Resolv: The True Delta-Neutral Stablecoin
The Problem
With over $100 billion market cap, stablecoins are the most practical use case of DeFi. Yet, their adoption across broader global markets is curbed by inherent design flaws.
One such example are stablecoins backed by real-world assets, such as fiat cash and money market instruments (e.g. bonds). This setup serves a crucial use case by providing a channel of exchange between fiat and crypto. However, it also exposes holders to real-world disruptions, censorship, and credit risks associated with financial institutions.
The alternative is a cryptoasset-backed architecture, with collateralized debt position (CDP) mechanics being most widely-used option. While this approach is less dependent on off-chain infrastructure, it comes with caveats. It is not capital efficient, limiting leveraged positions in financial instruments. Besides, the less capital efficiency → the less liquidity → the more price jitter (even despite fundamental overcollateralization).
And this is not even about the stablecoin trilemma. Current stablecoin designs bear a mix of exposures and are not perceived as risk-free assets.
TLDR: How We Resolv It
Resolv Labs is building a new kind of stablecoin architecture based on crypto-only narrative.
Our approach is based on tokenizing a market-neutral portfolio of:
- On-chain assets
- Derivatives positions fully hedging price exposure
We call this new approach a True Delta-Neutral (TDN) stablecoin, in contrast to pseudo delta-neutral strategies or liquidation risks inherent to CDP mechanics.
The resulting stablecoin, USR, is protected from crypto market movements by construction and is capital efficient, but the idea goes further — we create a novel layer of protection for stablecoin holders.
This is achieved by isolating CeFi and DeFi risks into a separate high-yielding token — RLP (Resolv Liquidity Provider). In other words, the exposure is tokenized and offered to the broader market. Such risk segregation allows USR to be fully backed by on-chain assets, which unlocks ultimately trustless stablecoin design.
The architecture is based on an economically viable and fiat-independent yield source, which allows to distribute competitive returns to holders.
Helpful Definitions
Skip this and go to Architecture Overview if you are versed in the concepts of perpetual futures, delta-neutrality, and basis trades.
Delta-neutral portfolio
A delta-neutral portfolio is a result of a trading strategy that seeks to minimize exposure to price fluctuations in an underlying asset, such as a cryptocurrency.
In a delta-neutral portfolio, an investor seeks to balance the risk of price movements by combining multiple positions that offset price movements of each other. This is typically achieved through the use of financial derivatives, such as options or futures contracts.
Here’s how it works:
Underlying Asset: The delta-neutral portfolio includes a certain quantity of the underlying asset (e.g. BTC or ETH). This serves as the core asset in the portfolio.
Derivative Contracts: To achieve delta neutrality, the investor enters into derivative contracts that are directly linked to the underlying asset’s price.
While this strategy is well-known and widely used in traditional finance, it is the ability to tokenize a delta-neutral portfolio that allows to create a fundamentally new type of stablecoin. And at it’s core, it requires only on-chain assets and derivatives market to function.
For the sake of further illustrations, let’s take a closer look on the most common derivative instrument used for hedging.
Perpetual futures
Perpetual futures (often abbreviated as “perps”) are a type of futures contract that does not have an expiration date like traditional term futures contracts. This allows them to mimic the behavior of the underlying crypto asset. Perps are settled periodically, usually every few hours, through a mechanism called funding.
The funding mechanism ensures the perp price remains closely aligned with the actual spot price of the underlying asset. In instances where the perpetual futures price diverges from the spot price, funding payments are exchanged between long and short position holders. This process incentivizes market participants and restores the price equilibrium with the spot market.
Perpetual futures are typically categorized into linear futures contracts and inverse futures contracts. In the crypto market, linear futures contracts are also referred to as stablecoin contracts, as their pricing is denominated in USDT or USDC. In contrast, inverse futures contracts, often termed coin-margined contracts, use tokens like BTC or ETH as settlement currency.
Since in base case Resolv treasury uses short futures positions, another thing to consider is what happens with short perps when underlying price moves.
When price goes up, short position has unrealized losses and margin has to be topped up (more funds to be allocated to the exchange). Otherwise, the position will get liquidated (forced closure of the position by the exchange with immediate settlement of financial result) and the losses become realized.
When price goes down, short position has unrealized gains. Since these gains are unrealized yet, there is a risk that exchange will not be able to make payments under the contract (payment default). It is a good idea to reopen the futures contract at new market levels to realize the gains and withdraw funds from the exchange to not carry that risk.
Architecture Overview
How is the TDN stablecoin minted?
For this example we will use ETH as the underlying asset, and perpetual futures as a hedging instrument.
On a high-level basis, minting process looks as follows:
(1) User triggers mint function within the protocol’s smart contract and transfers a corresponding amount of ETH to it. In exchange, the user will receive relevant amount of Resolv tokens
Once ETH is received, Resolv:
(2) Allocates main part of the assets into ETH staking;
(3) Reserves a portion of ETH as liquidity buffer;
(4) Enters into short perpetual futures contracts in a relevant trading venue. Volume of such futures fully hedges the market risk associated with the ETH position. Collateral for the futures is delegated to the trading venue via off-exchange custody.
Specific split among the parts of the treasury is dynamic and depends on several factors (the main one is obviously token price). The primary objective of this allocation is to keep most assets on-chain while mitigating trading platforms risks.
Process of minting for RLP is similar, the difference is in underlying economics of the tokens due to risk segregation (see following section).
Protection Layer for Stablecoin Holders
The architecture proposes a separate layer of protection from counterparty risk and interest rate exposure for stablecoin holders. How is that achieved?
Two-Tranche Token Structure
Tokens backed by Resolv treasury are segregated into two tranches:
- USR: it is the stablecoin representing the senior tranche.
