Proposal for Interprotocol aUSD Distribution Scheme (IADS)

Context

Acala’s aUSD ‘Honzon’ protocol is a decentralized liquidity facility for the Polkadot and Kusama ecosystem, over-collateralized with a basket of crypto assets to generate a native, multichain stablecoin - aUSD - as a hedging tool, routing asset, and medium of exchange.

We are at the very beginning of growing a native multi-(para)chain ecosystem built on and secured by Polkadot and Kusama.

  • aUSD on Acala has $65M worth of collateral assets (DOT, LDOT, LCDOT, ACA), and $4.4M aUSD generated, with ~1,477% collateralization
  • aUSD on Karura has $12.5M worth of collateral assets (KSM, LKSM, KAR), and $3.8M aUSD generated, ~329% collateralization
  • Total debt ceiling on Acala is $66M, where debt ceiling for DOT is $50M, LCDOT is $6M, LDOT is $5M, ACA is $5M
  • Total debt ceiling on Karura is $33M, where debt ceiling for KSM is $25M, LKSM is $5M, KAR is $3M

The required collateral ratios are conservative due to market volatility and liquidity available. Debt ceilings for DOT or KSM derivatives and ACA/KAR are set at a low level, as it is still a early stage to bootstrap liquidity of LDOT-like derivatives, although they are more desirable collateral assets (compared to plain DOT/KSM) as users can continue to stake DOT/KSM while drawing liquidity out of them to use elseware. See Gauntlet’s Acala dashboard here.

aUSD has been growing steadily and organically since launch. There is increasing demand for the aUSD stablecoin in the ecosystem while, at the same time, a shortage of stablecoin liquidity exists.

Interprotocol aUSD Distribution Scheme (IADS)

With Polkadot and Kusama’s multi-chain capabilities, aUSD can serve not only the local trading venues such as Taiga’s stableswap 3-pool on Karura, but also remote venues on other parachains via XCM. Trading venues are critical infrastructure to facilitate efficient markets and medium of exchange, help maintain a healthy stablecoin peg with ample arbitrage venues, and to serve as a liquidation backstop for aUSD and money market protocols.

IADS V0 is being proposed to launch as a new approach to providing liquidity into stableswap protocols like Taiga protocol. IADS will directly generate aUSD to be deposited into the Taiga 3-pool to improve liquidity efficiency and aid with keeping aUSD pegged to $1. This aUSD minted by IADS will be backed by 3USD, the LP token from the USDT-USDC-aUSD 3-pool.

This essentially allows the aUSD protocol to treat Taiga as an aUSD liquidity distributor, while the stableswap pools can facilitate arbitrage of stablecoins.

There is no stability fee (interest rate) charged in IADS, but the protocol will collect trading fees from the stableswap as a LP which will go into the Honzon Treasury.

This is the first step to grow a protocol-distributor network for aUSD across Polkadot & Kusama’s multichain ecosystem.

Potential Roadmap

  • V0: exploratory deposit to Taiga’s stableswap 3-pool
  • V1: pallets to auto-adjust liquidity provision levels and scale to support other similar type of protocols and parachains
  • V2: deposit to local smart contract protocols like the Pike money market
  • V3: extend the protocol to support remote protocols via XCM

Mechanics

aUSD will be generated from the aUSD Honzon protocol, deposited directly into Taiga’s 3-pool to receive 3USD LP tokens, which will then be stored in the aUSD protocol as the aUSD backing asset.

Deposit Cap

The 3USD exploratory deposit amount shall take into consideration the overall debt ceiling and can be adjusted by governance. For example, if the exploratory deposit is $100k, it would be 0.3% of total debt ceiling on Karura, and 3.2% of outstanding aUSD debt.

If the deposit is too large, the 3pool will become imbalanced which would lower the effective price of aUSD relative to USDC and USDT.

3USD

3USD is the LP token of Taiga protocol’s stableswap 3-pool, which consists of aUSD, USDC (bridged in from Ethereum via Wormhole), and USDT (natively minted on Statemine and sent cross-chain via XCM to Karura). 3USD represents the share of the pool and the trading fees accumulated overtime.

3USD is redeemable at any time to underlying assets (USDC, USDT, aUSD) proportional to currently available liquidity in the pool,and directly into a single asset like aUSD. A governance vote can be passed to execute the redemption.

