What is Asset Backing?
Baseline Price Insurance Service on OpenDApps Cloud3.1 Introduction3.2 How it works3.3 Baseline Price vs Market Price3.4 The Math
Deployment on OpenDApps Cloud [TBD]
Backing Management on OpenDApps Cloud [TBD]
In this blog post, we will do a quick overview of asset backing and how it is used to create the baseline price insurance service on OpenDApps Cloud.
We will examine the service, revealing how it works on the blockchain. We will compare the baseline price to the market price, and how it creates arbitrage possibilities. We will also go deeper into the math behind baseline price and how it can only increase over time.
In traditional finance, asset-backed securities refer to securities with value deriving from a single asset or a pool of assets which act as collateral for the security — “backing” it. When that total value of assets is divided by the total issues of security we get the baseline price for it that is “backed” by the assets. These assets are often illiquid and the security cannot be directly exchanged for them but the value of the assets secures the price of the security in case of company liquidation.
In decentralized finance, asset backing is most often associated with tokens. In most instances, asset backing is implemented using a smart contract that holds one or more assets that act as collateral for the token. As a result, the token can be exchanged for part of the assets which creates a baseline price equal to the total value of the assets divided by the total supply of a token.
The price created from asset backing is called baseline price in most of DeFi and it is different from the market price of a token. The market price of a token comes from DEX and CEX listings, while the baseline price is only defined from the assets held by the contract and it is only available through it.
IntroductionBaseline Price Insurance is a service designed to provide an asset-backed baseline price for a token independent of its market price. The asset-backing ensures that the baseline price can only increase and tokens can be exchanged for part of the asset-backing at any time.
How it worksTokens deployed using OpenDApps Cloud have access to additional services tied to their token. Such services are token staking, second-layer swaps, and baseline price insurance.
The service uses a fully-configurable array of assets to ensure the baseline price through asset backing. Clients can customize the assets used with support for ERC20 tokens and native cryptocurrencies. Additional assets for the asset-backing smart contract can be added manually or configured through tokenomics, inflation, or integrated parts of the OpenDApps ecosystem.
The service smart contract keeps track of available assets and provides a real-time baseline price based on circulation supply. The baseline price increases when one of two things happens: circulation supply decreases (token burn) or additional assets are added to the underlying contract.
To use the service, clients use our dApp to deploy a non-upgradeable contract with minimal public interface and no backdoors or direct asset manipulations. Once deployed, token holders of the client project can swap their tokens for the baseline price at any time.
Baseline Price vs Market PriceThe market price of a token is the value of a single token traded on a decentralized (DEX) or a centralized exchange (CEX).
On a DEX the price of an asset is determined by the interaction of buyers and sellers within the exchange’s automated market-making mechanism. The DEX smart contract calculates the new asset ratio based on the pool’s existing reserves and the amount being traded. If a token is published with a blockchain native token as a pair for the liquidity pool, the token price will be tied up to the native token price!
In a centralized exchange (CEX), the price of a cryptocurrency is typically determined by the forces of supply and demand in the market. CEXs provide a platform where buyers and sellers can place orders to buy or sell cryptocurrencies, and the prices are determined through the matching of these orders.
The baseline price of a token supporting asset backing is determined by the value of underlying assets held by the backing smart contract divided by the circulating supply of the token. Any % of the supply of tokens traded to the smart contract will be exchanged for the same % of the backing assets. This mechanism ensures that the ratio between collateral assets and circulating supply remains the same at all times.
Any exchanges of tokens on a DEX or a CEX do not have any direct impact on the baseline price unless they change the circulating supply of the token (eg. burn). If any burn occurs on trades the baseline price increases as well because the ratio between collateral assets and circulating supply increases as well.
Any exchanges of tokens for baseline price do not affect the market price. However, if the market price gets lower than the baseline price, an arbitrage opportunity occurs where people can buy tokens from the DEX (as an example) and exchange them for assets from asset-backing. This arbitrage trade can be executed until the market price with fees is greater or equal to the baseline price.
In this chapter, we will take a look at the math behind the baseline price and how it can ensure a stable $ value for a token when the price of the native currency falls rapidly and how arbitrage trading has no effect on the baseline price.Be warned that this can get geeky very quickly! Continue reading this part with caution!
For this example, we will use DFI on DMC Testnet and a test token asset-backed using a $ pegged coin.First, we give some initial variable and function names:
After that, we define the DEX price of a token, the baseline price from the price insurance service, and delta P measuring the arbitrage possibility between the two prices:
From here we can define the prices for our test token measured in tDFI and tUSD, as well as the delta P:
As we can see when the market price in tUSD is lower than the baseline price there is an arbitrage opportunity. Let’s calculate the size of the swap required to increase the market price back up close to the baseline price. Here we will find N — the amount of OPENDT that has to be bought in a swap to increase market price close to baseline price (delta P close to 1):
Now when we can define the size of the swap required for arbitrage to bring the market price to the baseline price in tUSD we can show how the arbitrage trading cannot decrease the baseline price even if all tokens on the DEX are exchanged for assets.
First, we show that if the DFI price is measured in tUSD heads toward 0, the market price of OPENDT measured in tUSD hands toward 0 as well:
Now we can show that if the market price of OPENDT measured in tUSD hands toward 0, delta P heads toward 0 opening arbitrage opportunity between the market and baseline price:
And finally, we can show that if delta P heads towards 0 (“endless” arbitrage), the arbitrage trades are limited to the supply of the token on the DEX, reserving the remaining assets for the rest of the circulating supply and preserving the baseline price:
Congratulations if you made it this far in the math train.Cheers to you! Let’s move on to the good stuff.
In-depth guides on all available services and other SaaS-related information resources will be available later on in this blog and any related content will be linked here: