EP 59: Another Stablecoin? | All-Weather Stablecoin Gyroscope
Stablecoin.
Welcome, premium subscribers! Thank you for subscribing. What will be shared today and the days ahead are alpha from our Economics Design's researchers. Please keep these mails secret and do not share them with any one because these alpha are confidential. Enjoy your reading. This is not financial advice.
Catch the episode on YouTube
Gyroscope Overview
Gyroscope is an all-weather stablecoin that is decentralised, scalable, and highly liquid, based on revolutionary new designs. It is not out yet, still in testnet phase. But we would like to share how the protocol works. It is reserve-based and the reserve ratio, in the long run, is supposed to be 100%. There are two tokens in the system, the $GYD and the governance token.
Three main highlights of GYD:
All-weather stablecoin
Dual AMM mechanism
Still in development
Mechanisms:
Reserve based:Â The reserve ratio, in the long run, is supposed to be 100%.
Algorithmic:Â It has a dual AMM model which is basically an AMM in the primary market and an AMM in the secondary market.
Dual-token system: There are two tokens in the system — the $GYD or gyro dollar itself, and the governance token which is used to set system parameters.
Peg
It is soft-pegged to US dollars. Instead of an external oracle, it uses a dual-AMM mechanism to maintain and balance its peg.
Collaterals
It is soft pegged to USD. It is algorithmic in the sense of the stablecoin creation, so it can fluctuate a little bit, but there is a hard stop in how far the prices can fall. This is a pretty good improvement compared to all the other stablecoins.
It is more than 100% collateralised and there are different kinds of stablecoins to mint the stablecoin. The collateral for each kind of stablecoin is different, based on how risky they are so that is something to take note of — not all collaterals are worth the same. Everything goes into one big vault and there are different c ratios for all of them.
Coordination among different decentralised participants
Economic agents
Gyro holders:Â People who are minting the $GYD. The general users would be the $GYD holders and they have a veto power to overwrite any governance that is not helpful to the system.
Governors:Â The governance role will then be the management of the funds or the management of the collateral. The way to make sure that they are incentivised to do the right thing is that the cash flow returns are delayed for a period of time so that you bind them to make sure that they continuously behave properly otherwise they do not get the returns.
Liquidity providers:Â The third type is yield farmers or liquidity providers. They help to utilize $GYD and help to maintain stability by doing arbitrage.
PAMM Redemption Curve
PAMM or the primary AMM is where you burn and mint $GYD. You will always burn and mint it quite close to the value of one dollar. You can deposit your collateral into the system and then get to mint $GYD. If you want to get any of the underlying assets then you buy $GYD and burn it.
What happens when the stablecoin falls below one dollar?
Each collateral has a different kind of ratio. If the entire system is more than 100% collateralised then go ahead and just take a dollar and mint one dollar worth of assets and take it out. There will not be any sell pressure on the system. However, if the system is less than 100% collateralised because it is so volatile in the market and it is not doing very well, then four things can be done:
You can redeem it at less than one dollar which nobody really wants to do.
You can wait for a while for the reserves to accrue yield and then push the prices back up to one dollar again.
In the future, they're looking at allowing leverage to happen so you can deleverage. It becomes cheaper to deleverage which helps with the entire easing of the system.
Auctioning of the governance token to recapitalise the system so sell off governance tokens and then people buy them at a discount and use that money to help boost up the reserve.
In this graph, you basically have a redemption amount all the way until about 80 cents where there is a hard peg in which the minimum reserve ratio is, for instance, 80%, so you can always redeem it at 80 cents and it cannot go less than that. If the reserve ratio is less than 80% then this is where they auction off the governance token. The ideal goal is a straight line and the way to push it back up to one is the different mechanisms that we talked about earlier.
Minting $GYD
Does it need to be the same asset to open the vault?
When we say vaults here we mean this section of the reserve portfolio. The reserve portfolio is like the balance sheet of the protocol, so if you are interacting with the primary market and minting, then you are increasing the balance sheet of the protocol. If you are redeeming then you are decreasing the balance sheet of the protocol, but also changing the other side of liabilities in that case. Each vault is designed to have risks in any assets or protocols that are used within that vault. So, for instance, you might have one vault that is providing liquidity between a couple of stablecoins in a Curve or Balancer pool but it is designed in a way so that the risks are contained to that vault or pool and other vaults do not carry the same risks.
If for instance, $USDC was in one of these vaults and $USDC was undergoing a censorship problem, then it would not cascade into the other vaults because the other vaults do not have $USDC or their exposure to $USDC is quite contained. The entire ecosystem runs as an aggregate reserve ratio instead of an individual reserve ratio.
Earning Yields
The reserve portfolio is designed in a way where there are segmented risk vaults and then within those the assets are deployed in ways that increase the expected value of the reserve over time. One example is that on the one hand you might want to be depositing in things like Compound and Aave, but on the other hand you also might want to be providing liquidity between stablecoins that have similar risks, such as custodial stablecoins.
The governance rule going forward is that this reserve portfolio should change over time, which is pretty much the main task of governance.
PAMM VS Redeeming Underlying Assets
This is the question of what is the price of redemption. The PAMM is autonomously running a monetary policy as hyperparameters that are being guided by governance, but, in the long term, these are like slow management decisions with a given set of hyperparameters which tell you what the redemption rate should be, depending on the health of the system.
