$200 000 USD
DESCRIPTION OF EVENTS
"A fully-backed, trust-minimized & community-owned stablecoin for web3."
"ESD is a stablecoin built to be the reserve currency of decentralised finance. ESD’s carefully balanced approach sidesteps the centralisation risk of USDC, USDT, & TUSD, avoids AMPL & BASED’s death spirals, the 100+ percent collateralisation requirements of sUSD & DAI, and, most importantly, it integrates perfectly with existing DeFi protocols."
"The ESD protocol expands on the pioneering work of Basis.io, which voluntarily shut down before launch due to regulatory pressure on the team. ESD has launched with an anonymous team to minimise pressure it may face down the road and the protocol includes a novel new mechanism in place of Basis’ seigniorage shares."
"Empty Set Dollar is an algorithmic stablecoin that serves as the reserve currency of Decentralized Finance." "It uses an algorithmic approach to maintaining price stability around a 1 USDC target. This approach relies on a tuned incentivization mechanism to reward actors who promote stability within the protocol."
"Empty Set’s stablecoin (DSU) has been developed to be collateral for web3 applications. The protocol’s low amount of dependancies and simple design make it suited for truely decentralized applications."
"DSU is designed to be simple & reliable. Users can mint & redeem DSU on-demand with stable collateral." "To operate Empty Set relies on two well established & throughly audited protocols: Compound & USDC." "Empty Set operates with a 100% or higher collateral. This ensures the DSU is always collateralised."
"A key tenant of web3 is decentralization, in all forms. Empty Set is able to issue a stablecoin against collateral with different trust guarantees and maintain the decentralization of its stablecoin."
"This allows for collateral with strong redemption guarantees to be used, while ensuring DSU and the protocols built on top of it are truely decentralized." "ESD is censorship resistant because it was developed by an anonymous team. This prevents regulatory bodies, or governmental agencies from really being able to pressure the protocol. With the STABLE Act potentially on the horizon in the USA, having a protocol that is free from government regulation is imperative. "
"For centralised stablecoins, like USDC, TUSD or USDT, they maintain their peg by providing a way for their tokens to be redeemable for the fiat dollars they represent. Similarly they expand the token supply when a user requests their fiat to be tokenised, and contract it when users request to burn their tokens for fiat. This is the safest and simplest way to run a digital dollar equivalent, as long as the centralised counter-party stays in business and doesn’t block your address."
"Another popular approach is to use Collateralised Debt Positions (CDPs) to issue a stablecoin whose worth is based on the redeemable value of the underlying assets (collateral). DAI and sUSD let users deposit assets into a ‘vault’ which in turn generates an amount of stablecoins that relates to a predetermined percentage of the value of the assets held within the vault. The value of the underlying assets are constantly monitored to ensure their value doesn’t fall below a specific threshold and if they do the vault is liquidated to ensure that the stablecoin is always able to be redeemed. This approach can succeed, however, it can be affected by heavy price fluctuations in the underlying assets and it requires assets to be locked in a CDP for the life of the issued stablecoins. Moreover, in most cases over collateralization is necessary to create a buffer in case of such high price fluctuations, which is inherently an inefficient use of assets."
"The most recent approach is to use a price feed to determine the total supply of the token. The logic goes: If the token is priced above its peg then more tokens should be created and distributed to token holders to inflate away the value of each token. Similarly when the price is below the peg the supply should contract to make the token more scarce and more valuable. The price feed is sampled at a specific interval (24hrs for AMPL) and the supply is changed (this is referred to as a ‘Rebase’). An equilibrium should be reached where the demand for the stablecoin matches the supply and the peg stays stable. Projects like AMPL, $BASED and ESD use price oracles to dictate supply, but crucially the methods to affect the supply differ. Both AMPL and $BASED use a mechanism which increases and decreases the amount of tokens in each user’s wallet each time a rebase happens, while not actually affecting the underlying value of the tokens."
"In contrast to standard rebasing tokens, in ESD rebases are voluntary. Users who choose to bond their ESD or lock their liquidity tokens in the DAO will receive the newly created ESD in the case of a positive rebase. For a negative rebase, protocol debt is issued which token holders can elect to purchase by burning their ESD for coupons that are redeemable for ESD at the next positive rebase. When purchasing debt for coupons: the greater amount of protocol debt, the greater amount of ESD they can be redeemed for. This incentivises holders to burn ESD, contracting the supply, as protocol debt increases."
