In the context of the current bear market, both users and builders in the crypto space have had a rare moment to catch their breath. It’s becoming increasingly clear that, as token valuations return to less euphoric levels, incumbent L1 projects such as Solana and Near are facing new and very real headwinds.
As builders look towards 2023 and beyond, the focus is often placed on their current chain’s sustainability, direction, and product market fit. All this coupled with attractive new opportunities in the space, is leading to an ecosystem shakeup behind closed doors.
dYdX leaving the Ethereum ecosystem to become a sovereign IBC blockchain was a watershed moment for Cosmos. The announcement was unprecedented, especially considering that dYdX is one of the largest trading apps on Ethereum in terms of fees, volume, and community size.
This has seen many eyes turn to Cosmos, the internet of blockchains from elsewhere, along with new opportunities in the form of Aptos, Sei, and Sui. These upstart L1 chains have the beneficial position of learning from the UX and ecosystem development mistakes of previous L1s, with no tech debt or bull market investor hangovers.
The first major team to announce they are making the jump from Solana to build on Cosmos is UXD, the foremost Solana-native stablecoin. UXD has a $15M market cap. With the promise of greenfield ecosystems and new investment, and spurred on by dwindling interest in the previous class of “alternative L1 chains”, the Sei team is anticipating many similar announcements in the months ahead.
What is $UXD?
$UXD is a fully collateralized decentralized stablecoin backed by delta-neutral position using derivatives. UXD Protocol accepts crypto assets, like ETH, and uses the deposits as collateral to short a ETH-USD perpetual contract of equal size. Hence the long ETH spot is balanced by the 1x ETH-USD short. The cumulative value of both the long spot and 1x short positions will always be $1. Due to $UXD’s delta neutral position, $UXD is much better insulated from the price movements of its collateral. If the price of $UXD becomes unpegged in either direction, arbitrageurs will arbitrage the price of $UXD back to the USD peg for riskless profit. This two pronged approach results in a more resilient stablecoin than overcollateralized stablecoin strategies.
What was $UST?
$UST was an algorithmic stablecoin that attempted to maintain a peg with the USD dollar through a “mint/burn” mechanism that was intended to encourage arbitrage. $UST was the stablecoin offering from the Terra ecosystem, which was represented by the $LUNA (now $LUNC) governance token. Terra allowed users to swap LUNA and UST at a fixed price of 1 $UST = $1. This meant that traders were incentivized to arbitrage the price of UST back to the peg by minting/burning to alter the circulating supply of $UST. Increasing supply when $UST is trading above $1 and decreasing supply when it’s trading below $1. LUNA’s crash in May 2022 was a high-profile crypto catastrophe, wiping out an estimated $2 trillion in value (source). In spite of UST’s failure, stablecoins still have an undeniable product market fit in decentralized finance and all of Web3.
How is $UXD different from $UST and other stablecoins?
More Capital Efficiency:
- $UXD is fully collateralized, it always costs $1 of approved assets to mint $1 of $UXD.
- 1 $UXD can always be burnt to redeem $1 of collateral.
- $UST was under-collateralized with an algorithmic peg. (Unsustainable)
- Most decentralized stablecoins are capitally inefficient, requiring a collateralization ratio between 150% to 200%.
Stability:
- $UXD is collateralized by a delta-neutral position (Spot Long + 1x Perp Short)
- The combined value of the spot long and 1x short position is a dollar.
- $UXD has a buy and burn mechanism where $UXD can always be redeemed for the collateral backing it. (No trading necessary)
- $UST also relied on a buy and burn mechanism where its value was inextricably tied to the value of $LUNA.
- $UXD holders had to mint $LUNA and trade $LUNA to exit their positions, liquidity pools on DEXs were quickly depleted.
Decentralized:
- Both $UST and $UXD are decentralized stablecoins, so their collateral is not held by a single custodian.
$UXD is the antithesis of $UST. It is a decentralized delta-neutral stablecoin with an efficient buy-and-burn mechanism, this makes $UXD much more resilient and peg-stable. $UST’s fully collateralized stablecoins are always redeemable for 100% of the underlying assets even during a “bank run” scenario like with $UST.
UXD has recently announced that they will be moving to the Cosmos ecosystem by deploying on Sei. Sei is the fastest L1 blockchain and it is DeFi-specific. Sei offers multiple DEX optimizations, such as its built-in order matching module, the fastest finality in web3, and MEV prevention via frequent batch auctioning. This native stablecoin integration will provide a stable unit of value for Sei users.
If the price of $UXD becomes unpegged in either direction, arbitrageurs will arbitrage the price of $UXD back to the USD peg for riskless profit. However, both UXD and UST are decentralized stablecoins, so the collateral is not held by a single custodian.
For many teams, the pressure of building in public rarely allowed time to pause and question their direction. In quieter times, larger changes of direction are possible, and these conversations are likely to emerge from behind closed doors soon.
