Sperax USD: a Hybrid Stablecoin with a Twist

The following report was written by Messari Hub Analyst(s) and commissioned by Sperax, a member of Messari Hub. For additional information, please see the disclaimers following the article

In their most basic form, stablecoins are the mediums of exchange that enable the usage of traditional stores of value, like fiat currencies, across the cryptoeconomy. We have seen DeFi protocols engineer stablecoins in a variety of ways in an attempt to create scalable, capital efficient, and governance minimized currencies that mimic our real-world store of value assets. In order for these stablecoins to become yielding, users must take an extra step and lend them out across DeFi. This action allows the stablecoin to become a capital asset and behave more like a high-interest savings account rather than a medium of exchange.

An Interest-Bearing Store of Value

To date, we have not seen a decentralized stablecoin that delivers a native yield to its holders. Sperax is aiming to change that with the upcoming launch of its stablecoin Sperax USD ($USDs). Sperax is a Silicon Valley-based blockchain company with the mission to build DeFi infrastructure accessible to anyone in the world. Sperax's stablecoin model will allow users to deposit or redeem $1 of protocol value at any time in exchange for 1 Sperax USD. Similar to FRAX, the collateral backing Sperax USD is composed of exogenous collateral, in the form of external cryptoassets, and endogenous collateral, in the form of SPA - Sperax’s native governance, volatility absorption, and value accrual token. The balance between exogenous and endogenous collateral will be determined by the protocol’s dynamic collateral ratio.

What differentiates Sperax USD from other decentralized stablecoins is that it will be a natively yielding asset. Sperax will deploy its exogenous collateral to a yield aggregator and regularly airdrop the interest revenue to Sperax USD holders, giving Sperax USD properties of a capital asset. This property will incentivize holders to keep Sperax USD in circulation as well as provide an additional monetary policy lever for the Sperax DAO.

Sperax USD Composition

The target collateral ratio (𝛘) will determine the composition of the value backing Sperax USD at any point in time and will be controlled by the following equation which will favor algorithmic stabilization when Sperax USD trades close to its $1 peg and as it matures as an asset over time:

Source: Sperax USD Whitepaper

Sperax has identified optimal values for the above parameters to make the protocol responsive to rapid price swings and to target a collateral ratio reduction of roughly 1% per month. These parameters will ultimately be governed by the Sperax DAO.

The Sperax foundation plans to launch Sperax USD with a conservative 95% collateral ratio to minimize the initial volatility attributed to SPA. Despite this precaution, Sperax USD will be exogenously collateralized by a basket of cryptocurrencies that includes USDC, USDT, UST, ETH, and WBTC. The inclusion of ETH and WBTC could create greater volatility at launch compared to competitors like Iron Finance and FRAX who relied solely upon USDC at launch. Future collateral types will be decided upon by the Sperax DAO. An asset’s volatility and its probability of under-collateralization will be key factors for determining these new collateral types, but the goal will be to optimize for assets that experience high growth and low correlation with one another.

Stability Levers

The arbitrage opportunity created when Sperax USD trades above or below $1 will serve as the base stability mechanism for Sperax USD. While the arbitrage will be left to be carried out by market participants, Sperax has three levers it can use to incentivize the market to facilitate the arbitrage and maintain the Sperax USD peg.

Dynamic Collateral Ratio

As mentioned before, the weighting between Sperax USD’s exogenous and endogenous collateral is a dynamic target that will change in response to market fluctuations. In times of market expansion, the price of circulating Sperax USD will rise above its peg as a result of its inflated collateral value. In response, the collateral ratio will decrease and Sperax USD will be backed by a greater proportion of SPA value. Arbitrageurs will be able to mint new Sperax USD, sell it for a premium on a decentralized exchange, and drive the price down back towards its peg through an expansion of the circulating supply. The greater reliance on SPA will result in a greater proportion of SPA burned when Sperax USD is minted.