Other Considerations:

  • Unbalanced pool: there could be premium or slippage when redeeming aUSD from stable pools. However, as the three are all stablecoins, the insolvency risk due to unbalanced liquidity is low.
  • Non-aUSD stablecoin risk: with fiat-backed stablecoins, there is centralization and depeg risk associated. If they are bridged assets, then there are inherit bridge protocol risks as well. The exposure is proportional to the liquidity mix in the pool. E.g. if USDT makes up 20% of the pool, then the aUSD protocol will need to absorb bad debt = 20% of liquidity deposited if USDT is exploited.
  • Taiga protocol risk: if the protocol is exploited, it’s possible to lose the deposit. There are on-chain mechanisms to pause part or all protocol operations to reduce attack impact.

We continue to work with various partners to evaluate ongoing economic, protocol and other types of risks.

Deposit Recommendation

This proposal is taking recommendations from Gauntlet to start with a deposit of 100k aUSD, which is a significant amount relative to the existing user deposits, but not so much that it will create an unbalanced the pool or expose the protocol to potential losses that the treasury cannot absorb.


from Gauntlet

Conclusion

Interprotocol aUSD Distribution Scheme (IADS) will bring the following benefits to Acala and the overall Polkadot & Kusama ecosystem:

  • Grow a protocol-distributor network for aUSD to deploy liquidity to protocols and parachains that need the ecosystem’s native stablecoin
  • Aid with aUSD stability, as this allows more arbitrage opportunities on more trading venues
  • Governance can directly impact the risk assessments and liquidity quota of these deployments by adjusting ceilings and other parameters
  • Enable Acala protocol-owned liquidity to help grow aUSD issuance locally on Acala/Karura and across the parachain ecosystem more effectively, thus aiding in the bootstrapping of all Polkadot and Kusama chains
  • Generate trading fees and incentives from protocol-distributors
8 Likes

That is a very interesting proposal and I have to congratulate you on the sharpness of mind to come up with it. I trust that you will deliver a solid technical execution, so I will go into the economical aspects of the proposal.

This is a significant new form of taking in collateral in exchange for issuing aUSD. For the first time, we would be (indirectly) accepting collateral in the form of tokens exogenous to the Dotsama security umbrella. Furthermore, the collateral would be in the form of 3USD LP which consists of centralized stablecoins. The proposal allows aUSD to scale issuance by adding centralized, bridged stablecoins to the collateral mix.

From an idealistic perspective, I will not be happy with that situation. I have avoided centralized solutions wherever possible and in the future, I will have to accept that by holding aUSD I will hold ~3% of centralized stablecoins.

From a pragmatic perspective, I assume you have considered this very thoroughly and consider it a solid option to grow aUSD issuance. I want to caution you to be very conservative with how much influence and risk you allow USDT and USDC to gain over aUSD.

Specifically, I ask for very strict risk parameters on the issuance of aUSD towards the 3USD pool. Or to put it into a bigger picture: Since aUSD has grown considerably since launch and now exists in 2 security umbrellas and accepts several different assets in CDPs, it would be good for users to gain a global perspective on the whole risk configuration and what asset is allowed to extend what amount of risk to the protocol.

I would like to ask for clarification on one issue. In your proposal, you mention:

[…] The exposure is proportional to the liquidity mix in the pool. E.g. if USDT makes up 20% of the pool, then the aUSD protocol will need to absorb bad debt = 20% of liquidity deposited if USDT is exploited.

My understanding is that if any exploit happened to one of the other tokens, you have to that an infinite amount of bad debt can be swapped into the 3USD pool, and the whole pool would be drained, putting 100% of the aUSD deployed into the pool at risk; not just the percentage at the beginning of the exploit. If my understanding is correct, I think this should be stated more plainly in the proposal. If not, please correct me.

All in all, I would hope to see a statement on the intention of the maximum allowed risk IADS will be allowed to exert over aUSD. Will it be 5%? 10? I think we need an intended exposure to better assess risks & rewards. If possible an estimate on the expected return from 3USD fees would help better make this decision on the expected return on risk.

While my comments here are more on the critical side, I think this is an exciting proposal and look forward to getting harder numbers to work with and making a proper risk/reward consideration. Thank you!

6 Likes

Thanks for the thoughtful comments.

