Empty Set Dollar (ESD)

An experiment in decentralised, composable, oracle-driven stablecoins

9 min readOct 19, 2020

The last few months have flown by, almost every day new financial primitives are deployed to the Ethereum mainnet. Lending markets, insurance, derivatives, and synthetic assets have been set upon the eager Ethereum community. Some primitives mirror that of Traditional Finance (TradFi), leveraging tried and tested blueprints to bring financial inclusion without gatekeepers or extortionate fees, and others are completely novel innovations that can only exist in the world of Decentralised Finance (DeFi).

One core primitive of DeFi that underpins the whole space is that of Stablecoins. A low volatility token whose purpose is to represent a stable asset, usually USD or other well known fiat currency. With these tokens primitives, such as lending, insurance and synthetics, can function in ways that make sense to consumers who’ve grown up in a fiat currency world. Their central role in the space has led to fierce competition to launch and popularise these tokens. Centralised tokens like USDC, TUSD, PAX and USDT sell their solution as a digitised version of the asset they represent, claiming to have 1-to-1 fiat reserves to back the tokens they issue. Other protocols like DAI or sUSD have a crypto asset backed design, and others are elastic supply tokens governed by algorithmic mechanics to maintain a price peg.

Empty Set Dollar

While these projects have varying approaches, it seems that they all miss the mark in some respect: for some it’s censorship resistance and with others it’s a flawed protocol mechanic. The recently launched Empty Set Dollar (ESD) project offers an unmatched combination of decentralisation, novel protocol mechanisms and composability that places it perfectly as a central part of the DeFi space moving forward.

The article will briefly explore these themes in context of other stablecoin projects to explore ESD’s advantages, however if you are incapable of reading for more than 5 minutes here’s the gist and pretty table:

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 a novel new mechanism in place of Basis’ seigniorage shares.

An overly simplistic, yet overly optimistic comparison chart.

Decentralisation

A core tenet of Decentralised Finance is decentralisation (shocker). It’s a core theme that ensures equal access to the financial tools built on the platform regardless of your age, gender, political affiliation or religion. This is something significantly lacking in the traditional finance space where individuals are routinely discriminated against by governments and financial institutions for a litany of reasons. In DeFi, protocols are being designed in a way that limits the power of external actors, whether they be governments, groups within society or disgruntled individuals.

However some of the most popular stablecoins, such as USDC/TUSD/USDT, have at least some elements of centralisation built into them. While they serve a purpose as a bridge to the DeFi ecosystem, these can not be relied on as stable, censorship resistant fiat analogs. This is due to the simple fact that tokens are operated by companies in varying jurisdictions, subject to various laws, making them targets for governments and law enforcement to exert their influence over. For example, the consortium behind USDC (Centre) has blacklisted a number of addresses holding their stablecoin from transferring USDC, effectively freezing their assets. Similarly, the operators of USDT have used their admin keys to arbitrarily move tokens to other addresses when it suits them. To date, interference with stablecoin transactions and holdings by regulators has been modest, however, in the current state of DeFi, it is the most obvious vector for governments to exert unwanted influence over DeFi applications.

Other stablecoin projects have addressed this issue by developing and releasing their protocols in such a way that the founders have no arbitrary control over the protocol once it has launched, and require large communal coordination to consent to change the protocol after the fact. DAI*, AMPL, BASED and ESD achieve this by using token based governance to ensure decentralisation of the protocol while ensuring its upgradability. This significantly limits the ability of external actors to influence the project.

While direct influence can be mitigated using token-based governance, the political influence of the founders still exists after the protocol has launched. This means a project’s founders can be pressured to champion and push through governance proposals which might be directly detrimental to its users. A mitigation for this is employed by BASED and ESD, where the founding teams are anonymous and therefore free of being personally pressured. This approach is a significant risk for those who are early adopters of the project as there is no risk or reputation on the line for the founders, but in the long run this approach is the only way to ensure they are not targeted for their contribution to DeFi. This approach has most visibly and successfully been validated by the anonymous launch of Bitcoin by Satoshi in 2010.

* DAI’s new Multi Collateral DAI (MCD) now relies more on trusted assets like USDC, PAX etc than trustless assets effectively destroying the decentralisation of the token

Supply Mechanism

The second most important feature of these decentralised fiat analogs is how they maintain their peg and how their supply is managed. These two are crucial to ensure that the token is usable: no one will use a stablecoin that isn’t stable and if there is a way to manipulate the supply then your tokens are effectively not at their peg.

The process by which USD is tokenised into USDC (Source: Centre Consortium)

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.

Stability through user incentivisation

Using a supply adjustment through emission and redemption of debt, ESD creates a dichotomy of users:

Users who are financially interested maintaining the price peg: they will be rewarded with newly minted ESD
Users who want to use a stable fiat analog: they are passively holding the token and will accept some dilution for not being active participants

The amount of supply inflation is relative to the volatility of the token. In periods of high price volatility, the inflation burden will be increased on passive holders as those who are active will capture the protocol rewards as they work to maintain the peg. Periods of volatility are expected during the initial months of the protocol launch as the supply will inflate and contract trying to match the demand for the token and the price peg.

An AMPL holder checks their token balance during successive negative rebases

In contrast, AMPL and $BASED rebase mechanisms can cause panic for uninitiated users as they see the amount of tokens in their wallet decreasing. This can cause a negative feedback loop called a “Death Spiral” where users panic, sell their tokens, which in turn causes further supply contraction, and the cycle repeats itself until Market Capitalisation of the token becomes low enough to incentivise users to repurchase the token and stabilise it.

Technical implications

While decentralisation and sound protocol mechanics create a strong candidate for a fiat stablecoin, compatibility with the rest of the DeFi ecosystem is crucial to widespread adoption of ESD. Centralised stablecoins, such as USDC/USDT/TUSD, all follow the ERC-20 standard closely enabling most developers to integrate them right out of the box. As mentioned previously, AMPL and BASED both use a system that modifies the amount of tokens within a user’s wallet by using non-standard functions. While it achieves its goal of adjusting the supply, this comes at a compatibility cost with the rest of the DeFi ecosystem.

Balancer keeping account of Statera tokens in the contract.

In contrast, ESD adjusts its supply negatively through the issue and redemption of debt, not by modifying the amount of tokens held in users wallets. This mechanism allows for better integration with a broad variety of DeFi protocols that might not react well to outsider events ever changing balances of tokens. This was experienced during the recent Balancer incident involving Statera where the Balancer protocol was not taking into account how the Statera protocol was adjusting the effective amount of token held in the contract after a transaction.

Conclusion

ESD is a decentralised, oracle-driven stablecoin which uses novel protocol mechanics to overcome the downfalls of other rebasing tokens. All of this in a single token, DeFi compatible protocol with voluntary participation in rebases. Which means token holders who are disinterested in actively maintaining the price peg can safely use ESD in dApps or hold it as a stablecoin without trusting a counter-party, without committing funds to a CDP and without worrying about amounts changing in their wallet.

The one stablecoin to rule them all.