- RLP: functioning as the junior tranche, the RLP token offers protection to USR holders.
The core objective of Resolv revolves around ensuring that RLP tokens consistently provide complete coverage for exposure to trading venues and market risk.
📌 Maintaining low counterparty exposure level
Main component of treasury exposure is counterparty and/or protocol risk of trading venues, including centralized exchanges (CEXes) and decentralized exchanges (DEXes). This risk is expressed as a percentage of the total assets managed in the treasury, committed as margin or represented as unrealized PnL on the exchange. For example, an exposure metric of 5% means that up to 5% of treasury assets could potentially be lost if all trading venues experience insolvency simultaneously.
Resolv employs treasury management mechanisms with the primary aim of maintaining exposure metrics at a low target level (illustratively 8% and is a dynamic level). It allows a relatively low amount of RLP to entirely cover the credit exposure to trading venues.
Resolv Liquidity Pool Role
Designed to attract investors with higher risk tolerance, the RLP token functions as an insurance mechanism for stablecoin holders.
Furthermore, this architecture not only offers protection but also mitigates centralization risks for USR holders. The intended structure ensures that stablecoin holders are backed solely by on-chain assets, even when the protocol employs CEXes as futures trading venues.
The yield of RLP tokens increases if there are less liquidity providers in the RLP pool, and vice versa, so it is self-balancing in terms of economics.
The ratio between the total value locked in RLP and USR tokens is analogous to the capital adequacy ratio (CAR) applied in the evaluation of financial institutions. This CAR metric is actively monitored, and the withdrawal mechanism for RLP tokens is contingent on maintaining an adequate CAR to keep protocol stable.
The Why: we are building a trustless crypto-backed stablecoin
Dual-tranche architecture is not only helpful to achieve risk segregation and full on-chain backing for the stablecoin. It will also unlock a design where the senior tranche is supported by, but does not rely on operation of the centralized elements, such as protocol contributors, or third party exchanges and custodians.
This is achieved by building rule-based safeguarding mechanics into protocol smart contracts. A quick example: protocol will only be able to process withdrawal from on-chain treasury in amount just necessary to meet margining requirements.
We are focused on implementing trustlessness into the protocol on all levels, from safeguarding mechanics in the treasury-linked smart contracts, to decentralized governance. Watch out for the protocol token soon after protocol launch!
Protocol Economy
How yield is generated…
In the proposed TDN architecture, yield is derived from two principal sources:
- Staking of On-Chain Assets: Yield is generated through the staking of on-chain assets. Currently, the approach uses leading liquid staking protocols, such as Lido. The roadmap includes a transition towards a more diversified structure, with direct delegation of tokens into Proof of Stake (PoS) validation nodes. Ensuring sufficient liquidity for on-chain assets is critical, considering the time required for staking and unstaking of ETH. To maintain liquidity, ETH will be borrowed in lending protocols against staked forms of ETH.
- Earning Funding Rate on Perpetual Contracts: Historically, short position holders in perpetual futures are net receivers of funding rate. This results in additional yield generation for Resolv through short positions.
How is that reflected in real numbers?
- YTD yield of the model strategy as of 30 September topped 10% APY;
- Backtested performance over 2-year span yielded ca 7.50% APY;
- Simulated performance provide a range of 7–10% APY within three standard deviations, i.e. 99+% cases.
…and distributed
The generated yield is then distributed to holders of staked USR and RLP tokens, with part of the proceeds going to Resolv equity / token holders.
Allocation ratios are subject to governance decisions. The overarching objective is to achieve favorable yields for all instruments operated by the protocol and keep system balanced. This balance includes targeting a specific RLP/USR capital adequacy ratio to ensure the protection of USR holders.
Indicative benchmarks for the instruments are:
- USR: 5–6% APY;
- RLP: 20–30% APY.
We are excited about the value proposition the RLP brings to the investors. It is a moderate-risk, fungible, redeemable token with secondary market and competitive yield. We will dive deeper into its economics in one of the upcoming articles.
Key Takeaways: Resolv Architecture Benefits
Resolv is not just yet another forked stablecoin. Here’s a recap of features making Resolv unique:
Independence from fiat currencies. There is no $1 in the world directly attached to Resolv tokens. The only link is a claim to the exchange (in case it is a CEX, and it is even better with DEXes), efficiently managed in terms of counterparty risk.
Capital efficiency. Minting $1 worth of USR or RLP requires $1 worth of assets (net of minting costs). No need to overcollateralize stablecoin position.
Remarkably low price jitter. USR can be burned at all times for $1 worth of ETH, so any deviation from the peg can be promptly pulled to zero by arbitrageurs. Also, holders do not need a secondary market to be able to turn around Resolv tokens with low slippage.
Superior inherent profitability. The treasury allocates inventory into staking and earns additional funding fees on futures positions. The resulting inherent yield is approaching 10% and is better than comparable metrics of current RWA and CDP models.
Scalability. The model utilizes perpetual futures market, which has grown rapidly over past 3 years and is 2+ times more liquid as compared to spot market. The combined open interest in BTC and ETH perpetual futures tops $20bn as of August 2023. Architecture can be scaled to other on-chain assets and chains as the market develops.
Risk segregation. The two-tiered protocol structure allows to segregate the risks and allocate senior and junior instruments to categories of investors with different risk appetite.
Trustlessness-enabling design. 100% on-chain collateralization, made possible with dual-tranche mechanics, paves the way for ultimate decentralization of the stablecoin.
W(h)en launch?
Resolv will go live in the first half of 2024 — look out for updates on our progress!
This is it for now, but there’s more to come! In the next articles, we will be sharing further project details and insights on relevant DeFi mechanics.
In the meantime, do follow us on Twitter and check out https://www.resolv.im to learn more and contact us!
