Alpaca Finance New Product Proposal: Stablecoin on Stacks
Product Overview
We propose to create a decentralized stablecoin product on Stacks. Its main feature will be to allow users to use Bitcoin on Stacks as collateral to mint stablecoin. Key value propositions for our stablecoin will be:
- 1.) Capital Efficiency
- 2.) Interest-free (i.e., no borrowing interest)
- 3.) Robust pegging mechanism.
Rationales for Selecting Stablecoin
We have evaluated many opportunities, and explain the consideration factors for selecting this product below.
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Base Layer Protocol: One of the challenges with Alpaca leveraged yield farming product is that it must be built on top of another protocol - i.e., DEX, which makes the product susceptible to uncontrollable risks when there are changes in the underlying protocols. Moreover, for the LYF business case to make sense, a large DEX is required to support the additional TVL from LYF. But with the stablecoin proposed here, there would be no dependencies on other protocols. This is especially useful because we will likely be one of the first protocols to launch on Stacks after the Nakamoto upgrade.
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Current Market Regime: It’s clear we have now entered a new bull market with BTC back at the all-time-high range, and demand for leverage to go long has been high. Building a product that serves up this demand has a high chance of success, in our opinion.
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Team Experiences / Expertise: Our dev team has prior experience building a stablecoin (AUSD.) We have the know-how on the product’s key risks, design trade-off, and why AUSD didn’t have a strong traction. At the core, the stablecoin product is a form of leveraged product, which we have strong expertise in. Taking learning from AUSD and other products, our team is confident we can build a high-quality and safe product for our users.
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Team’s belief / preferences: Among the products considered, the working team is most excited about this opportunity and believe it has the highest chance of becoming big. A motivated team goes a long way when building a new product when the rough patches will eventually come.
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Size of the Opportunity: The market size for decentralized stable coin is large, and as will be shown in the analysis in the later section, a small market share could already result in substantial protocol revenue.
Rationales for Selecting Stacks
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Green Field: Stacks ecosystem represents a green field opportunity, with a nascent ecosystem, giving legitimate and capable teams a chance to claim a first mover advantage.
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Tapping into the Bitcoin ecosystem: We believe Stacks represents a massive untapped potential into the Bitcoin ecosystem, due to only ~1% of Bitcoin currently being deployed into smart contracts (i.e., wBTC is less than 1% of the BTC circulating supply). sBTC, developed by Stacks, is aiming to change that and create a new Bitcoin economy with many improvements over the other tokenized Bitcoin solutions available currently:
– No Wrapping / Pegging fees
– No Custodial fees
– Inherits 100% of Bitcoin’s security budget
– No oracle or alternative L1 chain risk
We believe these properties give sBTC a high probability to gain adoption among the BTC community members. Note also that the lack of adoption of tokenized BTC such as wBTC, etc. could be from the fact that it adds nothing to the Bitcoin ecosystem, but instead adds value to the other networks (e.g. Ethereum) which are considered as rivals by some bitcoin maxis.
- Upcoming Upgrade: Stacks is a Bitcoin Layer2 that enables decentralized apps and smart contracts.
– Stacks is a blockchain linked to Bitcoin by its consensus mechanism that spans the two chains, called Proof of Transfer. This enables Stacks to leverage Bitcoin’s security and enables Stacks apps to use Bitcoin’s state.
– Bitcoin is Stacks’ secure and robust base layer where all transactions are settled, and Stacks adds complex apps and smart contracts. Stacks apps can interact with Bitcoin state, so you can have an app that uses Bitcoin as its currency.
With the upcoming Nakamoto Release (Approx. April before halving), Stacks’s network performance and usability will improve greatly. The most important one being the block production time which will no longer be tied to the Bitcoin block time (~10mins.) It will be under a fixed cadence instead (in seconds.) This fast block time will make the UX on par with other chains. For more info on the Nakamoto release, please see Stacks Docs here.
- Launch Timing: Our development timeline should coincide with the launch of sBTC and Nakamoto Release which will enable our product to be one of the first protocols to go live on it and having the first mover advantage. This was proven a successful strategy with the launch of Alpaca back in 2021.
Product Details
Users will be able to deposit Bitcoin as collateral to take out a loan (i.e., mint stablecoin), interest-free. The stablecoin is backed by users’ deposited collateral, stability pool, and the collective borrowers as last resort.
Interest-Free Borrowing
We will charge a one-time loan origination fee to users when they borrow stablecoin. Only paying a one-time loan origination fee is one of the killer features in our opinion as borrowers are not susceptible to interest rate risk during the lifetime of the loan.
This is especially true during a bull market where the demand for leverage goes up significantly and there could be periods where the borrowing interest rate spikes or remains stubbornly high for a period of time.
How is peg achieved?
The issue with the original AUSD:
AUSD’s lack of adoption was mainly due to its ability to hold the $1 peg. While the AUSD system was safe (i.e., overcollateralized and fully backed at all time), it couldn’t hold peg because there was no robust direct redemption framework available.
While we had a stable swap module in place, it required a stablecoin treasury to be built up first (i.e., someone needs to first mint AUSD via a stable swap module) before it can be used for redemption (AUSD → BUSD.) In this scenario, arbitrageurs were reluctant to step in and buy AUSD when it was < $1, because they did not know how long they had to hold onto AUSD before it returned to peg.
A way to solve this problem is to allow for a direct redemption of the stablecoin for an underlying asset. One way this can be achieved is by building up a treasury to be used for direct redemption. One example of this would be FEI where they raised a massive amount of treasury to allow for a direct redemption from FEI → USD. However, building up a large enough treasury is no easy feat, and has only been achieved through a fund raise in conjunction with token sales.
