Gyroscope is Different, Part 1: Meta-Stablecoins
Gyroscope has the best design and technology today for decentralized stability. Here’s how we reinvent the stablecoin.
At Gyroscope, we have a unique background on DeFi, having ourselves done the cutting edge research on every approach, which puts us in an ideal position to build a decentralized stablecoin. We have designed Gyroscope for DeFi power users who want the best decentralized stability. In this sequence of posts, we illustrate how the Gyroscope design choices shape up against the wider space of stablecoins.
This article is Part 1 on meta-stablecoins. Also see Part 2 on algorithmic stablecoins. Join us for Part 3 on custodial and leverage-based stablecoins coming up next.
Meta-stablecoins are stablecoins that are composed of a basket of other stablecoins. The idea is that the basket diversifies the risks of the individual stablecoins. To some extent this is true, and to some extent the stablecoin faces a new type of risk, called composability risk, or the risk that a problem in one system can cascade into other systems.
Composability Risk in Meta-stablecoins
In one type of meta-stablecoin, the basket takes the form of a liquidity provider (LP) position in an automated market maker (AMM). Since these pools make markets on a decentralized exchange (DEX), the basket weights change, in token terms, with exchange demand. As a result, the meta-stablecoin takes on LP risk in the AMM, on top of the underlying stablecoin risks.
For instance, yUSD is a stablecoin issued by yearn based on positions in the yCRV Curve AMM pool, composed of USDT, Dai, USDC, and TUSD. Should a stablecoin fail in this basket, the yCRV pool will devolve into holding only the failed stablecoin, with the value of yUSD cascading to zero. In addition, the yCRV pool deposits assets into Aave and Compound, and so the failure of either of these systems would cause a similar cascade in yUSD value.
As a result of all of these choices, the yUSD stablecoin faces massive composability risk, which amplifies problems in any individual component. To be fair, Curve pools are intended to earn yield by taking on this risk. However, the massive level of composability risk is still likely to surprise normal users who think of yUSD as a stablecoin or savings alternative, and better risk-adjusted yield is certainly possible.
A similar result applies in mStable though with a little better risk control. The failure of any of Aave, Compound, or three stablecoins (e.g., the custodial stablecoins in the basket) would cascade into the failure of mStable. Further, the failure of a single stablecoin alone would cascade into a 33% wipeout of mStable value.
Gyroscope solves this, while maintaining capital efficiency, by stratifying composability risks. The Gyroscope reserve is separated into lower-level vaults (triangles in the above figure) with carefully contained risks. There are little overlapping risks between the vaults. The failure of an individual vault (if a triangle is removed in the above figure) then has no effect on the remaining vaults. If vaults should fail, the Gyroscope system will remain stabilized at $1 through the peg coordination mechanism (described fully here). After a vault failure, the Gyroscope reserve can also recover back to full strength through the yield earned on reserve assets in the remaining vaults.
A meta-stablecoin’s basket can also have static weights in token terms. This more resembles an exchange-traded fund (ETF), where the meta-stablecoin can always be created or redeemed at the static proportion of underlying tokens. The Reserve Protocol stablecoin works in this way. Unlike Gyroscope, however, this mechanism is unable to maintain the peg if a basket constituent fails.
Governance Extractable Value
A remaining issue common to all decentralized stablecoins is sound governance. This surfaces in Governance Extractable Value (GEV). In DeFi systems today, it is commonly possible for governors to derive better payoff from actions that are counter to protocol health. For instance, by introducing questionable collateral types, seeking short-term profits, or even outright malicious actions to steal user funds. The risk is amplified in DeFi, where governors are practically anonymous, compared to traditional corporate governance, which is backed by the legal system.
A common GEV mitigation today is the use of time delays before governance actions take effect. This aims to allow users time to withdraw funds from protocols ahead of a malicious change. In terms of protection, this is commonly not enough for two reasons. First, many DeFi systems, such as Dai fundamentally don’t have exit liquidity since Dai can only be redeemed by the vaults that created it. For further discussion, check out our work on this type of governance problem in Dai, stablecoins more widely, and DeFi in general. Second, timeframes tend to be quite short, and users who aren’t constantly tracking very technical smart contract details (e.g., supposing you’re an engineer in the first place, you could be on vacation) remain unprotected.
Among current meta-stablecoins, yUSD has zero GEV protection: yearn governance is run by a multisig of governors that is able to arbitrarily change the strategies of vaults, making it possible to maliciously steal collateral. Further, yearn governance has no time delay! mStable is a bit better with a week time delay. And the Reserve system has not yet entered its full governance phase. Ultimately, the level of GEV in these systems, and so the size of the problem, remains an open question.
We do not think that current GEV mitigations are adequate to protect users. Limiting GEV should be a primary focus for DeFi protocols. We are pioneering this in the Gyroscope governance mechanism with the use of checks and balances. For instance, Gyroscope uses Conditional Cashflows, which only accrue to governors in the long-term if the protocol remains healthy. And Gyroscope truly puts power into the hands of Gyro Dollar holders with Optimistic Approval, an option to veto during the time delay. If enough users scramble to protest a malicious governance action, they are able to block it. Check out our documentation to read more about how Gyroscope governance provides the best incentive alignment in DeFi today.
Read on to Part 2 on algorithmic stablecoins. And stay tuned for Part 3 where we will compare with custodial and leverage-based stablecoins.
What to do next: become a Gyronaut!
- Follow us on Twitter @GyroStable
- Join our Discord!
- Try out the Gyroscope testnet (guide here)! And watch for coming announcements
- To dive deeper on composability risk and GEV, read our DeFi SoK and Stablecoins 2.0 papers
Thanks to Jun-You Liu for discussion on yearn vaults and many other DeFi enthusiasts and researchers for discussion on governance extractable value.
