Most centralised exchanges that allow leveraged trading make use of an insurance fund to help manage liquidations on their exchange.
Typically, to trade a certain size requires an initial margin amount in a user’s account. As the price of the instrument varies, the exchange monitors each user’s position and requires that the user maintains a maintenance margin. If an adverse price movement takes the maintenance margin required above the amount of margin in the account, the exchange will liquidate that position.
But what happens if the price moves so quickly that the exchange is unable to liquidate the user’s position before the margin requirement hits or goes below zero? Cryptocurrency markets generally have no recourse to any further monies from a user and are unwilling to backstop those leveraged positions directly themselves. There are generally two options:
Build up an insurance fund slowly through charging a fee for regular liquidations. Use that fund to bail out an account in case it has negative equity. The user and account are zeroed out, but the system itself stays solvent by drawing on insurance.
Force user accounts that have positive balances to subsidise possible losses in losing accounts. This is sometimes called socialised losses.
Some exchanges use both of these options. BitMEX is a well-known example of a centralised exchange that builds up a large insurance fund from regular liquidations, but also stands ready to socialise losses from individual winning positions in a process called auto-deleveraging.
In decentralised finance, the best known example of socialised losses come from MakerDAO. The collateral posted in any CDP is in the form of PETH (Pooled ETH) and can be used to bail out liquidated CDPs with negative equity.
At Serenus, an insurance fund contract has been launched that will be funded by regular takeovers of issuer contracts that are under-collateralised. Takeovers are our form of liquidations. Anyone may take over ownership of an issuer contract that is under-collateralised. The original owners receive nothing. Anyone can call the insurance contract to make it fund an issuer contract that has less than 100% collateral against the serenus that it has issued. For more details see the insurance section of the white paper.
We believe that this is the first instance of a wholly on-chain insurance fund approach to managing ETH/USD exposure. We do not plan to use any form of socialised losses.
At Serenus Coin we have produced a DEX-powered stablecoin. Our decentralised exchange, or DEX, trades only one pair of assets: ether against serenus. Like most stablecoins, serenus is pegged to the US dollar. It is a synthetic dollar.
What is a “synthetic dollar”?
Consider the following scenario. The creation of synthetic dollars on BitMEX — the world’s most liquid bitcoin derivatives exchange:
Use a throwaway email account to open a new BitMEX account and deposit 1 bitcoin.
If the price of bitcoin is currently $4000, short 4000 contracts of BitMEX’s perpetual swap. You are now perfectly hedged and your account has $4000 worth of bitcoin in it.
Ignoring funding costs, if the price of bitcoin goes up to $8000 your account will have been debited down to 0.5 bitcoin and therefore still be worth $4000 of bitcoin.
If the price reverses and falls to $2000, you will have been credited up to a 2 bitcoin level in your account and so still have $4000 worth of bitcoin.
The account is itself somewhat painfully fungible. You could give someone else your email account/password and BitMEX password. Once they change the passwords, they will now be in control of that same $4000 of stable bitcoin value.
Note that all of this is possible for one important reason. Someone else with an account on BitMEX was willing to buy those 4000 contracts from you. If they also had 1 bitcoin in their account they will have gone 2x leveraged long bitcoin to accommodate your desire to create 4000 synthetic dollars.
The Serenus DEX
Our DEX replicates this process of synthetic dollar creation. Except Serenus Coin is decentralised and permissionless. The contracts on the ethereum mainnet will continue to be available for any use indefinitely. And anyone can use the system. We believe that decentralised finance or DeFi is the way forward for cryptocurrencies. As a form of programmable money, ethereum is an ideal platform for Serenus Coin.
Anyone willing to go leveraged long ETH/USD can create a serenus issuer contract for themselves. This is their own contract and is fully under their control. Issuers will have to hold some ether as capital in their contracts.
Users of Serenus Coin hold ether and may wish to swap that exposure to ETH/USD for serenus. In effect, they may want to create their own synthetic dollars. They simply send their ether to an issuer contract. The issuer contract looks up the current ETH/USD price and sends back an appropriate amount of serenus less fees. Any users may cash in their serenus for ether with any issuer contract at any time. In the meantime, as serenus is a regular ERC-20 coin it can be transferred freely as a medium of exchange or held as a store of value.
DeFi and MakerDAO’s Dai
The MakerDAO Foundation have made great strides forward in the DeFi space. Their stablecoin, the Dai, has become the linchpin of decentralised finance. We believe that the move to Multi-Collateral Dai (MCD) will further bridge the gap between “real world” finance and crypto DeFi and will be very successful.
In the MakerDAO system, long-term holders of ether can lock up their ether and borrow against it. The borrowing is in dollar-pegged stablecoins. Since their launch over a year ago the expectation has developed that because these are over-collateralised borrowings against your own assets, the borrowing rate should be very low. It has been treated as a credit risk.
However in recent weeks, it has become clear that most users of the MakerDAO system are locking up their ether to borrow Dai, and then use that Dai to purchase more ether. They are borrowing against themselves to go leveraged long ETH/USD. This means that the supply of Dai is not modulated by variations in the demand for it. The Dai has been trading at a 3 to 5 percent discount to the US dollar. There is no arbitrage available that can return it to par with the dollar. The only solution is to ratchet up the stability rate to levels that match current funding costs elsewhere for being leveraged long ETH/USD. But this will break the expectation that the stability rate is a credit risk measure.
The flip side of this is also strained for MakerDAO. As Su Zhu and Hasu make clear in their cogently argued article, the Dai is not scalable. There is no tight arbitrage available that can return an over-valued Dai back down to the US dollar. In both cases supply is being created at the margin in response to a demand for being leveraged long ETH/USD, not a demand for Dai itself.
Why are synthetic dollars stable and scalable?
As long as sufficient collateral is available in the issuer contracts, serenus will remain pegged to the dollar. This is because serenus is powered by its own DEX. At all times, anyone can transact into and out of serenus at the prevalent ETH/USD rate. If cheaper serenus is available elsewhere, anyone can purchase that serenus and immediately cash it into ether. Likewise, if serenus is more expensive than the dollar elsewhere simply create new serenus on the DEX and sell it at the higher rate.
The limit to this process lies with issuer fees, currently set to 0.2% (20 bips) per new mint of serenus. Issuers collect this fee each time a user sends in ether in exchange for serenus. Serenus Coin also collects an additional 10 bips fee per trade. If the fees are too high, serenus will remain stable but users may be unwilling to convert their ether to serenus. Likewise, if the fee is too low issuers may be unwilling to carry leveraged long risk in ETH/USD on the Serenus DEX as they may find cheaper funding rates elsewhere.
The theoretical upper limit for scalability is determined only by the global appetite for leveraged long crypto risk against the US dollar.
Serenus Coin is a DEX that produces a crypto-collateral dollar pegged stablecoin. It does this by allowing issuers to create contracts that users can mint or burn serenus from. Users do this by sending ether or serenus, respectively, into an issuer contract. For more see this introductory article.
Why create an issuer contract?
Since November last year, liquidity providers on Uniswap have earned fees by providing the ability for users to swap between ether and a variety of ERC-20 tokens. MKR and Dai are the biggest markets sofar. The fees are good but changes in price also affect profitability. Understanding how providers’ exposures to ether and those tokens vary as the price changes is complicated. To get some idea of the difficulty here see this article on uniswap fees and a follow-up article comparing holding just ether to participating in the ETH/Dai pool.
In general, a liquidity provider on uniswap will lose money if the price of ETH/Dai moves either up or down from the initial price when they joined the pool. Their potential profits are non-linear with respect to price movements.
Issuer contracts also collect fees as users swap back and forth between ether and serenus. Issuers target a particular collateral ratio and provide some initial capital as ether. From there the contracts receive ether up to a maximum derived from the target collateral ratio. If users wish to sell serenus, they stand ready to send ether back to them. The price of ether/serenus is set by an oracle contract.