Gyroscope VS $USDC
In the case of $USDC, every one dollar can always be redeemed for one US dollar which is the underlying reserve, whereas with Gyroscope that one-to-one relationship is not fixed but is defined mathematically in the PAMM in which one $GYD can be used to redeem one dollar worth of reserves, or slightly less, depending on what the PAMM dictates.
It is this explicit one-dollar redemption in $USDC up until the point where maybe $USDC does not actually have those assets backing it, or maybe it has some risky assets, as we are seeing recently. You are putting the primary market power in the hands of circle and trusting that indeed it will remain at that dollar level, but instead, in Gyroscope, this is occurring on-chain so you can fully understand transparently what is going to happen in all possible circumstances.
SAMM
SAMM is where you can exchange $GYD with other assets so here they create different kinds of liquidity pools. Basically, you pair $GYD with another token and this is where you can help to defend the peg via the secondary market. A lot of other stablecoins just assume that if the coin is less than one dollar or more than one dollar then it will be evened out based on arbitrage by the system, but they have to rely on Uniswap, Sushiswap, etc. to help maintain that peg. Gyroscope, however, takes this external risk or this external stability mechanism and brings it into the market and allows the users in the market to maintain this peg, and incentivises them to do that.
You can see that in the model you have a range and the AMM has a mint and redeem quote. This is the range which you will use to pair against the secondary AMM. As the gap widens, the price range in which you can redeem $GYD for another asset also increases, which is where it becomes quite algorithmic.
Stability Mechanism
There are four stability mechanisms:
Use stablecoins as collateral which is a little more stable.
Decentralise in terms of the different types of stablecoins being used so that you can decentralise all the different kinds of risks.
Use stablecoins to generate cash flow so that you get cash flow returning, which helps to boost the ecosystem.
Use a dual AMM model to maintain the peg and when prices drop too far mint the governance token and auction it off as a backstop.
Lines of Defense
Gyroscope takes a behaviourally neutral assumption approach where they do not assume that agents will behave in certain ways. They might behave in some ways, but there is circuit breaker protection in case they do not. It is designed so that if there are no big shocks to parts of the reserve portfolio (if all the other stablecoins remain healthy) then it is always very close to 100% reserved. If the price does dip below a dollar then a closed arbitrage loop will bring it back to a dollar.
The problem comes up if you do have a failure of some of these assets or platforms that are used in the reserve portfolio. This is where the pricing mechanism of PAMM comes in, which is designed with several desired properties in mind. One important one is that it is basically impossible to exhaust the reserve itself. It is designed to provide some liquidity around a dollar depending on how healthy the reserve is, but it is not going to do that to the extent of actually exhausting the reserve itself. It has a circuit breaker in case there is too much outflow and then it comes down to a sustainable level of redemptions, which you can think of as re-pegging to a sustainable level and then providing a path back toward the initial peg going into the future.
PAMM VS SAMM
The main idea of the SAMM is that it is going to take the minting and redemption bounds of the PAMM and then split the pricing region of gyro dollars which would normally be zero to infinite dollars in general. Anything beyond these minting and redemption curves is very niche and is going to be priced by the PAMM. The only remaining region that needs to be priced is between those bounds, and that is where the SAMMs are going to be pressing liquidity.
Designing Governance
Governance Extractable Value
Governance extractable value is about a potential perverse incentive for governors of DeFi systems to be either choosing parameters in ways that only suit them and not the protocol, or potentially direct malicious actions to try to steal collateral or value in other ways. This is particularly a problem if you do not have the traditional legal system which provides a recourse mechanism which disincentivises such behaviour. But if you have totally anonymous governors then there is no recourse if they decide to pull the rug.
Governance extractable value is trying to localize where these governance risks come from, how big they are, and then how do we make it more difficult for governors to exploit the system in these ways. This is the approach that guided how the gyroscope governance mechanism was designed. They have introduced several checks and balances around this governance system.
There are two types of governance extractable value:
Directly malicious actions so basically the rug pull system.
Chasing short-term profits that may be good for governors because they can get short-term bonuses from it, but then the system itself is sacrificed in that and there is a greater probability that it will not survive into the future. Gyroscope wants to design something that is going to last for decades.
One of the two mechanisms that have been devised to help combat these two issues is conditional cash flow, which is combating the short-term problem.
Conditional Cash Flow
The conditional cash flow approach says that realistically in the long-term the system will be generating cash flows, and parts of these cash flows may be used to incentivise governors to pay for their services because you do need various updates to the protocol over time, and you need someone responsible for bringing them to fruition. These conditional cash flows are withheld from governors until a point in the future and are only disbursed conditional on the system actually being healthy at that point.
Accruing Cashflow
It will ultimately be up to the fully decentralised DAO to decide these things but some possibilities now are:
The reserve portfolio itself is aiming to earn a yield and some portion of this yield may be paid as a management fee because it is like a portfolio management problem to some degree for these governors.
Another way is from trading fees on some of these specialized PAMMs and SAMMs with the idea being that they are providing very high liquidity for the $GYD and other assets across the ecosystem therefore by default bolster the reserve itself, so portions of that may be used to incentivise the governors.
Listen on podcast if you prefer audio version.
