Deep Dive: Stargate Finance

Published in

SMUB Research

11 min readFeb 27, 2023

Co-authored by Reuben Yang, Kai Xuan & Megan Aw

Nothing in the following piece constitutes financial advice—if construed otherwise, NGMI.
All data presented henceforth accurate as of 27/02/23.

Introduction

Macro Overview

Macroeconomic conditions have taken a turn for the better in 2023 with inflation showing signs of slowing. The shift down in the pace of interest rate hikes by the Federal Reserve has provided a boost for the equity markets, with the equity markets rallying after the bottom back in late 2022.

With the cryptocurrency market being closely correlated to the equities market, it has successfully broken out of its slump, with BTC increasing by more than 50% since the lows back in late November 2022. This has resulted in the rise in other cryptocurrencies, with many Altcoins producing more than 100% returns.

An optimistic outlook to the market could certainly aid in the price action of STG. However, it is important to note that any downturn in macro conditions would negatively impact the performance of STG and should therefore be taken into consideration.

DeFi Overview

With the recovery of the cryptocurrency market, the DeFi market capitalisation has also shown positive signs of recovery, with it rebounding 70% since the lows in 2022. The recent charge by the U.S. Securities and Exchange Commission against crypto exchange Kraken for failing to register its staking program as securities further amplifies the potential issues surrounding centralised exchanges, as authorities try to clamp down on these activities which they deem illicit. This could result in users looking for alternatives on chain, where many protocols offer enticing yield from staking. LDO and RPL, the native tokens of Lido and Rocketpool respectively, have increased significantly as they serve as alternatives to the staking offered by the centralised exchanges.

With the recovery of the markets, many users are looking to hop on the next narrative to outperform the market. Interoperability, that is the ability of blockchains to communicate with other blockchains, is gaining traction as one of the narratives to do so. Therefore, STG could prove to be one of the success stories in the midst of this recovering market.

Existing Industry Problem

Presently, there are 2 options for users who interact with DeFi to execute cross-chain asset swaps:

(a) Off-chain, through CEXs, which introduce regulatory, counterparty, and privacy risks
(b) On-chain, through bridges, which introduces all the risks that are associated with bridges.

Fig 1.2 Chainalysis on Cryptocurrency Exploits

In 2021, DeFi protocols accounted for 82.1% of all cryptocurrency stolen by hackers — a total of US$3.1B — up from 73.3% in 2021. Of that figure, 64% (US$1.98B) came from cross-bridge protocols. One particular reason for this significant sum is that cross-chain swaps via bridges require the asset to be “wrapped”. The creation of an intermediary synthetic asset introduces a perpetual risk for users holding wrapped assets — if the bridge contract gets hacked, the wrapped assets turn worthless because holders can no longer swap them back for the native asset. Apart from perpetual risk, “wrapping” assets means more gas fees paid by the user during each cross-chain bridging activity.

Protocol Overview

Stargate Finance

Stargate is a community-driven organisation building the first fully composable native asset bridge, and is the first dApp built on LayerZero. Stargate allows for single-transaction cross-chain swaps and this helps save on gas fees paid by the user. The application of Stargate extends out to yield-farming protocols and this is far-reaching as they can compose Stargate to deploy assets cross-chain, opening up new APY opportunities for the users of these yield-farming protocols.

Through what they term as the Delta Algorithm, Stargate is also the first cross-chain bridge protocol to solve the bridging trilemma, as pictured below:

Stargate’s UVP

Unified liquidity pools

As a novel, composable cross-chain bridge built as the first dApp over the trustless omnichain interoperability protocol LayerZero. It is a user application-configurable omnichain messaging system that runs an ultra-light node to provide the security of a light node with the cost-effectiveness of middle chains. This allows for more secure and capital-efficient native asset swaps by removing the need to ‘wrap’ assets. Next, by leveraging on the Delta Algorithm, Stargate enables unified liquidity pools shared across chains. The Delta Algorithm enables this by seamlessly rebalancing liquidity pools between the originating chain and the destination chain so that the deposited and withdrawn amounts are always equal. Crucially, instead of having each of the supported chains maintain a separate liquidity pool, Stargate has a single, unified liquidity pool per asset for all connections.