"The protocol forces the token back to the peg of $1 based on the time weighted average price (TWAP) over an epoch (measure of time). If ESD TWAP > 1, expansion rewards go to bonded ESD holders. That expansion (inflation) increases supply devaluing the token. If ESD TWAP < 1, contraction occurs and coupons are sold at a premium. The coupon premium value grows with each epoch that passes if the TWAP continues to stay below peg. When the premium is enticing enough token holders may burn ESD in exchange for coupons for future ESD. The risk: coupons expire after X epochs (currently 90 epoch expiry.) The reward: coupons are redeemed when TWAP >1 for enough epochs to clear debt through expansion. ESD has been through multiple debt and expansion cycles. Expansions and debt cycles have lasted weeks, and they’ve also only lasted days or hours."
"As outlined in EIP-7 by AlexL, there are fundamental issues with the current ESD couponing mechanism. Simply put, the risk/reward ratio is not sufficiently attractive to entice speculators to buy and burn ESD for coupons. A stablecoin must maintain its target when sellers emerge, and effective hawkish tools are needed to stabilize the price during periods of weakness."
"V2 was inspired by [an] article written by prominent members of the ESD community. This spurred a successful treasury proposal to create a team to further research and create the code needed to implement V2. The first milestone for that team is fast approaching as their design is to be presented to the community on January 18th. In the community call from 1/8/21, they let us know they are on track. It’s important to remember, whatever their conclusions, and however they hope to change the protocol, that change will have to be presented to the community, and voted on by bonded ESD holders."
"The new system will be partially collateralized, rather than uncollateralized. This provides for a robust stability mechanism that is ~10x more capital efficient than current trustless collateralized stablecoins." "ESD supply is expanded by minting and selling ESD on the market when the system is above target. This will be done by a public incentivized function callable by anyone. The proceeds of this sale will be used to fund the reserves, and any excess will be distributed to DAO members."
"To encourage users to buy coupons, the Empty Set Dollar system sets an enticing exchange rate between ESD stablecoins and coupons, say 1 ESD stablecoin to 1.1 coupons. So if you own 10 ESD stablecoins, and their price falls below the $1 peg, the system will let you convert your 10 ESD stablecoins into 11 coupons. When (or if) the price of ESD stablecoins rises back above $1, you’ll be able to reconvert your coupons into 11 ESD stablecoins. Voila, your 10 ESD stablecoins have become 11, for a 10% profit."
"Got that? A coupon, in short, can be thought of as a promise to pay even more ESD stablecoins in the future, conditional on locking up one’s ESD stablecoins now, but only if and when the $1 peg has been restored."
"The further that the price of ESD stablecoins falls below $1, the more enticing the system-set conversion rate into coupons gets. Put differently, the more that it fails, the more the algorithmic stablecoin system tries to harness forces to repair itself."
"This meant that when the price of Empty Set Dollar rose above $1, then the protocol would mint more stablecoins to increase supply. The protocol would burn coins from wallets when the price fell below $1."
"This all sounds good in theory, but what about in practice? Luckily for us, algorithmic stablecoins aren’t just ideas jotted down on paper. ESD debuted last September and is providing real data on how these things function."
"Both algorithmic stablecoins have proven to be popular. At their peaks in late December 2020, ESD and DSD had respectively issued $550 million and $300 million worth of stablecoins into circulation."
"This actually worked pretty well until the end of December 2020. At that point, the value of the stablecoin fell below $0.90 and the peg simply could not be reached again." "Empty Set Dollar stablecoin [fell] from its $1 peg to less than $0.01 within months."
"How close did their prices hew to $1? For the first few months, the pegging mechanisms seemed to work. When ESD or DSD rose above $1, new coins were created, driving their prices back down. And periods of sub-$1 prices were successfully fixed, too, with the aforementioned coupon freezing mechanism pushing them back up to $1."
"However, since late December the price of ESD has gradually fallen to 23 cents. DSD stablecoins have fallen to 24 cents. There is little indication that either will ever return to $1. The value of ESD is presented in Figure 1. The value and volume of DSD is presented in Figure 2."
"A likely explanation is that people do not like to see the amount of coins in their wallet decrease. That caused distrust in the protocol, which resulted in selling pressure that the protocol could not correct by simply shrinking the supply."
"To summarize, Empty Set Dollar was a stablecoin that did not use collateral to defend its peg. Instead, it controlled the supply to maintain the peg, which worked until faith in the stablecoin was lost. At that point, the stablecoin became worthless and has not recovered."
Empty set dollar was a complex algorithmic stablecoin that maintained a price around $1 until December 26th, 2020, growing to a market capitalization of $200m according to CoinMarketCap. After that point, the price appears to have crashed and is presently fractions of a penny. The protocol would automatically burn user balances to decrease the supply. However, nobody wants to hold a token that automatically loses supply.
HOW COULD THIS HAVE BEEN PREVENTED?
Algorithmic stablecoins are an experimental technology that may not actually be possible to survive a "bank run" scenario where users want to leave en-masse.
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