Stablecoins are an essential component of DeFi, and while their primary purpose is to offer safety from volatility and risk, their varied implementations sometimes expose users to danger, defeating the purpose entirely.
Fiat-backed stablecoins were among the first to emerge with a simple premise: each token issuer holds its fiat equivalent in reserve to allow for redemption. While this sounds logical, it creates risks associated with the reliance on centralized custodians of these assets, becoming a single point of failure vulnerable to hacks, insolvency, and regulatory entities.
Open Dollar provides a novel solution using the GEB framework. Instead of backing the token’s value with fiat currency, a dynamic control system is employed tied to the protocol’s function.
$OD is a stablecoin pegged to an algorithmic control system that keeps it at $1.00.
The system adjusts $OD’s redemption rate on Open Dollar, which reprices user debt.
Debt repricing incentivizes users to take actions that keep the price of $OD stable.
Open Dollar is a lending protocol that enables users to borrow its native stablecoin, $OD, by locking their Liquid Staking Tokens (LSTs) and other assets into Collateralized Debt Positions (CDPs) via NFT Vaults. To withdraw their collateral, borrowers pay using $OD.
Let’s see how this works with Lido’s stETH, a popular LST:
While earning yield on staked ETH, Lido’s stETH can be used in money markets for additional yield, or as collateral to access liquidity.
stETH holders come to Open Dollar, deposit stETH into a vault, and borrow $OD.
They now have access to an asset with low volatility compared to its own collateral, while staking rewards continue to accrue on Lido.
Here’s where it gets interesting: The redemption rate of $OD is dynamic, meaning that the debt price fluctuates. The protocol uses an algorithm to do this intentionally, creating incentives that stabilize the token’s price. The volatility of the debt price correlates to the deviation between redemption price and market price.
The way $OD remains stable is through an automated control system that changes the Redemption Rate (the rate at which $OD is being revalued) depending on market conditions. This, in turn, adjusts the Redemption Price (protocol's valuation of the token), which affects the token's Market Price (price on secondary markets).
The rate adjustment controller can be compared to your home’s thermostat.
The typical home has a steady temperature of 22°C, much like $OD's price point of $1.00. This is known as a reference set point.
If the temperature goes below 22°C, the thermostat activates the heating systems to bring the temperature back up. If the temperature goes above 22°C, the thermostat activates the A/C to bring the temperature back down.
🏠🌡️ < 22°C Heater Activates 🔥🔥 Temperature ↑
🏠🌡️ > 22°C A/C Activates ❄️❄️ Temperature ↓
In both cases, what triggers the thermostat’s actions are external factors, and the deviation in temperature is barely felt when chilling on your sofa. The control system maintains an equilibrium between hot and cold which you translate as a constant temperature of 22°C.
With Open Dollar, the process works in a similar way. The control system reacts to market conditions by adjusting the redemption price. By doing this, it incentivizes users, bots or Market Makers to buy or sell tokens to decrease the deviation between Redemption Price and Market Price.
Essentially, the system reprices user debt to incentivize actions that keep $OD stable.
Whenever the price of $OD deviates from its reference set point, the redemption rate adjusts upwards or downwards. This creates a chain reaction that looks like either of the following scenarios.
Market price > Redemption price
= Redemption Rate ↓
= Redemption Price ↓
= Market Price ↓
If the market price is greater than the redemption price, the redemption rate turns negative. A negative redemption rate lowers the redemption price.
Since $OD is now cheaper inside the protocol compared to the market, borrowing power increases. Users are incentivized to borrow more $OD and/or sell it at market price as an arbitrage opportunity. The increased sell pressure lowers the market price and the redemption price continues to lower until the market price reaches it.
E.g. If the redemption price of OD decreases by 1%, users can leverage their collateral to borrow 1% more $OD from Open Dollar. They then sell their OD at market price, earning a profit from the price deviation, and protecting themselves from a drop in the token’s value following the negative redemption rate.
Market price < Redemption price
= Redemption rate ↑
= Redemption price ↑
= Market price ↑
This process also works in reverse. When the market price of $OD falls below the redemption price, the redemption rate turns positive. This increases the price of accumulated debt which causes users to buy more $OD from secondary markets to pay it down. It also incentivizes them to buy more $OD with the expectation that the market price will follow a similar trajectory to the redemption price.
E.g. If the redemption price of $OD increases by 1%, users need to buy 1% more $OD to redeem their collateral. They can also buy more $OD at market price and sell it when the market price matches the redemption price (+1%).
In both scenarios, the process continues until the deviation between the market and redemption price is reduced to 0.
Note that Open Dollar doesn't change the amount of $OD you hold. It only changes the target price that the protocol wants $OD to have on exchanges. Hence, it is not a rebase token, but rather a stablecoin with a floating redemption price.
We now know how Open Dollar algorithmically stabilizes the price of $OD. Practically, however, not all users can take advantage of these fluctuations.
For investors, a.k.a. regular DeFi users, the protocol mainly offers the opportunity to access liquidity and earn more yield. They interact with the protocol when they create vaults, borrow $OD, and withdraw their collateral or sell their Non-Fungible Vaults to exit. The arbitrage opportunities described in the previous scenarios are very risky for investors since the redemption rate fluctuations are only experienced for a split instance.
On the other hand, Market Makers, and bot builders are more qualified to take advantage of the opportunities presented above. They spend time learning the protocol’s mechanics, building tools to interact with it, and defending $OD’s peg. This segment of users risks their capital to help return the redemption price back to the peg when it deviates from its reference set point and gets rewarded accordingly.
To summarize, Open Dollar utilizes a stablecoin with a floating peg that incentivizes its users to keep the price stable. To achieve this it adjusts the redemption rate of $OD in response to market conditions. The deviation between the two price points creates arbitrary opportunities for MMs and bots.