate the execution and verification process of digital protocols. Blockchain-based smart contracts use Turing complete scripting languages to build complex functions that are compatible with each other and are executed through consensus algorithms to ensure consistency. Smart contracts enable fair transactions that do not rely on third-party credit intermediaries, thus making cross-industry, cross-field, and cross-ecosystem value interactions possible.

**On-chain transaction. **On-chain transactions require blockchain addresses and instructions for the transactions. A blockchain address is composed of a fixed number of letters, numbers, and characters。It is a unique identifier for users to send and receive assets, much like a bank account and has a pair of corresponding public and private keys to verify the authenticity of the transaction.

**Data coding. **Through data coding, files can be compressed into an effective format to save storage. The authentication of the NFT assets is actually the authentication of the hash values signed by the creator of the NFT. Others may copy the metadata, but they cannot prove their ownership.

2 Fundamental Model

2.1 Protocol Standards.

Fundamentally, the underlying logic of NFT is based on distributed ledger and relies on peer-to-peer networks for transaction. If the blockchain distributed ledger is regarded as a special type of database, then it is the place where NFTs are stored – the actual storage of NFTs is more complicated though. Assuming that this database is secure, consistent, integral, and accessible, the entire NFT closed-loop ecosystem mainly includes the following scenarios.

• **NFT digitalization. **The NFT creators will check whether the files, titles, and descriptive sentences are completely accurate, and then convert the NFT metadata into an appropriate format.

• **NFT storage. **NFT creators can choose between on-chain and off-chain methods to store the metadata. On-chain storage costs more and is more congested, but the metadata will be permanently stored together with the tokens. Off-chain storage has higher limits for space, but in theory bears the risk of metadata losses. The currently available solutions for off-chain storage include centralized data centers, IPFS, and decentralized cloud storage.

• **NFT signature. **The creator of the NFT signs the information including the hash values of the NFT data, and then sends it to the smart contract.

• **NFT minting and trading. **After receiving the complete information of the NFT, the smart contract can start the minting of the NFT and initiate the transaction at the same time. The main mechanism is formulated following the token standards.

• NFT confirmation. Once the transaction information is confirmed on the blockchain, the minting process is completed, and the minted NFT will be permanently linked to a unique blockchain address to prove its existence. However, the actual content of NFTs is usually stored off-chain, independent from where the ownership is stored.

2.3 Key Properties

NFT is essentially a type of dApp, that is, a decentralized application. It inherits various qualities from the underlying public ledger, which can be summarized as follows:

1. **Verifiable: **NFT’s token metadata and ownership can be publicly verified. The premise is that metadata is stored on the blockchain. If it is stored off-chain, then it is up to the off-chain storage system to determine whether it can be publicly verified. Centralized storage does not allow public verification, which means the device owners can change the data as they wish; IPFS can verify whether the data has been tampered with through CID, but cannot verify the storage status; MEFS and other decentralized cloud storage systems can not only verify whether the data has been tampered, but also the storage and redundancy status of the data.

2. **Transparent: **the entire process of NFT include minting, selling and purchasing is publicly accessible. However, the storage of NFT metadata and media data is not completely transparent or available to the public. NFT creators can choose the storage method they like, but the security of most storage methods cannot be clearly assessed.

3. **Available: **The system on the blockchain that NFT relies on will never be compromised. All the issued NFTs will never have difficulty in selling or purchasing. There are the potential risks of unavailability for off-chain storage for NFT data. Currently, only decentralized storage systems such as MEFS have set up well-established risk control mechanisms; all the centralized storage systems and IPFS are not yet ready for risk control.

4. **Tamper-proof: **once confirmed, NFT metadata and the complete set of transaction records are permanently stored; it only allows further addition of new information but not modification to the existing information. If the metadata is stored in a centralized server, the service operators can tamper with the data at will; and file systems such as IPFS and MEFS are tamper-resistance.

5. **Easy to circulate: **the information that each NFT user sees is updated in real time, which eliminates the traditional information barrier between the creator, credit intermediary, and the buyer, and makes the information clearer and easy to circulate.

6. Atomic: NFT transactions can be completed in an atomic, consist, isolated and durable (ACID) system.

7. Tradable: NFTs and the corresponding products can be traded and exchanged as one wishes. The storage standard of NFTs is the key to recognizing its value, and therefore the value composition of the NFTs traded needs to be revisited.

2.4 Risk Assessment

The NFT system is a technology that integrates blockchain, storage and network applications. Its security faces challenges as each component may become a security weakness and expose the entire system to attacks. This article uses the STRIDE method for threat modeling, assessing the potential risks of the NFT system from the aspects of Spooling, Tampering, Repudiation, Information disclosure, Denial of service (Dos) and Elevation of privilege.

1. **Spooling: **spooling, as opposed to authenticity, is the ability to impersonate another person or thing in the system. When users mint or trade NFTs, malicious attackers may use authentication loopholes or steal users’ private keys to illegally obtain ownership of the NFTs. It is recommended to verify the NFT smart contract in a formal way and use a cold wallet to isolate online data so as to prevent the leakage of private keys.

2. **Tampering: **tampering is related to integrity, which refers to malicious modification of NFT data. The blockchain is a powerful distributed ledger. The hash encryption algorithm it uses is resistant to preimage and second preimage. If the metadata of the NFT is stored on the blockchain, once the transaction is confirmed, the metadata of the NFT and the ownership cannot be tampered with maliciously. However, if the NFT metadata and media data are stored off-chain, the information may be manipulated. It is recommended to use a decentralized distributed cloud storage system to ensure the safety and reliability of data.

3. Repudiation: relative to non-repudiation, repudiation means that the creator or owner of the NFT cannot refuse or withdraw once the transaction information is confirmed on the blockchain. The security of this process is guaranteed by the qualities of the blockchain distributed ledger and the unforgeable signatures. That being said, there is still the risk of the hash value involved being stolen or replaced by malicious attackers. It is recommended to use smart contracts with multi-signature verification to avoid certain risks.

4. **Information disclosure: **Information disclosure relates to confidentiality, which refers to the disclosure of NFT-related information to unauthorized users. In the NFT system, the status information and the code for transaction instructions of the smart contracts are completely transparent for anyone to access. This can lead to multiple risks of information disclosure. Even if only the hash value of the NFT is obtained, a malicious attacker can use the correlation between the hash value and the transaction information to do nasty things. It is recommended that NFT creators use privacy-preserving smart contracts to replace ordinary smart contracts to protect privacy.

5. Denial of service: denial of service runs against availability. It refers to malicious attackers attacking the raw data stored in the dApp or off-chain, causing them to deny services to the NFT system. Thanks to the high availability of the blockchain, users can call the information they need at any time without worrying about denial of service by the on-chain systems. However, due to the limited space and communication pressure on the blockchain, some NFT functions can only be enabled via off-chain systems, such as the storage of metadata and media data. Centralized network applications and storage systems are still at risk of traditional DoS attacks, causing denial of service to the NFT system. It is recommended to use a new hybrid blockchain architecture or a decentralized cloud storage system.

6. **Elevation of privilege: **elevation of privilege is related to authorization. It refers to cases where the attacker obtains NFT-related privilege by exploiting vulnerabilities in smart contracts, or gains illegal permissions by attacking relevant off-chain systems of the NFT. As the NFT authorization is completely managed by smart contracts, design flaws in smart contracts will bring authorization risks. Meanwhile, the authorization may also be impacted by the NFT metadata or media data stored off the blockchain. For example, tampering or deleting metadata or media data stored off the blockchain will make the ownership of NFT meaningless. It is therefore recommended that creators use mature and complete smart contracts when minting NFTs, store all data on the blockchain whenever there are no cost concerns, or use a more reliable decentralized cloud storage system to reduce costs.

3 Status of NFT storage

3.1 Product Types

With its unique attributes, NFT has brought about changes to certain extent to many areas, including Metaverse, digital artworks, collectibles, games, DeFi, public utilities and sports. This article summarizes the NFT products with the highest market cap in each category as the target group for studying the status of NFT storage.

a) Metaverse

Decentraland

Decentraland is a virtual reality platform based on Ethereum. Users can create contents and dApps and monetize them. The contents created can be provided to other users for interaction. The land in Decentraland is marked using the Cartesian coordinate system, of which the community has permanent ownership, and the creators can have full control over their works.

Decentraland stores the ownership of digital assets and other tradable information on the Ethereum blockchain, while other information that requires real-time interaction, such as scene status and user locations, are stored on the users’ computers or the scene owners’ private servers. Developers need to choose what information is worth storing on the blockchain because it entails a higher cost.

The Sandbox

The Sandbox is a community-driven UGC platform where users can obtain ownership of digital land and creative contents. Their works can be traded freely and turned into components of this user-generated Metaverse. All elements in the Metaverse are self-driven by the community.

SAND, the token on the Sandbox, is an ERC-20 token, while the authentication and transactions of digital assets on the platform follow the ERC-1155 and ERC-721 standards. This information is stored on the Ethereum blockchain. The actual media data of digital assets, on the other hand, is stored on IPFS and leverages Amazon’s S3 cloud service to support the front end of the web page. The digital assets that are yet to be minted will be stored on the S3 cloud server, and it requires decentralized storage solutions to further protect the data privacy.