Fig 1.4 Stargate vs Interoperability Protocols

Quoting Ryan Zarick, the benefits that the Delta Algorithm introduces are as follows:

“Instead of having, for example, one USDC pool on Ethereum connected only to Avalanche; you can have a pool for a single asset on one chain connected to pools of the same asset on all other chains. This allows liquidity providers to accumulate fees from people moving assets on their chain from seven or more different chains rather than a single one. This means more fees, which means deeper liquidity, which attracts more users and spins the whole flywheel again.”

As Stargate scales by adding more native assets and blockchain network connections, the LP accruing fees will decrease significantly. This is due to the ever-more cross-chain links instead of having ever-more LPs accruing fewer fees from a single connection like regular bridges

Security

Stargate employs a security concept known as “pre-crime” and what this means is:

(a) Break the responsibilities between two different parties: the Oracle and the Relayer

This leverages the security of oracles such as Chainlink, with the additional security layer via the relayer system

(b) Since LayerZero is an open protocol, dApps building on it can choose their combination of oracles and relayers or run their own relayer, taking security into their own hands.

“One of the major problems with bridge hacks is that it’s almost never the consensus mechanism but the smart contracts that get exploited. So someone exploits the endpoint smart contracts and then sends a message to another chain and steals the money. But who delivers the final blow? It’s actually that middle chain — it delivers the death blow because it doesn’t look at the message.”

Thanks to the Delta algorithm, when someone puts $x on the originating chain and attempts to withdraw more than $s from the destination chain by exploiting the smart contract, LayerZero will simply not deliver the message across to the destination chain.

Stargate’s Functions

Fig 1.5 Relationship between the different functions

1. Transfer

All non-STG token transfers incur a 0.06% transaction fee.
Non-STG token transfers may incur a pool rebalance fee depending on how imbalance the source & destination transfer pools are with respect to pool equilibrium weights
STG token transfers do not incur pool rebalancing fees.

2. Pool

Users can add liquidity to token-chain pools (eg USDC-Ethereum pool) and receive either farm-based or transfer-based rewards

In exchange for adding liquidity to a pool, users receive LP tokens (eg S*USDC). These LP tokens represent a proportional share of the pooled assets, allowing the user to reclaim their funds at any time. Note that each time a liquidity pool is used for a transfer, a 2–10 bps fee is collected.

3. Farm

Liquidity providers on Stargate have the option of staking their LP tokens (S*USDC) for STG rewards. These STG rewards can then be staked in exchange for veSTG (vote-escrowed STG) for voting rights in the Stargate DAO.

4. Stake

STG tokens can be staked for veSTG in order to participate in Stargate DAO governance. Voting power is time-weighted — this is beneficial for long-term holders of veSTG as this group of holders will have greater governance weight and control of the protocol.

Revenue Generation

Stargate charges a 6bps (0.06%) fee on all non-STG transfers using the Stargate protocol.

This revenue is then split into three parts:

4bps (0.04%) goes to the Stargate Treasury
1bp (0.01%) goes to the veSTG holders
1bp (0.01%) goes to the liquidity providers

As such, there are two main ways in which one can share in generated revenue from the Stargate protocol, leaving aside token price appreciation. The first would be to contribute liquidity to one of Stargate’s liquidity pools (pool and farm), and the second to directly stake STG tokens for time-weighted veSTG, which would serve the dual purpose of granting voting rights.

Alternatively, a third option appears in the form of rebalancing fees — charged by the platform to incentivise users to maintain an ideal target balance of reserve coins. Users are rewarded for participating in a transaction that refills the token(s) which the protocol is most lacking, and punished for actions that could drain the reserve balance completely. As such, taking incentivised actions to balance the network reserves could pay off in small refund sums, though this method is an inconsistent source of income that should be used only to subsidise one’s planned transactions.

Network Growth Stats

*Sources: Data taken from DefiLlama and TokenTerminal*

Tokenomics ($STG)

The STG token has a hard cap of 1 billion tokens and is distributed as shown below.

The token release schedule is as depicted below, and the next unlock event is on 17 March 2023. One downside that STG faces is the significant unlock events throughout 2023–2025 as these could contribute to increasing sell-side pressure going forward.