When the market contracts, the price of circulating Sperax USD will fall below its peg from the reduction in collateral value. The collateral ratio will increase and Sperax USD’s value will rely more upon its basket of exogenous crypto collaterals. Arbitrageurs can buy Sperax USD at a discount in the open market and burn it to generate a profit. The reduced Sperax USD reliance on SPA during market contraction will mean a smaller proportion of SPA will be entering the market when Sperax USD is burned. Since the collateral ratio is programmed to target a collateral ratio reduction of 1% per month, Sperax USD will gradually rely more upon SPA for stability as the protocol matures. This will also put deflationary pressure on the SPA token as the protocol will, on average, be burning a greater proportion of SPA for newly minted Sperax USD.

Sperax USD Savings Rate

In the spirit of capital efficiency, Sperax puts its exogenous collateral to work in the broader DeFi ecosystem. When users mint Sperax USD, their exogenous collateral is deployed to a DeFi interest protocol and earns interest. Sperax will initially use Aave but will eventually create its own yield aggregator. In order to become yielding, Sperax USD needs to have been minted for at least 7 days. After this initial lockup period, the interest revenue generated by the yield aggregator is collected by the protocol and distributed to Sperax USD holders on a weekly basis. As a result, Sperax USD holders are directly incentivized to keep the stablecoin in circulation.

While the amount of interest revenue generated by the yield aggregator will be variable and out of Sperax’s control, it is still able to influence the interest revenue passed on to Sperax USD holders. Sperax will boost the overall interest payout with its SPA reserves in order to attract Sperax USD liquidity and compensate for the risk of a new protocol. The interest subsidy will also act as a mechanism to stabilize the protocol’s average short term return with a slower moving long term return. The idea here is that a less volatile rate of return will create a stickier stablecoin and lower the velocity of the money supply.

The SPA reserved for interest subsidies will be hard capped. As Sperax USD matures, the hope is that SPA’s value will become more established and the SPA subsidy will no longer be necessary to incentivize Sperax USD liquidity. This means that the maximum long-term savings rate cannot exceed the rate achieved by the yield aggregator if SPA is to remain sustainable. To still maintain control of the interest rate for Sperax USD holders, Sperax could withhold a portion of the revenue generated by the yield aggregator. This would provide another way to incentivize users to burn Sperax USD when its price falls below its peg. Since the interest rate passed through to holders would be less than what could be generated from interacting directly with the yield aggregator, users could burn Sperax USD and seek yield directly from the yield aggregator.

Dynamic Swap Fees

To combat the volatility produced by monetary expansion and contraction, Sperax charges dynamic fees to mint or redeem Sperax USD. The base fee for either action will begin at 0.1% for a given transaction. The minting fee is designed to prevent excess minting of Sperax USD and will increase quadratically when the 3-day average price of Sperax USD falls below the $1 peg. The purpose of the redemption fee is to defend against a bank-run situation that depletes the amount of exogenous collateral backing Sperax USD. The fee will increase exponentially when the 3-day average ratio of Sperax USD redemption volume to Sperax USD minting volume exceeds a specific threshold. The beginning threshold will be determined by the Sperax Foundation’s simulations but will be controlled by the Sperax DAO in the future. The increased redemption fees will also drive more revenue to SPA stakers. This price barrier will help to mitigate the negative feedback loop exhibited when market participants expect SPA to depreciate and dump it on the open market, leading to a further depreciation in SPA value. Therefore, an increase in redemption fees should not only make it more expensive for redemptions to occur and slow the contraction of the Sperax USD supply, but it will also result in more value accruing back to the SPA token when the market takes a dive.

As with any other algorithmic stablecoin, this model is not perfect and relies upon price shocks to be relatively short lived and impermanent. However, when price shocks do occur, the slowed expansion and contraction will decrease the probability of a flash crash scenario similar to the recent Iron Finance meltdown since the protocol’s other stability mechanisms will have more time to kick in and rebalance the system.

Mitigating Insolvency

One of the greatest problems all stablecoins face is the potential for protocol insolvency. This occurs when the market value of a protocol’s assets falls below the value of its circulating stablecoin supply. Collateral-backed stablecoin models use overcollateralization to defend against the risk of insolvency. Should the value of the collateral fall too close to the value of the protocol’s debts, the protocol will liquidate collateral to cover a portion of the debt and remain solvent. Since Sperax USD is undercollateralized by design, Sperax does not have the luxury of a collateral buffer. Instead, protocol insolvency is only mitigated by faith in SPA’s value.