CryptoVoxels

CryptoVoxels is a Metaverse based on Ethereum. Users can build, develop and sell digital assets on the street, and their ownership will be permanently recorded on the blockchain. The style is similar to Minecraft, where users can use customized pixel blocks to build their own land. The platform also provides users with the system’s native COLR tokens to color the land. At present, CryptoVoxels stores the media information corresponding to the digital works created by users on the land in the company-operated server. It has stated on social media that it will consider transferring the data to a decentralized storage system.

b) Digital Collectibles

CryptoPunks is a suite of pixel style avatar with different characteristics, with a total of 10,000 in number. These characters were claimed for free through the Ethereum wallet at the very beginning, and now need to be purchased through a second-hand trading platform. Initially, in order to save gas expenses, CryptoPunks aggregated 10,000 characters into a picture, and stored the hash value of this picture in a smart contract on the blockchain, but did not disclose the storage location of its original media data. As NFT storage risks get more attention, CryptoPunks spent 75M gas fees to store all avatars on the Ethereum blockchain.

Bored Ape Yacht Club is a total of 10,000 ape avatars with distinct features. All of the avatars have been minted and are available for purchase on the second-hand trading platform. BAYC announced on its official website the TokenID, SHA-256 hash value and IPFS hash of each avatar. It has also backed up the media data of each avatar in a decentralized storage system and released the back-up information.

NBA Top Shot is a collection platform for NBA fans to collect and trade various highlighted moments in NBA history. These highlighted moments are minted into NFTs through Flow, a public blockchain that was also developed by the same development team Dapper Labs, and can be traded freely. Some descriptive data information of NFTs is stored on the blockchain, and the video stream data corresponding to each NFT is stored in the centralized data center off the blockchain.

c) Games

Gods Unchained is an Ethereum-based NFT card game similar to Hearthstone. Players can form their own decks to play under different game modes such as Ranked Constructed and Arena Adventure. Cards can be freely traded in the market and are owned by the players. At present, the ownership of the NFT in the game is stored on the blockchain, while the metadata and media data of the NFT cards are stored on the company’s server and integrated with the smart contracts for use through an API interface.

Axie Infinity is a pet-raising game similar to “Pokemon Go” based on Ronin, a sidechain of Ethereum. Players can collect, train, raise, and own the imaginary Axie pets in the form of NFTs. The project stores the ownership information of each Axie and its unique genetic data on the blockchain while keeping the media data on the central server off the blockchain in order to meet the requirement of low latency.

MyCryptoHeroes is an Ethereum-based RPG game set in a fictitious world. Players can collect heroes in the form of NFT and form their own hero team to fight. The metadata of the NFT involved in the project is stored on the blockchain, and the media data is stored on the server managed by the company.

3.2 Trading Platforms

Opensea is the earliest and currently largest NFT trading platform, occupying more than 90% of the trading market. Initially, Opensea also used a centralized server to store NFT metadata and media data. With the spike of value of a single NFT and affected by the data losses from time to time, Opensea now also provides decentralized storage options for users. Currently, creators can choose to use IPFS to decentralize NFT metadata and media data, but they need to pay for it.

Rarible is currently the second largest NFT trading platform, supporting both ERC-721 and ERC1155 protocols. The project stores the metadata and media data of the NFTs minted by the creator at the backend of the website, which is a centralized server. They can be called on the blockchain by new buyers when needed.

SuperRare is an online art gallery that can be used for trading as well. It has also issued its own trading token RARE. The NFTs auctioned by SuperRare did not show very detailed technical information to users, such as smart contracts, tokenID, metadata, etc. This may be the reason why the market share of the platform has been low. According to our research, SuperRare uses IPFS for metadata and media data storage.

3.3 On-chain Storage

At present, the blockchains used by NFT mainly includes public blockchains such as Ethereum, Flow, and BSC, and sidechains such as Polygon and Ronin.

Due to the high gas fees and congested communication on the blockchain, most NFT projects choose to store only NFT ownership data on the blockchain to ensure that the ownership is tamper-proof, traceable, and cannot be repudiated. The transaction does not require a centralized credit agency as an intermediary and can be completed directly on the blockchain through smart contracts. This approach widens the circulation of NFT. It also uses a credit intermediary that is not controlled by any third party.

The media data representing the actual form of the NFT is stored off-chain, and in some cases, some more complex metadata information, too. Separating them from the ownership storage system casts shadow on the ownership that is stringently protected by the blockchain technology.

3.4 Off-chain Storage

The mainstream off-chain storage methods currently used by NFT are: centralized, centralized verifiable, decentralized, and decentralized repairable, etc.

1. Centralized StorageMost NFT projects do not have a market share as big as Opensea; many are still in their infancy and do not pay much attention to the security of off-chain data storage. The specific identifiers in the smart contracts can be used to return related metadata and media data. They usually use the URL on the web server as the identifier. This server is run by the company or provided by cloud service providers such as Amazon. The risks with centralized storage are tampering and denial of service.

2. Centralized Verifiable StorageLet’s take CryptoPunks as an example – it initially stored the integrated image of its products in a centralized server, and then stored the encrypted hash value of this image in a smart contract for verification. The advantage of this is that the image can be verified through the hash value to ensure that no modification has been made, making the NFT media data tamper-proof. However, the media data itself is stored in the central server instead of being backed up in the nodes all over the network like the NFT ownership stored on the blockchain. It therefore brings potential risks of data losses and denial of service and so on.The centralized verifiable off-chain storage method is an optimization of the centralized method, but there are still many risks. It cannot well address the requirement by NFT and Metaverse of highly reliable storage of the authentication data.

3. Decentralized StorageAs a representative of decentralized storage, IPFS has gradually been accepted by the NFT industry. IPFS aims to provide a decentralized addressing supplement to the traditional centralized HTTP. Take Bored Ape Yacht Club as an example – its metadata and media data are stored in IPFS; IPFS provides redundant backup and stable content addressing. As an addressing network running on multiple nodes, it solves the sore point of invalid URL address with the previous centralized storage method and avoids reliance on centralized service providers.The decentralized addressing method of IPFS has further improved the storage method of NFT metadata and media data, but as an addressing system, it cannot provide storage services that are safe and reliable enough. Though the CID address will always be in the system, the corresponding specific data does not have such stability. The reason is that the network nodes in IPFS are self-driven when backing up the contents – if only a single node or a small number of nodes back up the corresponding contents, the stored data will disappear when these nodes are damaged or offline, leaving only void message for CID.

4. Decentralized Repairable StorageAs a new possibility for NFT to solve off-chain storage problems, the decentralized repairable storage system has attracted extensive attention both within and without the industry. Decentralized distributed cloud storage projects such as Filecoin, Memo, and Arweave are also actively exploring better storage solutions for NFT followers, among which Filecoin and Memo have launched NFT storage projects based on their own storage ecosystems.NFT.Storage is an NFT storage project based on the Filecoin ecosystem launched by Protocol Labs. The NFTs stored through this project will be stored in IPFS or Filecoin. Currently, the capacity of a single piece of data stored is limited to less than 100MB. Its repair function is built upon Filecoin’s incentive mechanism. Through the scoring and verification system of storage nodes, it can detect and repair damaged or missing data in a timely manner. However, the storage in IPFS is provided by Protocol Labs, which requires more network nodes to participate and needs to be further decentralized. The storage on Filecoin has not yet been connected to the main network and is provided by test network nodes, thus the risk of data losses due to network reset.Metastorage is an NFT storage project based on the Memo ecosystem launched by Memo Labs. The NFT stored through this project will be double stored in both IPFS and MEFS – a storage system independently developed by Memo Labs. There is currently no limit to the amount of data stored. Its repair function is based on the MEFS storage system, leveraging multiple copies and the redundancy mechanism of erasure coding while providing open verification methods. The KEEPER role in the system is responsible for matching the nodes that have passed verification and challenges for the users and provides continuous evaluation and maintenance. Although the overall repair mechanism of MEFS is decoupled from the blockchain, it still requires Memo to engage a larger range of nodes to provide support for the MEFS system and build a stable ecosystem.It is possible that decentralized repairable storage becomes the future solution for NFT storage, making a better match for the storage of metadata and media data and the storage of ownership for NFT. At present, the product technology and scale are still very embryonic, and the degree of implementation needs further observation.

4 Opportunities for NFT Storage

4.1 Metaverse Value Support

Generally speaking, Metaverse refers to a virtual world built with a series of technologies including the Internet and VR. This concept was born decades ago but was never realized. With the rapid development of blockchain, Metaverse sees the prospects to become a reality – blockchain provides an ideal decentralized environment for Metaverse and the emergence of NFT also offers a feasible way to authenticate digital assets. Restricted by the current blockchain technology, the actual content of NFT needs a storage method that matches the ownership storage. Pushed by the demand, the booming of the technology is well expected to break through the security bottleneck for decentralized storage for NFT, and a broader market space for the decentralized cloud industry that focuses on addressing the NFT storage issues is right ahead.

In this virtual reality driven by blockchain, participants can have a very broad and rich space for imagination, such as enjoying games, displaying self-made artworks, owning and trading virtual property, etc. Users can even profit from the unique virtual economic system. They can purchase land controlled by a decentralized organization, build on it freely in the form of NFT, rent the building to others for return, or raise and breed rare pets and sell them for money.

The Metaverse ecosystem covers all the projects in the Metaverse discussed in the previous section, most of which are still in their early stages. Blockchain is usually used to record and ensure the ownership of users’ digital assets, and the media data corresponding to the ownership is mostly still stored in centralized servers or IPFS and has not been given the same level of protection as the ownership. This casts certain risks on the integrity of digital assets. Without a complete and reliable closed loop for storage, the use of blockchain technology to protect ownership will also lose its meaning.

