Stablecoin Solutions: A Comparative Analysis

Stablecoins are digital tokens designed to maintain a consistent value relative to an underlying asset or currency. They offer liquidity to cryptocurrency markets and provide a buffer against market volatility. Today, we’ll discuss how Zephyr Protocol compares to other stablecoin solutions in the market.

The Central Dilemma

Decentralized Algorithmic Stablecoins face a balancing act: how to best protect the base coin and the Stablecoin simultaneously. These two components are critical, and Zephyr Protocol aims to safeguard both in the most practical manner — primarily through being over-collateralized as opposed to algorithmic.

The Unique Proposition of Zephyr

Zephyr Protocol’s design ensures no additional ZEPH (the base coin) is ever spontaneously created, safeguarding the stability and value of the network. Instead, ZEPH’s supply grows only through scheduled emission.

Zephyr sets a conservative minimum reserve ratio of 400%. Consequently, no stablecoin can be minted when the reserve ratio falls below this threshold. This design ensures that every ZephUSD (the stablecoin) has backing from an equivalent value of at least 400% in ZEPH.

The protocol incorporates mechanisms and incentives to maintain adequate collateral supporting the circulating ZephUSD. These include transaction fees on minting and redeeming stablecoins, which contribute additional ZEPH to the reserve over time. Furthermore, the value of ZephUSD is tethered to both the spot and moving average prices of ZEPH, reducing the strain on the reserve during mint and redeeming actions.

In scenarios where the reserve ratio drops, users are incentivized to deposit ZEPH in exchange for ZephRSV (reserve tokens) at a discounted rate, thus bolstering the reserve. In the worst-case scenario, where reserve ratios fall below 1, the value of ZephUSD corresponds to the actual share in the reserve.

Zephyr vs. Other Djed Implementations

A full breakdown on Zephyr and Djed can be found here

Zephyr Protocol’s stablecoin solution is built on the Djed framework. However, it incorporates certain unique features that set it apart from other Djed implementations.

Oracle Pricing

Zephyr Protocol implements dual prices for all assets — a spot price and a moving average (MA). Using these dual prices mitigates potential oracle “front-running” and provides anti-price manipulation protection.

Privacy

Privacy is a core tenet of the Zephyr Protocol. While maintaining all the fundamental principles of Djed, Zephyr goes a step further by incorporating privacy features inherited from Monero

Native Chain

Unlike other Djed-based projects that may operate as a layer on top of existing blockchains (like Ergo and Cardano), Zephyr Protocol operates on its native blockchain. This approach offers greater freedom and control to serve and enhance the stablecoin protocol directly.

Reserve Provider Incentives

• Divergence Between Spot and MA Prices: The divergence between the two Spot + MA prices results in bolstering the reserve whenever actions are performed.
• Transaction Fees: All actions, barring adding value to the reserve, attract a fee, which is subsequently added to the reserve.
• Block Reward: Leveraging the advantages of a native chain, Zephyr Protocol can directly reward reserve providers by adding a portion of the block reward to the reserve, creating a pseudo staking reward mechanism.

Embracing Djed

While Zephyr introduces these unique features, it does not deviate from Djed’s core principles. The Zephyr team recognizes the value of the Djed model’s stability and robustness and builds upon it to create a more private, efficient, and incentivized stablecoin solution.

Notable Stablecoin Solutions and Comparisons

To understand how Zephyr compares, let’s delve into notable stablecoin solutions that have entered the crypto space.

Tether (USDT)

Tether (USDT) is one of the most well-known and adopted stablecoins, However, Tether has been criticized for inadequate transparency and auditing of its reserves over the years. Tethers reserve breakdowns can be found here.

Originally Tether claimed to be always backed by USD cash in its reserves. The goalposts have been moved since then, now < 1% of reserves are in cash. Its hard to determine exactly how liquid Tether is and how much

Tether, being a centralized entity, is fundamentally at odds with the ethos of decentralization underlying DeFi. We must trust Tether Ltd. to maintain the parity between USDT and USD, exposing users to significant counterparty risk. The potential risk of a Tether collapse makes the case for alternatives that can provide stability without such dependencies.

Moreover, unlike Zephyr’s ZephUSD, USDT tokens do not offer privacy. Transactions on the Tether network are traceable, which can expose sensitive information about users and their activities. A private stablecoin and fulfill the vision of true digital anonymous cash payments.

Terra (UST)

Terra network offers an algorithmic stablecoin, TerraUSD (UST), which was pegged to the U.S. dollar. The protocol is designed to maintain this peg through a system of minting and burning of its native coin, Luna. However, when UST’s value began to significantly deviate from its $1 peg, the protocol’s response led to a catastrophic outcome.

