For everyone patiently waiting, the wait is over. XStable is here and we are finally ready to launch. In this article, I will dig into what XStable really is, how it operates, the story behind it, and the internal mechanics that drive it.
Over the past few months, I have been deeply fascinated with several algorithmic stablecoins that have stemmed in the cryptoverse but was not satisfied with the basic premises that these have been built upon. Ampleforth, ESD, FRAX, and several other stablecoin protocols have been born with one core premise, that an asset needs to follow another asset (“pegged”), at least in principle, to become stable. This in itself is a fallacy. Each of the global fiat currencies are relatively stable in their value, but not because they are pegged to each other or backed by each other. In the real world, these currencies are used globally creating demand and supply, and are traded in free-floating markets to satisfy these requirements. When supply or demand shocks originate, central banks constrain the supply by increasing the interest rates or expand the supply by decreasing interest rates and printing more money. Fixed exchange rate regimes have suffered trade-offs with stability compared to floating rate regimes with inflation targeting monetary policies.
In my view, a stable coin protocol does itself grave injustice by looking at the price in terms of another asset and trying to follow it. In contrast, what should be done is to look at the underlying economic factors that impact its own price and smooth supply and demand shocks akin to a central bank to achieve stability. This is the core premise of XStable and what has led to its genesis.
How XStable works
- XST does not try to achieve a stable value in perpetuity as it just doesn’t make sense. What it instead does is, splits time into multiple epochs and tries to soften the shocks in each epoch. In the initial stages, where supply rests with few and volatility is a necessity, epochs are much shorter allowing for larger value expansion and supply drift. Over time, epoch durations are expanded.
- Inside an epoch, if there is excessive demand in the form of a higher buy volume, new supply is minted with each buy aiming to increase the sell pressure to counteract the demand shock. As the buy volume outpaces sell volume more and more, the minting becomes more aggressive with the help of a quadratic function, as a linear function would not help counteract the aggravating demand imbalance effectively. This does two things — i) token holders have a higher supply, and ii) higher prices due to the imbalanced buy volume. This forms an incentive to the token holders to add sell pressure.
- As the sell pressure ramps up in a particular epoch, contracting the balances of the token holders does not achieve any added buy pressure. It instead creates race conditions to be the first to sell before your balance diminishes and value lowers. In the case of a supply shock or imbalanced sell volume, it imposes a penalty on the seller that is burned. This is determined by the same quadratic function that is used for minting in the previous scenario. As the imbalance widens with higher sell pressure, the penalty ramps up more aggressively. This incentivizes the potential seller to hold off until the next epoch when the penalty resets to the base level.
- At equilibrium, mints from buys are balanced by burns from sells. Protocol strives to achieve this state in each epoch.
- In the case of really aggressive time local demand or supply shocks, incentives might not be strong enough to alleviate them. In such scenarios, the protocol takes a more direct approach using a stabilization reserve that market buys or sells the tokens to reduce the imbalance to targeted levels.
The protocol works to achieve stability by looking at the primary fundamentals of demand and supply, as I believe it should be.
However, as can be inferred, there are a couple of caveats that are not addressed in the core mechanics above. In the case of excess sell pressure, the protocol only incentivizes holding off on the sell but does nothing to increase the buy pressure in the above-described form. Let us look at a real-world scenario where demand for a currency has steeply plummeted and hyperinflation is on the horizon.
Pure monetary policy can only do so much in case the currency does not really have use and no real demand exists. Even in cryptoverse, speculative demand can only account for so much and is short-lived. In such a scenario, sell pressure eventually wins out while the community moves on to the next shiny apple. Real demand is generated via utility, and in my opinion, a real stable protocol should plan and should be positioned for this. In today’s cryptoverse, utility primarily rests in being used in defi protocols. Let us look at a couple of the existing top algorithmic protocols to understand what is lacking here.
a. Ampleforth/Rebase protocols — A token with oscillating balances. It becomes really tough to be used either as collateral or a lending asset while its balances move about steadily. Protocols record your deposit amount at the time of your deposit to put your money to good use. However, when the balances themselves can oscillate, it becomes incredibly difficult to actually put this to use, unless those protocols change the way they work altogether.
b. ESD/Seigniorage protocols — In the case of seigniorage protocols, your balances are stable which is a good thing. However, the incentive for a token holder to actually utilize the tokens in defi protocols, even if such an option is available is completely absent. In reality, it is the opposite. You have full incentive not to participate elsewhere. In case of an expansion cycle, unless your tokens are staked in DAO or at particular defined locations, you do not get to be a part of the supply expansion and lose out on your equity.
As such, both of these models only operate to gain speculative demand and once that wanes, they will track 0 instead of their targeted price pegs. XStable counteracts both of these negative aspects.
- XST balances never decrease and only continuously accrue similar to an interest-bearing savings account. The dividends/interest is derived from the participants exiting the protocol. This can be safely used as collateral as a token holder’s equity in the ecosystem only increases gradually increasing the net value of the collateral.
- For defi protocols that cannot operate with automated balance increases, a wrapped version called XSS, XStable Shares, exists. This is similar to depositing your balances in a savings pool and XSS denominates your share of that pool. As such, XSS balances do not oscillate but each XSS keeps continuously accruing more XST value and becomes more valuable over time.
- There is no issue with misaligned incentives as you never have to stake or position your tokens at a particular place to be part of the supply expansions. You are a part of it no matter where your tokens are deployed. In fact, you gain dual yield by generating incentives for token utility as well as token dividends from continuous supply expansions.
This forms an initial base for generating real utility driving real demand for XST. As we enter more advanced stages, we will be uncovering more of our planned roadmap, that will outline how we move from sell-side penalty to buy-side incentivization in case of imbalanced sell pressures. We will also be unveiling more complex financial products that are centered around the XStable ecosystem. This is just the beginning. Let us see how far innovation takes us.