Thread by @resdegen

After recent events, it is time the crypto space develops a new stablecoin that is

- 100% decentralized
- censorship resistant
- truly resilient

In this thread I'll explain and summarize one interesting idea to issue a BTC/ETH-backed stablecoin using derivatives contracts 🧵👇

1/ Let's understand the motivation first

Today:

- The US sanctions Tornado Cash and following this event
- Circle blacklists Tornado cash addresses by freezing USDC
- Github suspends accounts of Tornado contributors

https://twitter.com/bantg/status/1556721709931175937

2/ USDC, USDT and BUSD are the biggest stablecoins in the market and they have an aggregated market cap of $138bn+

These stablecoins are issued by centralized entities

And the vast majority of "decentralized" solutions are also backed by these centralized stables

3/ Being a centralized issuer means that Tether or Circle have full control of the tokens and can actually decide to

- Blacklist addresses
- Freeze assets, i.e. DAOs treasuries might be affected
- Control decentralized assets heavily backed by them

https://twitter.com/Tetranode/status/1556737636383051786

4/ Lately, for example, there has been a discussion around ETHPoW / ETHPoS due to the speculation of some major stablecoin issuer honoring redemptions on a fork instead of on ETH2.0

Regardless of the speculation, it just shows how powerful these institutions might be

5/ It's therefore imperative that other solutions emerge and are adopted to the same level

The problem accentuates as the other major stablecoins such as $DAI or $FRAX are also heavily backed by USDC

What happens if USDC collateral for those is blacklisted or frozen?

6/ There are some truly decentralized solutions such as $RAI or $LUSD as their collateral is just $ETH

I highly recommend reading about them (Vitalik is a big supporter of RAI)

However, being collateralized stablecoins means that their scalability depends on ETH market cap

7/ How can we then create a fully decentralized, censorship resistant AND scalable stablecoin?

The solution is to use, quoting Arthur Hayes, the most pristine crypto collateral: Bitcoin. I'd also argue that ETH can be considered in the same league

(pls btc maxis leave me alone)

8/ How would it work?

The idea seems pretty obvious and it has been widely known, but I read it for the first time in one of Arthur's posts so I will basically summarize his explanations

entrepreneurshandbook.co/luna-brothers-…

9/ This stable is based on inverse perpetual swaps & future contracts

We need

- Contracts w/ an underlying of BTC/USD, margined in BTC
- This means profit, loss & margin are denominated in BTC, while the quoted price is USD
- Each derivative contract is worth 1 USD at any time

10/ Contract Value in BTC = ($1 / BTC_price) * number_of_contracts

- If BTC / USD = $1, then the contract value is worth 1 BTC
- If BTC / USD = $10, then the contract value is worth 0.1 BTC

Note also ETH can be used instead of BTC. Using just one for simplicity

11/ We can now create $100 synthetically

Assume that 1 BTC = $100 (let's hope not lmao)

What are $100 worth of BTC (or 100 contracts, since 1 contract = $1) at BTC/USD price of $100?

12/ Using our formula:

($1 / $100/BTC) * 100 contracts = 1 BTC

which means that

100 USD = 1 BTC + 100 short derivatives contracts

13/ If the price of BTC goes to infinity, the value of the short derivatives contract in BTC terms approaches a limit of 0

Let's further explore an example:

If the price of BTC goes up to $200, what’s the value of our derivatives contracts?

14/

($1 / $200/BTC) * 100 contracts = 0.5 BTC

- We have an unrealized loss of 0.5 BTC
- When we subtract the unrealized 0.5 BTC loss from our 1 BTC of pledged collateral, we now have a net balance of 0.5 BTC
- At a new BTC price of $200 --> 0.5 BTC x $200 = $100

15/ Therefore, we still have 100 USD even though the price of BTC increases and caused an unrealized loss on the derivatives position

It is mathematically impossible for this position to be liquidated on the upside

16/ The flaw with this system occurs when the price of BTC approaches 0

When that occurs, the contract value becomes greater than all BTC tokens that will ever be in existence, making it impossible for the short side to ever pay you back in BTC terms

17/ ETH does not have a fixed max supply but if ETH tends to 0 then ($1 / ETH_price) tends to infinity and the contract value would become greater than all ETH in circulation

18/ This is denominated as negative convexity and shows how this peg breaks as the price of BTC or ETH approaches 0

However, this scenario shouldn't stop anyone to go for this model because, if BTC or ETH go to 0... you know 😅😅

19/ At the end, we all support BTC and ETH

The benefit of this model is that it is scalable and doesn't depend dramatically on BTC or ETH demand

Overcollateralized stables rely on the collateral market cap, since you just can borrow a certain amount, know as LTV (Loan To Value)

20/ Arthur says that now we must introduce some centralization since the only places where these inverse contracts trade in sufficient size to accommodate a BTC/ETH-backed stablecoin are CEXs

This doesn't make sense, as the sole goal is to create a truly decentralized stable

21/ I believe that with effort and the talented people that we have in our beloved crypto space, we can create a stablecoin as such that can steadily scale thanks to these derivative contracts being offered in DeFi with sufficient liquidity

Our end goal is to scale DeFi

22/ This idea could actually be applicable to any other crypto, with this other asset being used as collateral for the derivatives contract

However, BTC and ETH are proposed in this example as they are the 2 biggest, most liquid and most decentralized assets in the world

23/ What are your thoughts on the idea?

Is it possible to build such tool on DeFi and bring such liquidity or it is only possible in CEXs?

Any other better alternative?

Everyone that is commenting that this idea is equal to $UST is dumb af