4.2 Infrastructure for the P2E Game Industry

The recent booming of P2E games have drawn widespread attention from both players and the capital market. With Axie Infinity overtaking NBA Top Shot to become the NFT project with the highest market cap, it is believed that NFT has great potential in the gaming industry. Some of the existing crypto games are CrytpoKitties, Cryptocats, CryptoPunks, Meebits, Axie Infinity, Gods Unchanged, and TradeStars. One fascinating feature of this type of game is the “reproduction” mechanism. Users can raise pets themselves and spend a lot of time breeding new offspring. They can also buy limited edition/rare edition virtual pets and then sell them at high prices. Due to the characteristics of value circulation of P2E games, the current storage methods cannot meet their high security requirements. Decentralized cloud storage systems such as Memo are therefore better suited for NFT high-value storage.

The additional rewards have attracted many investors to join the game, which makes NFT even more important. Another exciting function of NFT is that it provides ownership records of items in the game. Players can have their own personal game items, which promotes economic identification in the ecosystem and brings benefits to both developers and players. Players and game developers as NFT publishers can earn copyright royalties every time the NFT is sold on the open market, sending funds back to the ecosystem and forming a virtuous cycle.

The reliability of NFT storage will determine the growth ceiling of the P2E gaming industry. When the industry develops to a certain level, the hidden dangers in the NFT storage will eventually receive more and more attention, and various game projects will have to make investments in improving NFT storage to lower the risks.

4.3 Enormous Capital Market

The existence of NFT creates a mutually beneficial business model – while players and developers make profits on the second-hand NFT market, the blockchain community has also largely expanded the coverage of NFT to include various types of digital assets and prosperous virtual economic activities. Traditional online economic activities rely on centralized companies that offer trust and technologies. Although blockchain has already developed several financing channels, such as ICO, IFO and IEO, the use cases are still very limited. NFT has greatly expanded the additional properties of blockchain, such as uniqueness, ownership, and liquidity. With the help of NFT, blockchain has rapidly expanded its scope of application. This allows everyone to be linked to a specific event, just like in our real life. The storage method of NFT plays a pivotal part in realizing this vision. While FT (Fungible Token) can be stored on the blockchain due to the smaller amount of data volume, NFT requires an equally reliable storage method.

Let’s take buying tickets – a common economic activity, as an example. When buying tickets in the conventional market, consumers must trust the third party that provides the service. Therefore, consumers are at risk of being deceived or purchasing invalid tickets. These tickets may be fake, forged, or can be cancelled. In extreme cases, the same ticket may be sold multiple times, or non-transferrable tickets are traded in the market.

NFT-based tickets issued by the blockchain can prove the right to join any sports or cultural activities. NFT benefits from the fact that problems such as double spending, tampering and forgery have already been solved on blockchain in the FT stage. The uniqueness of the distributed ledger gives NFT tickets a clear advantage over traditional tickets. An NFT-based ticket is unique and cannot be tampered, which means that the ticket holder cannot resell the ticket after it has been sold. NFT, a blockchain-based smart contract, provides a transparent ticket trading platform for consumers, event organizers and other stakeholders. Consumers can buy and sell NFT tickets through smart contracts without relying on any third party.

It is equally important to store the corresponding media data of the NFT. High-value transactions must be protected by infrastructure with greater security. With the growing diversification and complexity of NFT forms, the NFT storage industry will also grow in parallel with the development of projects in the NFT ecosystem.

4.4 Protecting Digital Intellectual Property

Digital collectibles cover a variety of categories – trading cards, wine, digital images, videos, virtual real estates, domain names, diamonds, cryptocurrency stamps, intellectual property and other physical objects. Let’s take the art industry as an example. To start with, artists who are following traditional approaches have very few channels to display their works. Access to traditional channels requires capital and network, as well as a lot of energy. Due to lack of attention, the prices cannot reflect the true value of the artworks. Even when the works are published on social networks, they will be charged by platforms and advertisers for intermediary fees and advertising fees.

NFTs can convert their works into a digital format with comprehensive benefits. Artists do not have to hand over ownership and content to agents, which implies the possibility of higher profits. Typical examples include Mad Dog Jones’ REPLICATOR sold for $4.1 million, Grimes’s works sold for a total of about $6 million, and other crypto works from other great digital artists, such as the well-known Beeple and Trevor Jones. NFT has done a good job in protecting the property rights whereas the corresponding contents such as metadata and media data are not yet well protected by secure and reliable storage protocols – this is something Memo and other decentralized storage systems have a high hope to solve.

In addition, artists cannot obtain copyright royalties from the future sales of their works under the traditional model. In contrast, NFTs can be programmed so that the artist will receive a predetermined royalty fee each time his digital work is traded in the market. This is an effective way to manage and protect digital masterpieces. On top of that, some platforms, such as Mintbase and Mintable, have even established tools to support ordinary people to easily create their own NFT works.

The media data of the digital collectibles is actually the NFT itself. The NFT would be meaningless if the ownership and royalty rights of the work lose their value. Traditional collection activities often come with higher storage costs. Collection in the digital age obviously requires better storage solutions.

In order to realize the development of the above-mentioned NFT storage applications, a series of obstacles must be removed, just like any other new technologies. This article discusses some typical challenges faced by NFT such as system-related issues caused by the Bitcoin-based platforms and human factors such as regulatory, policy-wise and social impact, from the perspectives of availability, security, regulation, and scalability.

5.1 Availability

Availability refers to the process of measuring the effectiveness, efficiency and satisfaction of users when testing a specific product. Most NFT projects are built on Ethereum. Therefore, it is rather evident that the main shortcomings of Ethereum have been inherited. We will discuss three main challenges that have a direct impact on the user experience.

1. Scarce Redundancy MechanismThrough the aforementioned analysis, NFTs currently use centralized data centers and IPFS for storage. However, the redundancy mechanisms of these two methods are not very reliable. Centralized data centers usually make multiple copies of files for redundancy, which is costly. IPFS does not have a self-running redundancy method. Although the CID corresponding to each file is broadcast across the entire network, the data of the file itself is stored locally on the node, and relies on other nodes for spontaneous back-up. Filecoin as the incentive layer of IPFS has not fulfilled the mission of incentivizing nodes for backup either – most of the data stored in the network nodes are just for the sake of incentives and therefore invalid. The MEFS developed by Memo uses a storage method that combines multiple copies and erasure codes, together with data slicing storage and risk-aware repair technology to achieve

2. Slow in ConfirmationNFTs usually send transactions to smart contracts to make the management of activities such as minting, selling and exchange transparent and trustworthy. However, current NFT systems are tightly coupled with their underlying blockchain platforms, which makes their performance very poor. The speed of Bitcoin is only 7TPS and Ethereum can only offer 30TPS, which has made the confirmation of NFTs extremely slow.Solving this problem requires a redesign of the blockchain topology, optimization of its structure or improvement of the consensus mechanism. The existing blockchain systems cannot meet these requirements. This has also led to the fact that complex metadata and “huge” amount of media data are stored in off-chain systems.

3. High Gas ExpensesThe high gas expenses have become a major problem of NFT, especially when it comes to large-scale minting of NFTs where the metadata needs to be uploaded onto the blockchain network.  Each NFT-related transaction is more expensive than simple transfers because smart contracts involve computing resources and storage. Complicated process, high pressure from communication congestion and expensive fees have considerably restricted the widespread application of NFTs. In most cases, the costs for producing an NFT are much higher than the current value of the NFT. Storing NFT-related data off-chain as much as possible is currently the mainstream solution to address this serious imbalance. Yet it also brings various risks.

5.2 Storage Security and Privacy

Data from users is the top priority of any system. For the data that is stored off-chain while associated with the tags on the blockchain, there are risks of losing contact between the two or being abused by malicious parties.

1. Inaccessibility of NFT DataIn mainstream NFT projects, most of the encrypted hash values ​​are used as identifiers instead of real media data.  They are then recorded on the blockchain to lower of consumption of gas. However, the possibility of losing or damaging the original files makes users feel insecure about NFT. Some NFT projects have begun to cooperate with specialized file storage systems, such as IPFS, which allows users to address contents through hash values. As long as there is someone on the IPFS network taking care of it, users can always obtain the corresponding contents that matches the hash value.  Nevertheless, such a system still has inevitable flaws. When users upload NFT metadata and media data to IPFS nodes, there is no guarantee that their data will be replicated in all nodes. The data is stored on IPFS, and there may be only one node hosting the contents, with no back-up on any other node. If the only node storing it is disconnected from the network, the data may become unavailable. DECRYPT.IO and CHECKMYNFT.COM have reported this problem, and Memo is also trying to use the self-developed MEFS system to make up for this defect in IPFS.

   In addition, an NFT may also point to the wrong file address. If this is the case, the user cannot prove that he actually owns the NFT. All in all, relying on an external system as the core component of the NFT system will always be vulnerable.

2. Anonymity/PrivacyMost NFT transactions rely on their underlying Ethereum platforms, which only provides pseudo-anonymity rather than strict anonymity or privacy. Users can partially hide their identities. If the connection between the real identity and the corresponding address is known to the public, all activities of the user under the compromised address can be observed. The existing privacy protection solutions, such as homomorphic encryption, zero-knowledge proofs, ring signatures, and multi-party calculations, have not been applied to NFT-related solutions on a large scale due to their complex encryption primitives and security assumptions.

   Similar to other types of blockchain-based systems, reducing expensive computing costs has become the key to protecting the security and privacy of NFT data.

5.3 Regulatory Policies

Similar to most cryptocurrencies, NFTs also face obstacles such as strict regulation from the regulatory authorities. Meanwhile, how to properly regulate this new technology in the corresponding market is also a challenge. This article tackles this topic from two typical aspects.

1. Legal AspectThe legal and policy issues faced by NFTs cover a wide range of areas. Potentially relevant areas include commodities, cross-border transactions, KYC (Know Your Customer) data, and so on. Before entering the NFT field, it is very important to have a proper understanding of the relevant regulatory review and litigation. In some countries, the legal requirements for cryptocurrency are very strict, and the same is true for NFT sales. Regulatory difficulties are something one cannot circumvent when minting, trading, selling, or buying NFTs. Legally speaking, users can only trade derivatives such as stocks and NFTs on authorized exchanges. Some other countries, such as Malta and France, are trying to implement appropriate laws to regulate the service of digital assets. They require buyers to follow complex and even contradictory terms. Therefore, conducting due diligence becomes a mandatory step before investing in NFT assets.

   Taxable property. Products related to intellectual property, including art, books, domain names, etc., are considered taxable property under the current legal framework. However, NFT sales are not yet included. Although a few countries, such as the United States, levies cryptocurrencies as property, most regions in the world have not yet considered the taxation of crypto assets. This may greatly increase the number of financial crimes under the cover of NFT transactions to avoid taxation by the corresponding regional governments. Individual participants are taxed based on any capital gains related to NFT property. In addition, transactions such as NFT-for-NFT, NFT-for-IP, and Eth-for-NFT should all be taxed. Apart from this, higher tax rates should be applied to high-margin property or collectibles. It is therefore recommended that NFT-related industries seek more advice from professional tax departments after the profound changes.

5.4 Scalability

The scalability of the NFT solutions covers two aspects. The first is to emphasize whether a system can interact with other ecosystems; the second point is whether the NFT system can be updated when the current version is abandoned.

1. NFT InteroperabilityThe existing NFT ecosystems are isolated from each other. Once users choose a type of product, they can only trade them within the same ecosystem – this is restricted by the underlying blockchain platform. At present, if someone wants to make transactions across different ecosystems, he needs to do this through a third-party transaction platform similar to Opensea. Breaking away from the trust institution of the original blockchain platform will increase the cost of trust. Interoperability and cross-chain communication have always been a barrier for the widespread promotion of dApps, and cross-chain communication can only be achieved with the help of external trust parties. In this way, the quality of decentralization will inevitably be undermined to some extent.

   Fortunately, most NFT-related projects use Ethereum as their underlying platform. This means that they share a similar data structure and can make exchanges under the same rules. Differnet NFT projects have differnet storage methods. How to build a unified risk structure while maintaining decentralization is an important topic for future.

2. Updatable NFTs

   Transitional blockchains generally update their protocols through soft forks and hard forks, which illustrates the difficulties and trade-offs in updating existing blockchains. Despite being a generic model, the new blockchains still have strict requirements, such as tolerating specific confrontational behaviors and staying online during the update process. NFT programs rely heavily on the underlying platforms and have to keep consistent with them. Although the data is usually stored in separate components (such as IPFS and MEFS file systems), the most important logic and tokeId are still recorded on the blockchain, and it will be necessary to update the system appropriately.

The first stage in the development of perpetual derivatives is inverse perpetual contracts, namely the Bitcoin inverse perpetual contracts developed by Bitmex in 2016. In the traditional delivery futures, there are mechanisms such as settlement date, delivery and contract position transfer. Through the combination of the three mechanisms of pledge, fund rate and price tracking, perpetual derivatives enables perpetual contracts to shine brightly. However, it is not until 2020 that a large number of exchanges follow perpetual derivatives.

According to BitMex’s research, the yield rate on long inverse contracts is unbalanced: A market dominated by inverse contracts is more unfavorable for both holders of long or short position. Later, due to the introduction of stable coin, vanilla futures  contracts began to replace inverse contracts because the yield rate was more linear. That is, inverse contracts feature the convexity, which is similar to the nature of gamma in options. Thus, Bitcoin is actually not normally distributed and has a drift over a period of time, the yield ratio between long and short position is not balanced. Vanilla futures contracts make up for the nonlinear part of inverse contracts.

Figure: Non-linear yield of inverse contracts

Source: https://blog.bitmex.com/zh_cn-convexity-rektum-damn-near-killed-em/

The second stage of perpetual derivatives is on-chain perpetual contracts, and perpetual derivatives were launched with AMM going to the public in the DeFi summer chain in 2020. The second stage can be regarded as the process from concept validation to implementation of perpetual derivatives, with a daily trading volume of several hundred million US dollars. Due to performance limitations, it has not reached the stage of large-scale use.

Source: The Block

In the third stage, with the launch of Layer2, the limitation of the bottom performance of perpetual contracts has been broken. The orderbook has become the optional direction of the project again, and the integrated liquidity of Uniswap V3 has its own feature of orderbook, allowing professional market makers and traders to enter. Derivatives are not just speculation; and complex combination of on-chain derivative strategies begins to be adopted.

We believe that the fourth stage of perpetual derivatives is that perpetual options will become an instrument approved by new traders in 2022-23. With Paradigm’s discussion of everlasting option and some projects landing on the on-chain perpetual options, there will be more agreements to participate in this non-linear game. In the fourth stage, the market will begin to understand the greeks trading and portfolio opportunities brought by nonlinear derivatives. Perpetual options solve the dilemma that the liquidity of delivery options is divided on a two-dimensional plane. Long-tail assets will get more attention. Besides, the relatively large volatility may enable them to become a favorite type of instruments by traders.

Perpetual derivatives will eventually coexist with other delivery derivatives, generating more strategies for arbitrage of non-perpetual contracts against intertemporal derivatives. When the market returns to a multi-product state and liquidity rises sharply, it will enter a stage where the derivative market is much larger than the spot market talked by optimists (that is, using the TAM method of estimation). Another important feature of the fourth stage is that fixed income derivatives have become popular, thus really entering a very institutionalized era. Interest rate, a product that has not been traded before, is replenished.

We hold that perpetual derivatives boasts the following functions:

• A tool that facilitates the direction of the game. The existence of perpetual derivatives in the market proves the applicability of perpetual contracts

• A management portfolio tool, that can be combined with spot goods, delivery futures and delivery options. Professional traders can build more types of portfolios. Perpetual contracts, expiring contracts, perpetual options and expiring options can form a unique portfolio

• A way for providing fixed income. Because perpetual contracts have a special way of maintaining price stability, the form of purely acquiring fund rate is bound to prevail among professional traders, similar to the carry trade in foreign exchange. In addition to the portfolios that professional traders build themselves, some contracts start to template such portfolios.

• Provide a way to decentralize volatility trading. Use perpetual options to downplay the characteristics of delta and theta.

• Liquidity site for long-tail tokens

II. Pricing of Perpetual Derivatives

Differential form of general options:

S is underlying asset, σ means implied volatility, t is time, z is Gaussian process, and f is option price.

Futures can be regarded as the part containing linear term only:

Futures and options can be viewed as leverage over future objects. If there are no boundary conditions, options also include a quadratic term (i.e., volatility) in price change, and a value over time. Options can be regarded as having linear term, quadratic term and time item. Futures can be regarded as an option with only delta term, and option currency futures have more gamma and theta terms. The logic of futures is relatively simple, and both buyers and sellers have rights and obligations. Due to the existence of the exercise price, options have the payoff function, which is determined by the existence of the option premium. The buyer of options has only the right and no obligation, and the assignment of this obligation is expressed by the option premium. In selling the premium, the seller is obliged to make delivery on the due date.

The fund rate is the most delicate part of perpetual futures contracts, and all derivatives are expanding around their own rates. In other words, the buyer or seller of the fund pays the fund rate to the other party to maintain the balance between the futures price and the underlying price (index). However, as the possibility of liquidation of perpetual contracts with high leverage increases, perpetual options provide another solution: 1. perpetual options will not be liquidated, and the buyer of options has only right and no obligation. 2. On the premise of no liquidation, the leverage ratio will be enlarged.

The main problem to be solved by options is pricing. The introduction of quadratic term and time make the price show convexity. The difference between option pricing (put option) and actual transaction price is the profit source of option trading.

There have been many discussions about perpetual options in academic circles, such as the analytical solution of non-exercise of American call option and put option. However, the largest threshold for the user of options is: 1 understanding the relationship between options and underlying objects; 2 what additional benefits the options offer compared to the futures, so that the user can make an equivalent choice between the two. Due to historical reasons and product complexity, most users started with futures.

Paradigm provides a way of expression of pricing perpetual options with rate:

Deri protocol launched perpetual options on August 11, using the Paradigm model of pricing options and launching another expression of the perpetual model:

And C (t) and P (t) are denoted by the general BS model

The on-chain perpetual option protocol Shield protocol takes a step further and provides the analytic solution of the perpetual options:

The analytical solution of Shield Protocol is based on the empirical results of dynamic hedge validation of three-year historical data and over-the-counter option pricing theoretical study.

The pricing formula of perpetual options plays a fundamental role in the whole perpetual products, and the seller of options can calculate the risk exposure, that is, the traditional option seller strategy can be realized. The option pricing model proposed by Black, Sholes and Merton in 1973 is still the most important method to the pricing of options up to now, and the analytical solution is always the pearl of pricing. Of course, most options pricing formulas still depend on numerical solution because the analytical solution of the option model is too difficult to calculate.

III. Major Perpetual Derivatives Projects

Industry map

dYdX

Founded in 2017, dYdX provides cryptocurrency derivative products including perpetual contracts, spot and leveraged trading, and lending. The perpetual contracts of dYdX take USDC as collateral, and can use crossmargin, that is, multiple contracts use the same collateral. The funding rate of the perpetual contracts is settled on an hourly basis. The funding rate of dYdX also considers the interest spread of direct lending and the formula is:

Funding Rate = (Premium Component/8) + Interest Rate Component

The perpetual contracts of dYdX are based on the zk-rollup designed by Starkwarre. The zk rollup completes customer transactions off-chain and transfers the transaction results to the chain. The rollup is responsible for packaging transactions, and zk is responsible for providing zero-knowledge proof that the deposit into layer2 is valid. The interaction process is as follows:

• Ethereum to Layer2: dYdX monitors related Ethereum transactions, i.e. deposits, forced withdrawals and forced transactions. Once such transactions are received on Ethereum, operations such as adding funds will be performed on Layer2.

• Layer2 to Ethereum: After a batch of transactions is executed off-chain, a proof of their validity is generated and verified by the STARK verifier on the chain. The state transition takes effect after the STARK verifier approves the state transition, such as saving or withdrawing from the Layer2 to change the user’s Ethereum balance.

dYdX uses orderbook system, which can provide order with price limit, so it will be more suitable for derivatives. Perpetual derivatives agreement Injective has compared the two mechanisms of orderbook and AMM.

AMMOrderbookAdvantages

• Allowing liquidity to exist in illiquid markets

• A trader can always get a quote in the absence of a counterparty

• Orderbook trading is ideal for liquid markets

• Orderbook exchanges are still the best choice for surface market prices and placing large orders

• The exchange of orders reduces the risk of decline

• Orderbook exchanges are widely accepted by institutional investors and retail dealers

Disadvantages

• Due to the small liquidity pool, there is a risk of significant decline in large-amount orders

• Capital is inefficient because most transactions are executed within a narrow range of price levels, unless the market is extremely volatile

• Gratuitous loss of liquidity providers

• Compared with CLOB transaction execution model, the risk of early operation is higher

• No transaction can be made if the buyer’s bid is below the seller’s lowest bid, which will be a poor design for an illiquid market

• Orders are often at risk from front running. Front running is the risk that a miner will be able to extract a particular block from the information provided when the order is placed. This means that miners can make risk-free profits.

The advantage of the orderbook system lies in that it can provide many complex order types, but still relies on market makers, such as Wintermute as a market maker for dYdX. Thus, the orderbook and market makers are essentially a system. In addition to professional market makers, general liquidity providers can add USDC to the liquidity pool, and professional market makers can then apply this part of the USDC to distinguish liquidity from market making, which further facilitates participation by users who have funds but no trading capacity.

Much like the traditional trading market, the biggest innovation of dYdX is API which can already provide the level similar to the centralized exchange, that is, such an API completely removes the blockchain logic from it and only keeps remaining part applicable to market makers. For example, 1.25ETH is 1.25, instead of the most basic representation of wei. According to Wintermute’s feedback, crossmargin is friendly to market makers and can save a lot of capital.

After the launch of Layer2 on dYdX, the transaction volume has risen sharply

One-day trading volume can reach USD 7 billion. However, as the market declines, the trading volume also decreases. Three largest trading pairs are BTC/ETH/SOL/COMP.

Layer2 engine

dYdX uses the StarkEX engine that is a Layer2 network-based trading engine developed by Starkware. The engine was launched in June 2020 and can support many purposes, such as spot trading, perpetual contract trading and NFT trading. Starkware can support data on-chain (ZK – Rollup) and data off-chain (Validium) modes.

Source: Starkware

The user’s funds are transferred to the StarkEX contract to achieve decentralized self- hosting, and then can be traded on dYdX. Starkex’s off-chain component manages all trade orders and sends status update to the on-chain component after execution.

Changes in transaction and status are verified by StarkEX verifier. SHARP is a tool that packages various statements into proofs. Currently, Stark engine supports several agreements, such as dYdX, DeversiFi, Immutable and Sorare.

Perpetual Protocol

Perpetual once was the first largest perpetual futures market (currently the second) according to trading volume in the whole network, the V1 version of Perpetual uses a trading pool of vAMM type, and vAMM is an extended type of AMM. In terms of volume, Perpetual, dYdX and Futureswap top three in perpetual derivatives.

vAMM adopts the calculation method of AMM but does not adopt the clearing method of AMM. The value of K can be adjusted and should be matched with the OTC market. The larger the value of K is, the lower the slip point will be. vAMM can use almost infinite liquidity, so that there is almost no trade slip point according to the constant product formula k=x*y. All AMM pools with low liquidity are subject to insufficient liquidity and large trading slip point. The true clearing and settlement of vAMM is at the bottom of Perpetual, with insurance fund acting as a liquidity provider. Perpetual’s v1 uses xDai as a two-layer solution.

Insurance fund bears the counterparty risk of vAMM (such as consistently long position and consistently short position). If the business does not develop continuously and stably, the growth of insurance fund should not be sustainable. Large negative fluctuation will offset the increase in insurance fund for a few weeks.

In the new V2, Perpetual takes advantage of the liquidity of Uniswap V3 to introduce counterparty and reduce liquidity risk. There are many other improvements to V2, and V2 is divided into four steps: V2.1: taking advantage of the concentrated liquidity of V3 for market-making based on Arbitrium; V2.2: launching the cash order system and staking of PERP; V2.3: multi-pledge system other than USDC; V2.4: private market without permission. In V2.2, this will become an order system with price limit like dYdX. Offchain Lab thinks Arbitrium can package 4,200 transactions per second, 300 times higher than the main Ethereum network.

V2 of Perp selects Arbitrium. On the one hand, Uniswap V3 is related to Arbitrium, because the liquidity pool of v3 is established on v3. V3 is more progressive than Perp v1’s vAMM because the slip point of the concentrated liquidity is smaller. On the other hand, compared with Optimism, Arbitrium is fully compatible with EVM so that Uniswap can be launched online without any modification, which affects a large number of non-project choices. This is the difference between full compatibility and partial compatibility. At the end of May, Uniswap’s community group voted almost 100% in favor of v3’s launch online on Arbitrium. A number of projects have already started to support Arbitrium. 70 projects, including Aave, Band, Hop, imToken, MakerDAO, WBTC except Uniswap select Arbitrum.

Perpetual swap DerivaDEX

The main product of DerivaDEX is the perpetual swap contract, which is an on-chain version similar to Bitmex.

Source: DerivaDEX

DerivaDEX uses orderbook, and DerivaDEX has also designed insurance fund similar to Perpetual Protocol to protect against certain losses in the agreement (e.g., the counterparty’s losses exceed their collateral). There is no specific solution to forced liquidation, and insurance fund is needed to solve it. This is another mechanism created by Bitmex perpetual contracts.

In DerivaDEX, the game of fund rate can also become a trading strategy: For example, it is possible to continuously construct a portfolio of a spot long position and a futures short position. When it is assumed that the fund rate is in his/her favor, a fixed fund rate will be earned (ideally).

Source: DerivaDEX

Perpetual Options Shield Protocol

Shield Protocol is an on-chain perpetual derivative agreement whose economic logic is non-cooperative game logic. The first version of the product is an on-chain perpetual option product, which will be followed by perpetual contract product, OTC option and structured product. It is characterized by non-pledge, transparency, no intermediary fee, no requirement of trust and easy access. The formal logic of the perpetual option product is similar to that of the perpetual futures, that is, the payoff of the option price is determined by the price change, fund fee and trading fee:

Payoff= (No. of Contracts*Price Change) – Funding Fee – Trading Fee.

Compared with futures, options have no concept of close-out. The maximum loss per day is the fund rate. Its liquidity is supported by private pools and public pools. The core innovation of Shield lies in the analytical solution of the pricing formula of perpetual options, like the BS model, as mentioned aforesaid.

The main problem with options at the market fit level is that they are not suitable for retail investors because of their complex operation, and the T-shaped quotation board is the biggest obstacle. Deribit, the largest options exchange, has less trading volume, and the options space is more suitable for professional traders. Shield’s solution to this dilemma is: first, to introduce the role of broker who helps users understand options and provide trade/investment consultation. The whole process takes place on the chain, where a broker obtains commission, which, like in traditional finance, comes from the transaction commission of the presentee. Second, to transform the traditional delivery options into perpetual options, and the user can only buy the right with a flat value, which greatly reduces the user’s threshold and risk.

Shield features a public pool and private pool system. The private pool is the main transaction pool, supplemented by the public pool. Private pool is for professional traders who can transfer risk through external hedges. The public pool has a low threshold and is suitable for retail investors and risk averters. At T=0, the private pool is equivalent to the seller of options, the trader is the seller of options, all transactions are peer to pool, and liquidity comes from the pool. The allocation of new orders is determined by random numbers, one is the hash of the block, and the other one is the time of the block. Orders are randomly matched to private pools. Providers of private pools receive trading fee based on SLD (governance token), and private pools have higher income. The liquidator obtains reward by providing liquidation services. Shield’s five roles maintain the stability of the protocol through non-cooperative games.

The explicit use of perpetual options is reflected in that investors do not have to bear the trouble of moving positions, and suffer no risk of forced liquidation as the holders of options. Holding options for long-term has to pay the time value, that is, there is loss of time every day, while the perpetual options do not need to pay the time value but funding fee. The implicit use of perpetual options provides derivatives that can bet on volatility. When perpetual futures and perpetual options are combined, the linear term and the time value are removed (assuming that the funding fee is controllable), the synthetic product is a pure volatility, providing large space for non-directional bets. In addition, the product portfolio is enriched, and the true composability can be embodied. Perpetual options can be combined with delivery options to form some strategies. However, the current price mechanism of perpetual options is quite complex and it is not easy to calculate the risk exposure of various greeks.

Perpetual template and composability – Ribbon and OPYN

The story of Ribbon and OPYN shows an interesting phenomenon that complex product ideas often rely on extremely simple front-end to amplify, which shows the advantage of DeFi’s composability. Making use of the perpetual options template provided by OPYN, Ribbon Finance creates a fund pool similar to time saving, supported by the option selling strategy of put selling and covered call strategy. The combined product can provide users with a fixed income.

Ribbon creates a strategic aggregate income front end for OPYN and helps users to execute put option strategies on a weekly basis, which is similar to derivatives of perpetual options. The implementation principle is that Theta Vault (the fund pool on Ribbon) casts the coverd call in OPYN with 90% of the investors’ deposited funds and sells to the market with oToken (token representing option in OPYN). The parameter setting of option is determined by Theta Vault, and the user generally chooses out-of-the-money option without consideration so as to earn premium. However, the disadvantage lies in that in the unit period, if the underlying price rises to the exercise price, the user will suffer losses.

It has to be mentioned here that OPYN is increasingly going to the bottom, especially some practical tools such as call option, clearing robot, option liquidity pool and perpetual option vault template that is used by Ribbon and also raises a lot of TVL for OPYN. Almost all of the recent growth in OPYN’s TVL has been driven by Ribbon.

Source: Delphidigital

Bottom of OPYN: Perpetual Vault Templates. It uses a whole set of perpetual options templates, where anyone can construct the options they need (arbitrary exercise price, expiration date), which saves the effort of bootstrap at the bottom and comes up with any strategy, and represents this option in the form of oToken. It can accommodate a very large number of options strategies, and vault facing front end can build their own products (such as fixed income) that customers need.

IV. Review of Perpetual Derivatives from the Development of Options

The development of ancient and modern options can be traced back to the Middle East and the Tulip Bubble Age in the form of an agreed trade contract. For example, the buyer pays the seller a deposit of 3.5% -10%, and the seller is exempted from buying if the tulip price is lower than the contract price on the due date. Theories and application of modern options are both centred in the United States, where commodity options originated from crops and animal husbandry, and financial options (represented by stock options) were all decentralized and off-market options at the beginning. In 1973, a turning point in the development of the options market, the Chicago Board Options Exchange invited the Nansen Company to complete a Nansen Report. In the same year, Fisher Black, Myron Sholes and Robert Merton published two papers respectively, putting forward a similar conclusion on the option pricing model, which is later called the option pricing model of BSM.

SEC report in 1974 quoted a lot from the Nansen Report, and four conclusions are very important: 1. exchange-traded options help to reduce the volatility of exchange-traded spot goods; 2. exchange-traded options improve liquidity of spot goods; 3. exchange-traded options will not divert liquidity; 4. exchange-traded options allow investors to face complex markets in a mature manner. In 1985, the four major regulatory agencies in the United States launched the Research on Impact of Futures and Options Trading on Economy, which, commonly known as the Quartet report, puts the development of options on the track.

The development of options has a very long history, which is the result of the interaction of market, theory, trader and supervision. For option corresponding to crypto, we find that the theory is basically unchanged, the market demand exists, the traders are not very mature, and the supervision takes a very negative attitude, which accords with the characteristics of the stock option market before 1973. Speculation generally prevailed in the early development of derivatives. The nature of instruments did not slowly return until the investors began to mature. For institutions and individuals, the meaning of options is obviously different. Therefore, the development of crypto options market positioning is worth thinking about.

Why are we bullish on perpetual derivatives at this time:

• Performance boost: The launch of Layer2 seems to solve the performance problem. More importantly, it gives derivatives the opportunity to launch the new V. The AMM model in the base chain starts to transit to the orderbook. With the advent of Uniswap V3, the orderbook, a previously forgotten solution, has come back, with AMM.

• A variety of play ways: Perpetual is a good direction. Crypto has many retail users, and many people are not used to operating maturity derivatives. Perpetual derivatives have been proved by the market to combine into interesting yield products.

• Options fever: Options fever is on the rise. Options are well suited to the emergence of professional market makers, who have become commonplace at layer2. The pricing and timing of perpetual and everlasting options have begun to take shape, which is an important factor for professional traders to enter the market.

• Potential trading factors and non-trading factors: As long as the trading volume of the whole market rises, the volume of perpetual derivatives will increase very fast. And there are other factors increasing DeFi derivatives.

Risk of perpetual derivatives:

• The high leverage of derivatives can attract customers but also put pressure on the agreement

• For the designers of their pools, the provider of liquidity may face losses or be unwilling to participate actively

• The choice of collateral is a double-edged sword

• Whether the derivatives can support high trading volume has not been verified

• The closer to the centralized orderbook system it is, the closer to the position of competition with the centralized exchange will be. Before that, the user was stimulated by the mining/staking mechanism, followed by competition for real products.

Metaverse need algo stablecoin, which will underpin the real world to virtual world shifting process by blunt the impact from centralized stablecoin, and elevate metaverse to higher plateau with less interaction with legacy financial system.

Regulatory pressure will make algo stablecoin to takeover portion of market share that USDT/USDC processed, as USD-pegging one will face accusation of security offering now and then. Some algo stablecoin has already explore the possibility outside the USD-pegging regime, to provide a crypto native asset type. After years of struggle with centralized and over-collateralized peers, algo stablecoin finally find its way to stand out in the name of DeFi2.0(maybe not sustainable), by providing a DAO driven, yield enhancing product and unite all kinds of DeFi building blocks.

In a nutshell, the promising land for algo stablecoin is finding the market fit in Metaverse/DeFi, the real use cases, not just pump and dump.

2. Algo stablecoin evolution

First Attempt, 2017-2018

The long history of algo stablecoin can date back to 2017/18, when community was actively debating pro and con of the three kinds of stablecoin, namly, fait backed stablecoin, crypto backed stablecoin and algo stablecoin. Basis and Havvy were the presentative of the last kind.

Havvy, the former algo stablecoin protocol find its right way, transfer  itself to the synthetics assets issuing/trading platform, where sUSD are minted and circulated to support a variety of crypto synthetics and gained the leading position in Ethereum ecosystem.

Basis was faced severe headwinds at the end of 2018, SEC deemed it offers unregistered securities to users as the its stable mechanism rely on “bond” and “share” token to adjust total supply, and hence balance the price to 1usd. Though Basis shutter its operation and returned capital back to investors, its mantle, the nearly complete designing so called algorithm central bank has been inherited by Basis Cash, a new algo stablecoin project supported by an anonymous team with almost the same designing. Basis Cash spurred the algo stablecoin wave at the end of 2020. (Basis founder set off a another project called Bitclout)

Now the interim landscape is clear:  fait based stablecoin dominate with more than 100bn marketcap though Tether has always been criticized on its opaque reserve; crypto backed stablecoin（Dai）is acceptable by most DeFi protocols where also carved up by USDC; algo stablecoins are still rudderless, however massive influx keeps incurring from projects who backed by several reputable VCs to compete and chase for the final holy grail.

2020-up to date Frenzy

The so called 2020 DeFi summer shines every corner of open finance protocols, however seldom on algo stable coins. YAM flashed a week and suddenly led to a dead end due to its flaws in rebase function and supply goes almost unlimited. YAM’s experimental stablecoin protocol led by a star team, based on the elastic supply mechanics created by AMPL. Its supply will rebased every 12 hours to stabilize YAM at 1USD by inflation or deflation. Due to the fast pace of DeFi summer and new protocols with high yield spring up continuously. Even Yam V2/V3 cannot recover the its presence among the communities.

However at the end of 2020, AMPL, together with Basis Cash, Empty Set Dollar, FRAX and their imitators, pushed another stablecoin wave to the extreme, with their share token earned multiple times in short times. Only 2-3 month after, stablecoin can not be stable and nearly zero and most of them leave to moulder.

Basis Cash to USD Chart

The DeFi 2.0 is a fresh new story, with new generation algo stablecoin standing in the centre of the stage, become a new door opener to next wave.

3. Designing mentality

The reason why people crazy about however also sometimes despise algo stablecoin is all about its questionable stablization mechanism. Based on multiple creative designing, the algo stablecoin still cannot get rid of the spell of death spiral, a situation when stablecoin less than 1 dollar at the same time mechanize does not work and lead to further price decline. Here we will compare several stabilize approaches and their representatives to give a clear a picture why algo stablecoin still in early stages.

As stated previously, fiat backed and crypto backed stablecoin both need collateralizations, the price pegging is largely depends on the value of collaterals. The first generation of stablecoin took quite different and aggressive approaches on stabilization mechanism. Basis(not Basis Cash) originally made 3 token system to make that happen(at least theoretically).  Three tokens are Basis, the stablecoin of protocol, Bond tokens, the trading tools on open market to adjust the supply/demand of Basis, Share tokens, denoting the ownership of protocol and the entitle holder to receive dividend with fixed income.

Mapping of Algo stablecoin

3.1 Basis and first-generation algorithm Central Bank

Basis borrow the idea of Quantitative Theory of Money, in which Central Bank will using different kind of tools, like open market operations and reserve requirements to calm inflation and deflation, by stabilizing money supply. The protocol will take 3 steps to run the whole system: 1) define a target asset price, like USD where Basis is stabilize against, 2) after issuing Basis, the asset Basis price will be monitored continuously while oracle, through Basis-USD pair, 3) Supply of Basis will be expanded or contracted depend on price, by leverage Bond tokens.