It ought to be mentioned that Alameda Research holds roughly 10% of all the STG supply. However, the powder is dry as the Stargate DAO voted in favour of a reissuance of all STG tokens on 15 March 2023 — two days before the unlock — in the wake of the compromising of Alameda’s wallet. It was also mentioned that the Stargate Foundation will create a new multi-sig wallet to safeguard Alameda’s tokens while awaiting the outcome of their bankruptcy process and this would otherwise mean that the unlock should not lead to Alameda dumping their tokens to free up cash flow.

SIP#24 — Market Maker

SIP#24 proposes to appoint Stargate as an MM in order to allow for a better functioning STG market on CEXs to complement the robust liquidity the protocol owns on DEXs. The proposed method for execution is that STG would be made available to a suitable and qualified MM for STG under terms that do not exceed a loan of 8 million STG tokens (0.8% of total supply) for a 24-month period. After 24 months, STG would be returned to or an equivalent amount of USDC at a price of US$0.80 or above per STG. Theoretically, this could create a floor price of US$0.80 for the STG token.

SIP#18 — veStaking Reward Distribution

Currently, STG is staked for voting powers in the Stargate DAO. However, the exact rewards system is still yet to be confirmed. SIP#18 explores a potential reward distribution mechanism and if this proposal goes through and veStaking takes off, we could see the beginning of the Stargate Wars.

Risks

DeFi Risks

Though its main function is to serve as a cross-chain bridge, Stargate is exposed not only to typical bridging risks but also to generic DeFi risks due to its myriad of other features like liquidity pools and LP farms — all of which enhance the duration that tokens would typically be held on the platform. These staking mechanisms expose the user to common DeFi issues like counterparty risk, impermanence loss and so on.

Technological Vulnerability

Since Stargate is still a fairly young platform, it is relatively untested in terms of technological safety and reputation. While the platform has completed three independent audits by Zellic, Quantstamp and Zokyo on the 6th, 15th and 27th of March 2022 respectively, which was the month of its launch, the platform still receives a fair amount of doubt for potential exploits and security lapses. In fact, independent research and security firms like Cobo Blockchain have previously accused the project’s underlying protocol, LayerZero, of updating critical vulnerabilities without making any public announcements — meaning that further lapses may also currently exist, unnoticed by the community.

Centralisation Concerns

Early at the start of this year, Stargate was put under scrutiny for a system that places too much trust in the team’s integrity. Because Stargate relies on the oracle and relayer to be both non-malicious, independent parties, a Twitter user named James Prestwich claimed that the team could make remote changes to bypass this process and have any message they wanted sent across the bridge. Though the team disputed that he was “wildly dishonest”, they did admit that the LayerZero team could make changes if the project was using LayerZero’s “default configuration”. Though the Stargate team has made changes to ensure this is no longer possible, a portion of the community still remains critical of the power and authority held by the team to impact the overall protocol.

Regulatory Concerns

Stargate, as with many other blockchain projects, is at risk of being regulated. With the SEC having declared that most cryptocurrencies are securities (based on the Howey Test: that money is invested for a profit and generated through the efforts of others) and $STG in particular having been initially sold in an auction rather than farmed or earned, there is a decent chance of it being declared a security, should the SEC crack down on bridge protocols.

Additionally, considering how Alameda Research holds such a large stake of $STG and has already filed for bankruptcy, there is a possibility of the court ordering them to liquidate their stake (despite their pledge not to do so until 2025), causing a significant disruption in market price.

Conclusion

As a project, Stargate provides a substantial, unique utility for the end-user via its cross-chain bridge that attempts to tackle the difficult bridging trilemma. To some extent, its ability to maintain instant guaranteed finality is highly optimistic for both its projected user growth and for the protocol as a whole — bringing overall value to its token and ecosystem. With the rise in various alternate chains like NEAR, Aptos and Sui, blockchain bridges will be more critical than ever for users navigating the interoperable blockchain landscape.

Combined with the fact that Stargate has robust governance and staking infrastructure to further engage users, there is profit potential: whether as a pure token investor or as an end-user. With that being said, it is crucial to remember that the LayerZero protocol on which Stargate is built is still young and relatively untested, making technological requirements and potential vulnerabilities still an important concern.

References