CircuitDAO — An on-chain collateralized stablecoin protocol
--
For a Chinese version of this article see here.
CircuitDAO is the DeFi protocol behind the Bytecash (BYC) stablecoin. The protocol is permissionless and allows anyone to borrow BYC — pronounced ‘bick’ — against collateral locked up in a smart contract. Bytecash aims to maintain a 1:1 peg to the US Dollar.
The protocol is built on the Chia blockchain. BYC is a fungible token and adheres to the Chia Asset Token (CAT) standard. CircuitDAO is govered via its governance token, CRT.
Why is Bytecash needed?
There is currently no stablecoin on Chia, making it difficult to use the blockchain for payments and DeFi applications.
CircuitDAO has opted for an on-chain collateralized approach in order to keep the system open, permissionless and decentralized. This minimizes the risks inherent in stablecoins that are backed by off-chain collateral. An example of this was USDS, a stablecoin backed by US Dollars held by a custodian, Prime Trust. Despite being regulated, Prime Trust was pushed into receivership due to what appears to be a case of mismanagement of private keys and fraud. This ultimately led to USDS losing its peg, and USDS holders being left out of pocket.
CircuitDAO on the other hand is completely transparent as everything happens on-chain, enforced by smart contracts. The system is non-custodial, and the only way that collateral can be withdrawn is by Bytecash loans being repaid.
How does it work?
It’s pretty simple, actually. You lock up XCH in CircuitDAO as collateral, against which you can borrow BYC. In order for the system to be stable, loans need to be overcollateralized. This ensures that even as the price of XCH fluctuates, there’s always more than 1 USD worth of XCH backing every BYC in circulation.
To get started, connect your Chia wallet on the CircuitDAO website.
Step 1 — Deposit collateral
Decide how much XCH you’d like to lock up, and deposit it in CircuitDAO.
Step 2 — Borrow BYC
Once you have locked up XCH, you can borrow Bytecash against it.
The maximum amount of BYC you can borrow is determined by the liquidation ratio. This ensures that BYC is overcollateralized. For example, if the liquidation ratio is 150%, then you can borrow up to $400 worth of BYC against $600 worth of XCH.
In practice, it is advisable to leave a comfortable buffer, and borrow less than the liquidation ratio would allow. This is to avoid liquidation even if the XCH price suddenly drops.
Step 3 — Repay BYC loan
You can repay your BYC loan at any time. Borrowers need to repay the BYC borrowed (principal) plus a stability fee (interest) that accrues over time as the loan remains outstanding.
Once a loan has been repaid, the corresponding BYC is burned, and the collateral is released back to the borrower. Loans can be repaid partially or fully.
Stabilitiy fees affect the supply of Bytecash, which is used to maintain the peg to the US Dollar.
The stability fee is set by governance, and is the primary mechanism by which the peg is maintained. If the BYC price drops below USD 1, the stability fee increases. A higher stability fee makes borrowing BYC less attractive and encourages existing borrowers to repay their loans. This will tighten BYC supply in the market and exert upwards pressure on the BYC price. Similarly, if the BYC price exceeds USD 1, the stability fee gets lowered, making it more attractive to borrow BYC, and thereby increasing supply and bringing the BYC price down.
Bytecash use cases
There are numerous use cases for Bytecash.
- Payments — Bytecash makes it possible to send USD-denominated payments to anywhere in the world in seconds.
- Leverage — Users can get leverage on their XCH by selling borrowed BYC for more XCH. Leverage increases risk, but also potential returns.
- De-risking — By selling XCH for BYC, users can invest in a less volatile asset directly on-chain without having to off-ramp from the blockchain.
- Liquidity provision — Users can provide BYC liquidity on AMMs such as TibetSwap to generate income from trading fees.
- Earning yield — We are planning to launch a savings smart contract that pays depositors a yield from the stability fees charged to BYC borrowers.
We expect that many other use cases for Bytecash will emerge over time, and that the availability of a permissionless stablecoin will spur innovation in the DeFi space.
Liquidations
In order to ensure that there is always enough collateral backing Bytecash, loans get liquidated as soon as the value of the collateral drops below the liquidation threshold, which is defined as the outstanding debt multiplied by the liquidation ratio. The liquidation ratio is always greater than 100%, so that even if the XCH keeps falling during the liquidation process, the collateral value continues to exceed the outstanding debt.
Liquidations keep the system overcollateralized.
When a liquidation gets triggered, the collateral is auctioned off for the outstanding debt (principal + accrued stability fee) plus a liquidation penalty of 13%. This sets a strong incentive for Bytecash borrowers to top up collateral or pay back their loans to avoid liquidation.
The liquidation process and how to participate in auctions will be described in more detail in a future article. Sign up to the newsletter on the CircuitDAO website to be kept in the loop.