Stability Approach

If Basis is trading less than $1, Bond tokens issued and users using Basis to buy bond, reducing Basis in circulation. As Bond is priced by Basis, less than $1 Bond will motivate speculators to buy and expecting the Bond will redeem on 1$ and pay out after Basis back to normal.

If Basis is trading above $1, the protocol will create and distribution new Basis, the holders of Share and Bond have priority to receive these newly minted Basis, which in turn adding circulation and thus stabilize its price.

Basis protocol also compare its running like the Fed: It monitors the price and adjust the money supply by executing open market operations, involving creating Basis or Bond tokens in this case. These operations are predicted by Quantity Theory of Money to produce long-run price levels at the desired peg like the Fed.

“Central Banks” are not the same

Basis protocol deems their economy will run like any other central banks; however, they ignore the fact that a new coming blockchain protocol does not share the same reputation as traditional central bank have even though using the similar tools.  In a domestic capital market central bank basically dominate the market, any operation market operation will find its counterparties, like banks or mutual fund, which actively trading these short to long terms bonds. So This lead to the second concern, when the price goes less than $1, market will doubt about whether it is normal fluctuation or the protocol has some problems. As protocol’s creditworthy is low, users will hesitate to join the bond auction. To adjust money supply in contraction cycle is harder than expansion cycle, where the protocol only distributes tokens automatically, however in contraction cycle, speculators need to pay real cost to make the protocol back to normal. When bid in the market, more concern on protocols will arise, leading to further price plummet, a death spiral.

The likelihood of Algo Stablecoin Death Spiral

Source: On the Economic Design of Stablecoin

As Christion and Alonso in their paper “On the Economic Design of Stablecoin” stated, death spirals are likely to occur whenever the value of a stablecoin’s reserve is tied to the future success of the stablecoin itself. So the technology can borrow the idea of Central Bank, but it cannot naturally obtain the credit The Fed has and the matching money/capital market. The credit can be acquired by two ways, first is long standing commitment, which will show the sustainability; second is legitimacy, which Vitalik defined as “is a pattern of higher-order acceptance. An outcome in some social context is legitimate if the people in that social context broadly accept and play their part in enacting that outcome, and each individual person does so because they expect everyone else to do the same.”

Though Basis ceased to operation long time ago, Basis Cash, its successor, headed into the death spiral after several month pilot and seems no one can help it.

Original seigniorage shares

The idea of algo stablecoin comes from the paper “A Note on Cryptocurrency Stabilisation: Seigniorage Shares” , the author of which is Robert Sams, a Hedge fund manager and macro specialist, focused on central bank policy. In this paper, Robert discusses the elastic supply, ways to adjust quantity of coin supply and their difficulties and possible solutions.

He innovated a two-coin system, where coins are the object for stabilization, shares are the ways to do so. When coin supply need to expand, shares transfer to coins through a decentralized auction methods(a coin auction) and vice versa(a share auction).  This is the prototype of all multi-token algo stablecoin including Basis，Basis Cash and ESD. Beside he concluded the share price can be determined by formula like this:

A sum of NPV of future income stream.

The supply adjust process is called “rebase”. Here Robert inspired by the “Hayek Money”, the originator of which is Ametrano who advocated a quite simple solution. In this approach, all wallet contained stablecoin will be simultaneously multiplied by Qi/Qi-1, where Qi and Qi-1 are desired coin supply in i/i-1 times. And this mechanism is easy to implement, just need to calculate the rebase factor to include in each block header. This approach inspired the so called rebase money like AMPL later.

Quantity control and Price stability of the coin are two problems that Robert concern, however he considered the later one is harder to tackle. He sketched exogenous model using shelling point scheme and endogenous model, where fees and difficulties are the notions of stability rather than price pegged to some goods/assets. This designing thesis are inherited by Float/Rai.

3.2 Ampleforth – unit of account rebase money

Ampleforth was introduced in 2019 as alternative synthetics asset with low correlation with bitcoin and traditional asset groups.

Ampleforth positioned itself as Synthetic Commodity, a base money has absolutely scarce and lacks nonmonetary value, defined by Selgin(2015). Synthetics Commodity have far demonstrated risk trade-off comparing to stocks, currencies and commodities. Thus, Ampleforth introduced a protocol creating a new stabilization trading strategy and distinct volatility fingerprint, the essential of the designing.

Like Basis protocol, Ampleforth will expand/contract money supply when price of coin is lower/higher than the target price. To avoid overcorrections, it introduces smooth supply approaches to adjust supply in given k days, like this:

Rebase mechanism illustration

**
**Source: Ampleforth

Every 24 hours the supply change will be recomputed and executed once. At the end, the Ampleforth protocol will have countercyclical feature differentiated from other protocols like this:

“A step-function-lie market cap curve that alternates between dynamic stated and equilibrium states, and A price curve that trades around the exchange rate target, with deviation during dynamic periods.”

Belows are the illustrative scenarios on how price/supply /market cap react theoretically during contraction dynamics.

The protocol flow is simple, mainly comprising Ampleforth erc-20 contract, market oracle contract and supply policy contract.

Though the designing is simple but the price is relatibely stable this year, contrast to other mulit-token algo stablecoins.

Ampleforth to US****D Chart

Right time to launch right product

Timing and luckiness also play key roles in algo stablecoin. Ampleforth launched in July 2019 and after one year the pleasant DeFi summer kicked off. The team behind protocol wisely grasped the essence of DeFi – liquidity mining and expanded it on its Geyser V2 after V1 launched only one year. V2 has included 9 tokens like BAL/COMP/LINK into its liquidity pool and reward the LP in form of AMPL token. Any users providing liquidly on Mooniswap will receive total sum of $225,000 worth of AMPL in three month. Also in 2021, this single token project set another milestone, where FORTH, its governess token released to the users who have interacted with AMPL on-chain and then on board Coinbase soon, a motion that got highly attention from crypto community.

FORTH token is learning the model of COMP of Compound Finance, with an inflationary releasing schedule every year and can be used(directly or delegate) to vote on the protocol. It has nothing to do with the AMPL supply mechanism, which will maintain the same after this governance token comes out. Elastic Finance, a next ambitious milestone including dex, lending/borrowing, derivatives, build on top of AMPL, together with multichain solution, will made Ampleforth to evolve into an all-in-one platform.

It is not saying Ampleforth will is a successful project (not yet), however the team leading the project always rhythm with the market and at least make this algo stablecoin the longest running of its kind.

Elastic Finance: the next generation of financial platforms

**
**Source: https://www.ampleforth.org/roadmap/

3.3 Fei protocol – originator of self-owned liquidity protocol

Fei Protocol, a star-studded algo stablecoin, with investors like a16z, Coinbase Venture, launched in March 22nd 2021. The name of Fei comes from Yap islands’ circulating coin-fei stone, symbolizing its simplicity robust and universality.

Fei introduce a new mechanism called direct incentives to achieve the price stability. This new approach leverage the thriving DEX market, by using dynamic mint rewards and burn penalties on DEX to maintain the FEI to USD peg. Protocol Controlled Value(PCV), the bonding curve sell value denominated in ETH, will facility the new supply of FEI into the market. This bonding curve will the price between Fei and USD a arbitrage market, where traders can make profit and also stabilize the peg through activities on Uniswap. PCV will be used to support the arbitrage when price is lower than USD.

The direct invectives and Protocol Controlled Value are the essence of this new algo stablecoin.

PCV is the value the protocol itself controls, not IOU, not LP money. So, the value of PCV will not be affected by the market sentiment, which always exacerbate volatility on the money usable. PCV will be clearly used as the LP to the AMM, so the Fei peg can be controlled without any interfere of exogenous liquidity. Here is the example that how PCV can balance the peg:

PCV pegging mechanism

As all PCV is under protocols’ hand, this balancing mechanism can be done without using TVL and happens automatically. The Fei can be minted through bonding curve however can not be redeemed, which means users can only receive ETH(the collateral asset) on secondary market through ETH/FEI pair, so this collateralizations called “irrevocable protocol-owned liquidity”.

As the protocol only accept ETH as collateral, in the first few days, 4.4-4.7,  when ETH price sharply rise, FEI was sell out to market and price is far deviated from 1 USD. Fei’s Genesis have received 639k ETH and $1.3b FEI were minted, with 17k users participated, a real carnival for algo stablecoin like this and lead the PCV reached to 1.26bn, a meaningful reserve. However Fei touched near 0.1USD in just a few days.

Source: https://twitter.com/el33th4xor/status/1379759409111392265

The problem is the same, when Fei price above 1USD, users has the motivation to mint FEI(instant arbitrage), however when price down and penalty system does not work, as it will both reduce demand and supply, which is the worst case for algo stablecoin, this is called burn system controlled by Burner contracts. In theory when user sell Fei when its price at 10% discount to 1 USD, burn mechanism will give less ETH than the actual market price can give, which encourage user not to sell during turmoil and hold in long time.

Remedial measure

Several approached the Fei protocol utilized to rescue the plummeting coin: 1. Turn off the burn incentive, the source of vulnerability to reduce sell pressure on FEI, and use PCV to restore peg; 2 add redeem plan under FIP-2, where FEI can be redeemed by 0.95 USD, facilitated by a total of 30k ETH in PCV; 3 elevate tribe reward by inject 100m tribe into FEI/TRIBE pool. Fei price maintain stable after May.