Luna’s value had no protection, and suffered hyperinflation due to the protocol design.

Zephyr Protocol, based on the Djed model, does not face these issues. The supply of its base coin, ZEPH, is fixed to scheduled emssions via PoW mining only. No ZEPH is ever minted to maintain the peg.

Haven (xAssets)

Haven Protocol offers its stablecoin, xUSD, which is backed by its native cryptocurrency, XHV. However, this implementation has encountered a series of challenges. Initially, Haven’s design ensured that 1 xUSD was equivalent to 1 USD worth of XHV at any point. But, this model did not safeguard the value of the base currency, XHV, echoing the predicament faced by Terra/Luna. The protocol’s structure was aimed at maintaining the stablecoin’s value at any cost to XHV.

Haven deserves credit for its effort to mitigate the hyperinflation risk through Value Backed Shoring (VBS). Nonetheless, this system effectively protects the value of the base coin at the expense of the stablecoin aka the central dilemma. Due to the substantial gap between the market cap of XHV versus all xAssets, the “market cap ratio” remains high and is considered to be in a bad state.

Under the current model, users looking to acquire xUSD need to provide an increasingly large amount of XHV as collateral (>50x XHV value at the time of writing), which is then locked for a certain period. This introduces a substantial opportunity cost into the “1 xUSD = 1 USD worth of Haven” equation. Some users have found themselves unable to convert their xUSD back into XHV, compelling them to sell their xUSD under $1 on exchanges, effectively depegging the stablecoin.

Users in theory could purchase xUSD at the reduced price and effectively profit from arbitrage, but because of the massive capital requirement in XHV needed to onshore and risk associated of locking XHV for the conversion has made this process impractical.

While Haven is relaxing the VBS restrictions, this move raises concerns. If these restrictions are eased, more xUSD could be converted into XHV and potentially sold off, decreasing the XHV value and exacerbating the current problem. This being said, something does need to be done. The Haven project is still under active development and they are still investigating and implementing new features; the issues raised here don’t allude the team. Undoubtedly, the project has been in precarious state for some time.

Despite its challenges, Haven Protocol was instrumental in paving the way for private stablecoins and introduced additional xAssets such as xBTC, xAU (Gold), and xAG (Silver). These additions were enthusiastically received by the community due to their potential value. However, unlike fiat pegs, these xAssets can appreciate in value, placing significant strain on the protocol. Any profits generated come at the cost of XHV holders, as more XHV must be minted to maintain the peg when these assets are converted back into XHV.

The sustainability of such pegs remains unclear. Intuitively, it appears to present high risk for XHV holders and may, at worst, be flawed and unsustainable. One advantage of inflationary pegs, like fiat, is that they reduce pressure on the protocol over time. But assets like xBTC put Haven in a precarious position; a significant BTC bull run could potentially be detrimental for the protocol which is a strange position to be in.

MakerDAO (DAI)

MakerDAO is a decentralized autonomous organization on the Ethereum blockchain, which manages and controls the DAI stablecoin. The DAI stablecoin is soft-pegged to the U.S. dollar and is backed by collateralized debt positions (CDPs), now referred to as Vaults in the Maker system.

CDPs, or Vaults, are essentially smart contracts that allow users to deposit an asset (like ETH) as collateral in return for DAI tokens. This mechanism creates a system where the value of DAI is backed by locked-up assets.

However, this system has proven to be vulnerable in periods of extreme market volatility or blockchain congestion. An example of this is the “Black Thursday” event. During a significant crash in the ETH price, many Vaults became undercollateralized (below the 150% collateral required). Due to the congestion on the Ethereum network, liquidations were triggered to auction off the ETH from the undercollateralized Vaults. However, the congestion resulted in many auctions being won at $0 bids because other users were unable to place their bids, leading to significant losses for the MakerDAO system.

The Zephyr Protocol, following the Djed model, takes a different approach. Instead of using CDPs/Vaults, Zephyr Protocol achieves stability through an in-protocol reserve. This reserve, consisting of the native coin (ZEPH), backs the issuance of the stablecoin and ensures its peg to the U.S. dollar with minimum reserve requirements of 400%.

Contrary to CDP-based models, Zephyr does not rely on CDPs, thereby eliminating the potential for similar “Black Thursday” scenarios. There are no liquidation events, and users aren’t required to ensure that the liquidations work properly, avoiding potential theft of funds from the protocol. By avoiding CDPs and automating as much as possible within the protocol’s mathematical framework, these designs aim to reduce risk exposure to the end users and to insulate the system from issues related to blockchain congestion.