To protect against insolvency, Sperax USD will use separate minting and burning ratios when the aggregate collateral ratio (total value locked / Sperax USD in circulation) falls below the target collateral ratio. When this happens, Sperax will release a greater proportion of SPA to arbitrageurs and retain a greater portion of its exogenous collateral. In turn, the burning of Sperax USD will reduce its circulating supply and push the collateral ratio of the remaining supply back up towards its target collateral ratio.

Design Drawbacks

Sperax’s approach to protocol insolvency comes at the expense of existing SPA holders who are diluted from any excess SPA inflation. While the amount of SPA reserved for interest subsidies will be capped, the SPA reserve to mitigate protocol insolvency needs to be uncapped to ensure proper functionality. This will act in a similar manner to Maker’s MKR inflation when the protocol is forced to flush bad debt from the system. In order for the value of SPA to continue to prop up the protocol, the combination of swap fee revenue and long-term SPA deflation must outweigh the inflation caused by insolvency mitigation. This will be more difficult in the early days for Sperax USD. As such, at launch the initial collateral ratio (95%) will rely almost exclusively on exogenous assets, resulting in a small amount of SPA supply burned. Since the collateral ratio is designed to decrease over time, the amount of SPA burned should slowly increase in tandem with Sperax USD supply expansion.

Another drawback surrounding the Sperax USD model deals with how the collateral ratio is adjusted. Similar to the V1 version of FRAX, the Sperax USD collateral ratio is independent of SPA market liquidity. This contributes to a negative feedback loop in SPA’s price when users redeem Sperax USD and immediately dump their newly minted SPA onto the market. If there is insufficient liquidity, the increased supply will drop SPA’s value and the process will repeat. Sperax’s use of its dynamic swap fees will help to mitigate this problem in the short term, but in order for the protocol to grow sustainably, it will likely need to follow FRAX’s adoption of a growth ratio to determine collateralization ratio adjustments. This would mean that the collateral ratio would decrease as SPA liquidity grows relative to the supply of Sperax USD. Assuming redeemers immediately sell newly minted SPA, it would only increase SPA reliance when the market can handle an increased SPA supply without experiencing slippage.

A more speculative area of concern is that Sperax USD could face a crisis of identity when it is released into the market. Its blend of properties from both capital assets and store of value assets could lead it to take on different roles based on market conditions. When interest rates are high, Sperax USD will likely act more like a savings account. When interest rates contract, Sperax USD should function closer to a medium of exchange. This constantly changing behavior would be contradictory to the predictive nature of stablecoins, but maybe that is the point of this monetary experiment altogether.

The Road Ahead

The upcoming launch of Sperax USD will serve as Sperax's largest milestone to date. Up to this point, there was no “test in prod” for Sperax USD. Instead, the foundation relied upon thousands of simulations and test models to determine the appropriate parameters for its stability levers and algorithmic backing. The original stability mechanism for Sperax USD was developed by a group of Sperax researchers who previously helped to architect Luna’s Terra stablecoin model. One of these team members, Marco Di Maggio, is a Harvard Business School professor and is one of the most respected algorithmic stablecoin researchers in all of crypto.

Following the deployment of Sperax USD, the Sperax Foundation will shift its development work to roll out a set of synthetic derivatives. Protocol-developed derivatives will allow users to participate in active investment strategies rather than the de facto passive return strategy generated by simply holding Sperax USD. This will be the next step for Sperax to achieve its mission of becoming a decentralized hub for anyone in the world to build wealth-preserving financial products.

Source: Sperax.io

Sperax will initially launch Sperax USD and its derivatives on the Ethereum network. In the coming years, the Sperax Foundation will transition Sperax USD and its associated applications to the Sperax smart contract platform. Currently under development, this underlying chain will leverage the monetary system built upon Sperax USD and its various stability levers. If successful, a Sperax USD based financial ecosystem would likely function very differently from any system we have seen before considering its unique properties as both a capital asset and a medium of exchange.

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