The IADS at its current V0 only supports stablecoin swap protocol, actually only Taiga as a pilot, for obvious risk considerations, as this essentially allows stable values backing stable credits. There is a risk parameter - liquidity cap (how much aUSD credit can be issued to Taiga) being set to limit the exposure to the protocol. You are right about a few of the risk considerations in setting this parameter:

  1. currently the recommended liquidity cap is $100k by Gauntlet, this is roughly 0.3% of total debt ceiling
  2. risks of other stablecoins in the pool & stableswap protocol risks are also considered, the maximum exposure is $100k = liquidity cap. Depending on the type, severity of exploits, value of 3USD may be partly or entirely affected. The example given was superficial indeed, depeg risks can be temporary or permanent (probabilities for different risk events re different assets may also be different), there are also unknown unknowns, therefore the entire liquidity cap is used as risk exposure to the protocol, currently 0.3% of total debt ceiling.
  3. liquidity deposit affecting imbalance of the pool resulting in slippage

After all, it’s a balancing game to decide taking on different mix of risks to grow credit and liquidity in the ecosystem~

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Whilst I absolutely understand the benefits of this policy for liquidity, as well as the intention to take on a bit more risk for the long-term benefit of aUSD stability, I do have some reservations about the economics of this policy. The mechanics and risks here are not clear enough to me, in particular how the loan is ultimately backed and whether user collateral is involved in any way. I have three questions that would help clarify these points:

Firstly, “IADS will directly generate aUSD to be deposited into the Taiga 3-pool… This aUSD minted by IADS will be backed by 3USD” - Regarding this point, please clarify what level of 3USD collateral will be used to back the loan. Will the 100k aUSD be paired with 100k USDC and 100k USDT, or is the aUSD minted being swapped into the pool? If the latter, doesn’t this entail that 1/3 of the aUSD is backed by itself, leaving the loan 33% undercollateralised? The economics of having the same party as both lender and borrower seems quite unconventional.

Secondly, the proposal begins by talking about the collective overcollateralisation levels of user vaults. It then mentions exposing the protocol to “potential losses that the treasury cannot absorb”, but also says the “aUSD protocol will need to absorb bad debt”. It’s not clear to me whether the ultimate backing for this loan in case of default is the Acala treasury or the user collateral. Can you confirm that user collateral in the Acala protocol will be completely segregated from this loan and will never be used to repay any “directly generated” aUSD?

Lastly, the amount proposed here is currently 10% of the 3Pool. Won’t this scheme crowd out the existing Acala users in the LP and take a portion of the incentives? Also, what will be done with the incentive tokens (i.e. LKSM, TAI, taiKSM)?

CDP, whilst not totally capital efficient, is a tried and tested basis for stablecoin issuance. Moving away from that represents an important change for Acala, so I think the risks need to be more clearly articulated.

1 Like

Great questions.

#1 the 100k aUSD is fully backed by 3USD. It’s similar to a flash loan: flash loan 100k aUSD,add liquidity to get 100k 3USD, use 100k 3USD as collateral to mint 100k aUSD, repay flash loan 100k aUSD. So there’s no outstanding flash loan (unbacked). It is also in a way similar (nothing is really new under the sun) to D3M where Maker uses aDAI deposit receipt in Aave as backing to mint DAI to deposit to Aave at the first place. IADS for stableswap has way lower risk exposure than D3M as it has no counterparty liquidation risks.

#2 aUSD issued via CDP or via IADS would have their own risk exposures. CDP issued aUSD credit are over-collateralized by crypto assets. The loans are liquidated at certain set threshold to sell off collateral for aUSD to pay back outstanding debt. In most cases, because the loans are over-collateralized, the liquidation ratio is also always above 100%, it’s likely to be able to obtain sufficient aUSD to payback debt + liquidation penalty. However (remember Black Thursday), market spiral downwards triggering liquidation and price falls too sharply, sold collaterals cannot payback outstanding debt, which will result in bad debt (unpaid stablecoin) in the system. This is also a time where aUSD is in high demand, as vault owners need liquidity to pay down debt.
IADS doesn’t have similar level of risks, as stablecoins don’t fluctuate as much, and LP further sealed the disparity, and there is no vault management for IADS. Hence IADS is a complementary issuer to CDP to balance out the volatility and risks.
In either situation, if the protocol ended up with some bad debt, the treasury will need to absorb it: auction off ACA/KAR, or if CDP manages to collect collaterals then auction off collaterals to repay debt.

