Minting Synthetic Tokens on the Blockchain for Profit
In the Blockchain universe, miners are stakeholders that secure the blockchain. They work together to confirm and add transactions to a public ledger in a manner that is impractical to change by any one entity. In return, miners earn transaction fees and blockchain coins.
Minters perform the same sort of function at the application layer. Token Minters are a new class of players that use a programmable blockchain’s coin (like ether) to secure the value of synthetic tokens.
In return, they get a share of the transaction fees earned by contracts using the token. This transaction fee is distributed in the form of a market traded reward token called the TOC. Token Minting also presents opportunities for minters to make a trading profit by timing the selling and buyback of minted tokens.
Token Changer is a blockchain platform for distributed financial applications. We design, build and host a wide variety of DApps. From simple token trading DApps to complex applications. This article describes the DApp implementation of the Midas Exchange Protocol.
Midas (developed by Token Changer) defines a reference exchange protocol for minting synthetic tokens on any programmable blockchain.
Because, we intend to deploy the first minting DApps on the Ethereum blockchain, the rest of this paper uses Ethereum and ether interchangeably for blockchain and blockchain coin.
What are Synthetic Tokens?
Synthetic tokens are pegged to the open market price of real assets and backed with valuable blockchain coins like ether. Their primary utility is for use in short-term transactions.
Synthetic tokens solves three important problems.
(1) How to tokenise off-chain assets on the blockchain
(2) How to create cryptocurrency tokens with a stable value
(3) How to represent value across blockchains
A much more detailed analysis of some some of these problems, including current and future solutions can be read here and here.
How are Synthetic Tokens Created?
Using the Dollar minting DApp on the Token Changer platform, the minter deposit’s Ether. In return, the minting DApp uses a set mathematical formula to issue ERC-20 Dollar tokens to the minter. The Ether deposited by the minter in the contract secures the value of the tokens until the tokens are burnt on the DApp.
The Dollar example above is used for illustration purposes. Minters can mint a wide variety of fiat currency tokens on the Token Changer platform. Minted tokens must be burnt to release the coin that secures its value.
Let’s start explore the protocol mechanics by looking at the minting cycle.
The Minting Cycle
After minting tokens, you have two options, sell or burn the tokens. You can decide not to sell and burn the tokens. If you decide to burn the tokens after minting, the DApp will refund the ether used to secure the burnt tokens. But, it is always advisable to sell the tokens once minted since utility is the primary purpose of minting the tokens in the first instance.
Synthetic tokens have many use cases. This range from cryptocurrency trading, money transfer, forex trading and e-commerce. Minters put tokens in circulation by selling at the tokens.
At some point, the minter will like to get back the ether used to secure the value of the minted tokens. The way to do this is to buyback the minted tokens from the open market and burn it.
Minters make trading profit by buying back the minted tokens at a lower price than the sell price. So, buy back timing is critical. Minting is particularly suited for those that want to hold Ether for long lengths of time.
Storage Fee
Storage fee is determined on a ninety-day rolling basis. Storage is free if the holder transfers out 95% of inflows during the ninety-day time frame. Users can hold on to synthetic tokens received within the ninety-day free storage period. Midas imposes a steep storage fee for medium to long-term storage.
Storage fee is charged on the token balance of the address. In extreme cases, this fee is up to 60% of the balance.
Collateral
Each synthetic token that is in circulation is always backed by Ether until the synthetic token is burnt. Minters deposit Ether to create synthetic tokens.
When a minter sells a token, the Ether proceed is also held as collateral until the minter buys back the token. So, collateral has two elements. The Ether deposited to mint the token. And the Ether paid to the minter by the buyer of the token.
In extreme conditions, the one to one parity between the synthetic token and real asset is lost. This happens when the value of Ether falls by 80% or more against the real asset.
As seen on the chart above, the price of bitcoin (btc/usd) or ether (eth/usd) has fallen below 80% before. These are market over reactions and not black swan events. When price moves this way, synthetic token contracts become technically insolvent as long as price remains below 80%.
Users should not be concerned about temporary insolvency since the equivalent of a bank run is impossible. Minters are incentivized by the profit motive to keep buying back synthetic tokens at the market price of the real asset.
Token Restrictions
Money laundering and transmission laws place restrictions on the transfer of synthetic tokens. Only licensed financial institution DApps on the Token Changer platform can be used to move value off the platform. This legal framework ensures the long term viability of synthetic tokens.
The case for restricting transfer is further strengthened by the collateral mechanism. The ether proceed from the sell of minted tokens is a critical collateral component. Without restricting transfer, the collateral mechanism will be gamed.
Implementations
Synthetic tokens can be minted to represent the value of any market traded asset. Our initial focus will be to create synthetic tokens for fiat currencies. The first synthetic token that implements the Midas Protocol is the Ethereum Dollar. This token is an ERC-20 token that has parity with the United States Dollar (USD).