How will we keep the new stablecoin’s peg?
We propose a way for direct redemption via the ability to close out debt positions by anyone. Specifically, anyone who holds our stablecoin (not just the debt position owner) will be able to redeem it at $1 worth of collateral, net of fee. This means an arbitrageur can step in anytime the stablecoin price < $1 - fee, and would keep our stablecoin hard pegged to that price.
In order to determine which positions will be (partially) closed out when the redemptions occur, our smart contract will sort all existing positions by their risk level (collateralized ratio) and close the positions with the highest risks first. This method also has the benefits of reducing the overall risk level of the protocol.
For debt holders, if their positions are closed, they will forfeit the value of their collateral equivalent to the amount of stablecoins redeemed against their positions. In exchange, they do not have to return the stablecoins. Debt position owners can lower the risks by either partially paying back the debt or adding additional collateral to their positions to prevent it from being redeemed againsts.
Conversely, if the price of stablecoin is > $1, an arbitrager can deposit collateral, mint stablecoin, and sell in the open market.
How does Stability Pool work?
Assets in the stability pool are used to pay back debt for liquidated positions. When a liquidation happens, stablecoin in the stability pool is used to close the debt position (i.e., burn) and the position’s collateral is transferred to the stability pool. Over time, the collateral assets (e.g., BTC) in the stability pool will grow and stableoin will decrease, as liquidations happen.
Instead of requiring technical sophisticated liquidators in the past, this model will allow users of all technical levels to participate and support the protocol by becoming a liquidator. Stability pool depositors will earn a liquidation fee which is the source of yields.
Size of the Prize Estimation
One of the key questions is also " how big is this opportunity? "
While there are many factors, we can get an estimate of the size of the prize by triangulating it in the following ways:
1. Top-Down Estimation
- The total market cap of BTC is currently ~$1,300Bn USD
- Assumes 1% of the total BTC supply will be tokenized on Stacks (equivalent to wBTC)
- Assumes 50% is deployed as collateral in lending protocols (vs. deploying in DEX LP, staking, etc.)
This suggests the total size for wBTC collateral is to the magnitude of ~$6.5Bn USD. A couple percent market share of this pool would already make the opportunity interesting. We believe that TVL in the hundred of million of dollars is achievable in the medium to long term.
2. Comparables
- We look at a comparable protocol and estimate that the annual revenue can be in the millions of dollar range
- Full analysis here: AUSDv2 Revenue Model - Google Sheets
Resources and Timeline
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We estimate that the development effort will take ~3 months to complete and we are requesting a budget of $150k USD, which will be funded from the collected fees from BUSD conversion (AIP-29). A more detailed timeline and development plan will be provided if this initiative gains support from the community.
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If actual spend is less than the allocated amount, the remaining budget will be released back to be used for other initiatives as decided by the Governance process.
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We will need additional budget for launch incentives & marketing at the time of launch, which could come from a combination of Warchest and other sources.
FAQ
Q: What are the key risks?
A: Some of the key risks for this product include:
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Lack of Adoption: We rely on Stacks’s ability to attract TVL on its chain. A low / slow adoption rate would directly impact our protocol’s traction.
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Delay in Nakamoto Upgrade: The usability of Stacks is heavily dependent on the Nakamoto Release. A delay / issue with this major upgrade would mean a delay for us to launch our product as well.
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Development Delay: Stacks uses Clarity as its programming language, which is a different framework from Solidity / EVM that our team is familiar with. While we are confident in our dev team’s ability to pick up the new language very quickly, there is a risk that the development timeline will be longer than we expect. While this is a hurdle, it can also be considered as a moat as other protocols wanting to compete with us cannot just port over their code directly to Stacks but will have to spend the resources and time for the development as well.
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Smart Contract Security: Clarity is used by fewer projects, thus attacks vectors and security patterns are not yet as well known.
Q: Is this model proven? How do you know it will work?
A: We base some of the protocol mechanics from Liquity which has $800Mn + TVL, which has been live since the last market cycle.
Q: Why not LYF on Stacks?
A: Leveraged Yield Farming is a “second layer” protocol. Specifically it needs to be built on top of strong base layer protocols such as spot DEX or pool-based Perp DEX (See Vaultka)
Specifically, we need to establish DEX with decent yields (15% - 20%+) and TVL ($100Mn+.) We are very fortunate to have Pancake Swap serving that role on BSC.
So in short, this angle can be something we explore in the future when winners start to emerge in the future for the DEX category.
Q: How will the revenue from the new product be allocated?
A: While the specific numbers haven’t been defined, we expect to follow a similar framework with the other Alpaca product. That is, the revenue will go towards - ALPACA stakers, liquidity providers, and development funds.
Q: Can we somehow incorporate point system as incentives? Many protocols are doing that.
A: On the idea of using “point system” to attract users, what could make sense is a play on the Stacks’s potential ecosystem airdrop. I.e., It’s likely that Stacks will do some sort of potential airdrop to the early users in the future. We can allocate points to our users with a promise that any airdrop from Stacks to the protocol (e.g., like the one that Alpaca got from PYTH) will go to the point holders. The specific design of the point system is secondary level question at this point. Another potential idea is to have a temporary outsized revenue sharing to early adopter. E.g., We promise a boosted percentage of the protocol revenue for points holder for the first few months. Then the percentage sharing would revert to normal. Because the revenue will be unknown and will depends on the adoption itself, this can create a reflexive behavior / positive flywheel.