Lastly IADS is in a way protocol-owned-liquidity, which is more cost effectively and sustainable to provide liquidity into the ecosystem than rented approach. This also generates additional fees for the protocol benefiting KAR/ACA holders in the long run. Current 3pool LPs also receive KAR as early adopter rewards.

1 Like

Very interesting. Thanks for linking this. It provides a some additional context, and it is reassuring to see that there is precedent for something like this. I was initially quite skeptical of the idea, but I am starting to warm up to it. I think it can greatly benefit protocols and users throughout the ecosystem, as long as the risks can be mitigated.

I’m still trying to digest both this proposal and D3M, but at first glance there are a couple differences that may introduce additional risk factors for IADS that are not present with D3M.

The aDAI pool is a single asset pool, whereas 3USD aggregates 3 unique assets. While aDAI can be converted to DAI, redemption of 3USD provides USDC and USDT in addition to aUSD. I am concerned this could lead to complications if it becomes necessary to revoke the liquidity for any reason, including economic loss to the Honzon protocol or excess aUSD in the 3USD pool that is not represented by any debt position or vault (supply overhang/uncollateralized aUSD).

Due to Acala’s collateral staking incentives, the value of collaterals is likely somewhat inflated. For example, it doesn’t seem realistic that the average debt ratio of vaults on Acala with active debt positions is close to 1,500%. It seems that more analysis would need to be done to get an accurate representation of the backing of aUSD.

When Maker piloted D3M it was a much more mature protocol, with significantly more liquidity, adoption, and historical stability. Compared to the initial debt ceiling of 10M DAI, the proposed exploratory deposit of 100K aUSD is almost 4 times larger relative to the total aUSD supply. What went into the decision to measure the deposit cap against the overall debt ceiling instead of the relative supply increase?

Please let me know if I’m thinking about any of this incorrectly. I’m still trying to wrap my head around it all.

  1. IADs for 3USD makes sense, as it’s directly redeemable for value given it’s an LP token essentially.

  2. For protocols that don’t have this convenience (i.e. V1+); will lines of credit be issued in exchange for less-pristine assets, like governance tokens e.g. CRV? Or are the criteria strictly for parachain network coins only?

  3. Regardless if a gas or governance token, would you consider Karura to have a fiduciary obligation to maximise profits for its own protocol (even dumping where need be); or to fulfil a more pastoral role, to incubate new projects, potentially holding the bag on long tail assets?

1/ yup
2/ IADS’s current design is it’s protocol facing, so can’t do it w intermediate entities, nor manual cross-chain/wrapping etc non atomic actions. it’s currently also limited to stablecoin LP. V2 will extend to money market type protocol.
3/ KAR/ACA is utility token, Karura/Acala are app specific chains, real value accrues when the networks have increasing utility, which can come from native protocols, and enterprise version of native protocols that bring in retail/biz users e.g. Alluvial Institution-grade Liquid Staking, as well as ecosystem projects that will bring in more utilities. It’s likely that the ecosystem projects will choose Acala for value and biz case alignment and quality over quantity.

D3M is considerably more risky, as Maker will inherently carry D3M target (Aave)'s liquidation risk. This is also why when Aave faces huge stETH liquidation risks, D3M was urgently got turned off to seal Maker from the risk. Stableswap while has its own set of risks, in comparison to money market, has considerably less risks, especially no liquidation risks which is driven by market fluctuation.

The 100k is essentially debt ceiling for IADS. That’s the current max Honzon protocol can issue and inject into the 3-pool, and it can certainly be withdrawn if needed. Redemption of 3USD is essentially redemption of the underlying stablecoins, while there’re still risks, considerably less risks versus volatile crypto assets.

aUSD only fully launched for a couple month, while Karura has launched a lot longer, and is a bit more mature (more demand for aUSD), hence the more reasonable overall collateralization ratio.

Debt ceiling is one of the risk parameters of the protocol to control the amount of risk exposure for each type of collateral. Issuance goes up and down, but debt ceiling is specific to measure maximum exposure, hence using it to set some perspective. Since IADS is effectively stablecoin backed, uncorrelated with CDP crypto backed credit, in a way adds more balance and resilience to the protocol. When Gauntlet looks at this risk, they mostly focused on protocol risks, and the impact of the injection to the 3-pool prices.

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That’s a good point. Thanks for taking the time to clarify these issues.

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Interested to hear from the team how the recent aUSD exploit on Acala impacts this proposal.

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