The source of volatility may comes from the value of PCV is unstable as it is solely consist of ETH, when ETH in large fluctuation periods, it’s hard for the protocol to maintain the peg give it’s a one way redeem design and users can only exit through secondary market selloff even burning mechanism keeps wielding. After that in FIP-10a, Fei added a Dai bonding curve.

Recently Fei protocol plans to launch V2 in this November, including 100% reserve, 1:1 two way redeemability, efficient management of risk, liquidity, and yield, aligned incentives between TRIBE and FEI holders. It will also make PCV weight algorithm adjust through risk curves, where reserve ratio is determined by the collaterals respectively.

3.4 Float Protocol – floating unit of account

Float Protocol, as its name suggested, the stablecoin $Float is mimicking the major fait currencies, floating and changing value over time, so the price target of $Float is not $1, a non-pegged stablecoin pioneered of its kind.

The reason Float Protocol not intending to peg to USD includes: hard peg is hard to maintain, especially in weak demand; USD pegged stablecoin may face regulatory pressure; purchasing power, presented by $Float, will be variable over time; a global crypto financial system does not need a currency pegged to on particular country’s fiat money.

The actual value is no fixed. $Float aims to have a be a unit of account with low volatility in short term, however its value is determined by value of crypto currencies in basket and its own demand. When the cryptocurrency becomes bigger, the value of $Float will rise accordingly.

How the Protocol stabilize $Float and adjust supply?

• The initial price of $Float is $1.618, equalling the value of a basket of ETH(in v1, only ETH is included in basket). As the time going by, the price is determined by $Float target price.

The target price is reverse derived by this formula:

• B is the basket factor, b⋆ETH​ is the value of ETH stored in the Basket,  ΣFLOAT, the number of FLOAT tokens in circulation and  t⋆′​ is the target price of FLOAT. The current target b is 1 and can be removed or replaced by other value when the governance allows to do so.

• Two token system: beside $Float, there is also a governance token $Bank. Unlike other governance token, $Bank play a crucial role in this stabilizing system. When market price of $Float higher than target price, $Bank will used to takeover this excessive demand and vice versa.

• Auction and reverse auction: the way BANK are utilized is through auction system. In times of expansion (high demand of FLOAT), FlOAT token will be circulated through Dutch Auctin where minter can commit ETH and BANK in exchange for FLOAT. ETH will then be added to basket and BANK will be burned (that how BANK absorb FLAOT price pressure) . In time of contraction(low demand of FLOAT). Reverse Ductch Aution will start and the protocol will buy FLAOT token using ETH from Basket and BANK just like same function PCV from Fei protocol.

• Target price: long term target price is moved by market sentiment, by means of price of cryptocurrencies in basket and Float. Short term market price is largely determined by auction approach, where users can trade/arbitrage until the price reach to a local equilibrium.

Given no specific pegged price, the target value defined by basket formula is quite not easily understandable. So it is hard to tell the status of protocol by simply observing FLOAT price, participators should also consider basket value, this is even more complicated when basket include multi currencies.  I won’t say this mechanism is good or not. On the positive side, price is relatively stable when protocol has large power. However it also will mitigate traders to join if they can not perceive the arbitrage opportunities.

Market volatility is still the largest risk. Though it is not a collateralized type stable coin, its V1 designing will inevitably make user to think about its difference against MakerDAO, where ETH is over collateralized to mint Dai in single CDP time. To some extent, we can consider FLOAT is a fairly collateralized token backed by ETH. It will face the same risk that Maker suffered in 2020 March. So how to transfer this risk is still questionable. The vision of Float is admirable as it breaks out the usual mentality on algo stablecoin designing.

3.5 RAI –  Control Theory driven algo stablecoin

RAI is another algo stablecoin protocol not pegging to US dollar. RAI borrow the Idea of MakerDAO’s Single Collateralized Dai, and replace the pegged value of $1 with another underlying asset called Reflex-index. The protocol focuses on stabilization rather the actual value the stablecoin has. The reflex-index is a variable that determined by market. The aim of the protocol is to provide a low volatility stablecoin, where its market price and redemption price are as close as possible.

The core part of the protocol is a PID controller, coming from “Control Theory” to adjust input and output and thus stabilize the coin.

The PID controller use a three-parts formula to calculate its output:

 Controller Output = Proportional Term + Integral Term + Derivative Term

These three parts consider the deviation from three perspectives, namely: the range, the persist time and the change rate. The protocol adopts this PID approach is also inspired by the research finding that current central bank monetary policy are coincide with PID theory.

The system mainly adjusts the rate of change on redemption price, which called redemption rate here. The feedback mechanism will control the redemption rate in ways of tuning of automation.

How redemption price is changing in different scenarios

For example, in Scenario 1, when market price is higher than redemption price, the feedback mechanism will reduce the redemption price. With the expectation that redemption price will further decline, the participators will sell out index in market and thus squeeze the gap between market and redemption price. In Scenario 2, when the market price is lower than the redemption price, the collateralization ratio become less, the participators will buy index and some og them will pay back their debt, however both scenarios are based on theoretical estimate, the actual movements will not be that ideal. It is hard to answer why there will be large deviation between market price. As it occurs, user may assume there must be some factors outside the control of the system resulting this rather than reckless buy/sell index according positive/negative rate. Negative rate is an interesting config: in scenario 1, a negative redemption rate will be calculated and holder will be incentivized to sell RAI to push market price down to redemption price.

Rai share the same vision with Float, furthermore reflex index adjust is also similar to the target price setting to some extent, even though the former one is system controlled and the latter one is auction based.  For this kind of new algo stablecoin who strive to unpegged to dollar and maintain low volatility, the question is where it can be used? There are basically two routes: first is to build up an all-in one defi system by itself, the stablecoin will naturally the build block; second is to find the right partners to embed this new species into different protocols, which needs more market fit.

Rai has listed several use cases that other protocol may consider involving:

3.6 New Generation Algo Stablecoin

A brand-new bunch of algo stablecoin projects have emerged recent market, which are called DeFi 2.0 in a popular way in Asia crypto community.  They have enjoyed large expansion not only in market cap but also in business scale in no more than 30 days, and largely driven by community rather than institutions, among them are Olympus, Spell, Alchemix and others. The two major features of DeFi 2.0 is protocol owned liquidity and yield enhancement from product perspective.

OHM(Olympus DAO)

Olympus DAO，the protocol behind the OHM, is a collateralized asset issuing system, where every OHM are backed by 1 USD, in the form of DAI, FRAX, LUSD and several other tokens. However OHM is not pegged to any asset and allowed to fluctuation, so itself not aim to be a stablecoin but an algorithm reserve currency. Though OHM is backed, not pegged, the POL(protocol owned liquidity, like PCV in Fei protocol) can wield the power to buy back the OHM when its below $1. Not only the design, but also the price of OHM make it looks like a highly volatility asset.

Many reasons can explain OHM’s tremendous increase in market value, the heart is Bonding and Staking system along with their tangle. Staking is highly appreciated in the system, as it is a long term and primary strategy for value accrual. Staking rewards comes from the bond sales. OHM are locked and equal amount of sOHM are released to stakers and exchangeable to other assets. Bond sales are the core part in Olympus, as its sales proceed will go to treasure and used to mint OHM, which in turns the rebase reward to the stakers. Bonding is considered as an active, short-term strategy for price discovery.

Due to ultra-high staking APY, almost over 99% OHM are staked in treasury and boost the price of OHM. OHM’s premium 1 dollar will encourage user to mint(buy bond) more OHM on the market, further underpin the market value. We Assume the movement will reach equilibrium after the APY reach to a mild level. The protocol further expands its liquidity provision into wider range, where any projects can buy bond using their native tokens.

SPELL(MIM, Abracadabra)

SPELL, another DeFi 2.0 project, tells another story. SPELL aim the be the yield enhancement hub for the locked up for the interesting-baring tokens. For example, users can deposit xSUSHI(staked SUSHI) as a collateral to mint the stable coin – Magic Internet Money(MIM), which pegged to 1USD and tradeable with common stablecoins like USDC, DAI. MIM is rely on market arbitragers to make the peg stable, as it is a collateralized money, so does not need too much sophisticated mechanics.Beside NIM, there are SPELL and sSPELL token to run through the protocol. SPELL is the governance token and the sSPELL is the staking certificate. The staking yield comes from the interest, occurring alongside with NIM minter repay the loan.

The real “Magic” of SPELL is its collaboration with so many top tier DeFi projects in short term though providing a financial incentive for their users. Also these projects are invited to actively participate in the governance of SPELL, like this:

That’s why it is so popular and admired by crypto native community.

4. Algorithm stablecoin outlook – huge market potential however with long time to achieve

Here we can conclude some empirical rule on how an algo stablecoin can survive（at least in short term）:

• Legitimacy, especially gain the support from Ethereum/DeFi OGs

• Long time commitment and keep upgrading

• DeFi community patronage

• Market fit, ultra-high yield/yield enhancement is typical market strategy

• Fair lunch/DAO driven, essential for DeFi 2.0

• Proven record for stability, or at least positive stability

As Jump capital recently stated “ As stablecoin rails are used for everything from remittance and cross-border payroll, to powering domestic economies, we believe the value of stablecoin outstanding will grow into a multi-trillion-dollar market. “

Source: Jump Capital

We believe the DAO driven algo stablecoin is the jewel of the crown, but it has to prove its soundness and real usage to fulfil the role of money before be adopted as the building blocks of Metaverse.