Unlike on uniswap, issuers on the serenus system have a strictly linear profit/loss exposure to price changes in ETH/SRS while collecting fees. This is a much easier system to both understand and, if needed, hedge.
An example issuer
Suppose that ETH/USD is currently trading at $100:
Open an issuer contract with a target collateral ratio of 150%.
Send 1 ETH into the contract as initial capital.
Users are now able to interact directly with this contract or through the DEX on serenuscoin.com.
At this price, and given the target of 150%, users may over time sell up to 2 ETH into the contract, paying 0.2% in fees to the issuer contract each time they do so (there is a 0.1% fee to Serenus Coin too).
The issuer contract is now long 3 ETH and has a 200 SRS liability. An issuer wishing to hedge their ETH exposure simply has to short 3 ETH elsewhere. The best current options are with ether futures on Kraken, OKEx or SETH on dYdX.
If the price goes up to $200, the 200 SRS liability will only be worth 1 ETH. If a user sends in 200 SRS, the issuer contract will have 2 ETH (worth $400) from a starting point of 1 ETH (worth $100). It is in effect a leveraged long ETH/USD position.
If the price goes down, however, the issuer contract will be in danger of takeover by anyone else as the collateral ratio falls below 120%. This danger can be managed by the issuer owner in one of two ways: either send in more ether as capital or pay in serenus to the contract. Both of these actions will increase the collateral ratio.
Being an issuer on the Serenus Coin system is a good way to collect fees on long term ether holdings while being able to manage the exposure to price movements easily.
Serenus Coin doesn’t get off-chain access to ETH/USD prices. How then does it maintain a stable peg to the US dollar? Active on-chain swap markets now exist in multiple stable coin denominations. The market cap of coins like MakerDAO’s Dai, Centre’s USDC, Paxos, True USD and so on — all ERC20 tokens — collectively run into the hundreds of millions.
The oracle contract on Serenus is now setup to use Uniswap and Kyber Network to get prices for ETH entirely on-chain for the Dai, TUSD and USDC. These are real, live, market-driven prices. Any discrepancy between prices on those platforms and centralised exchanges like Coinbase or Binance can and are arbitraged away. More coins will be added as on-chain swaps like Uniswap and Kyber continue to expand.
This approach provides a much nicer set of trade-offs than pursuing a centralised oracle system to get off-chain prices. In time, however, if a truly decentralised approach to the oracle problem develops it would be easy to switch to that approach. In the meantime, Serenus Coin is in effect pegged to an average of other stablecoins. This should be sufficiently stable for the use of Serenus for hedging and as a means of payment.
3. MakerDAO and Synthetix: crypto-collateralized loans of stablecoins
When viewed through the lens of price volatility these types look like this:
1. Submerge crypto-volatility in the relative calm of the US dollar
2. Attempt to push price volatility in the present out to the future through a seignorage share system
3. Dilute the volatility of crypto by radically over-collateralizing it
What does Serenus Coin do differently?
Serenus Coin is a stablecoin on the Ethereum mainnet. It allows people who are willing to take on the price volatility of ether to produce a token that has had that volatility removed. They gain a fee for that service. It sells volatility onto those willing to bear it.
There are two primary participants: issuers and users. Issuers stand willing to go leveraged long ETH/USD and collect a 20 bips (0.20 percent) rebate for doing so. This is far more attractive than attempting to go leveraged long on centralized exchanges. Users are anyone wishing to mint a dollar stable ERC20 token for themselves to use as a means of payment or a store of value. Users can cash out their tokens back into ether at any time.
By separating out these two activities, unlike the MakerDAO Dai system, Serenus Coin is fully scalable and therefore able to take on the heavy weight fiatcoins like Tether, Circle USD and Paxos.
It consists of five smart contracts working together to produce a stablecoin: ERC20 Token, Oracle, Governor, Factory, and Issuer contracts. They are written in Vyper and are on Github.
The website contains a DApp for trying out the system and has an FAQ. The obligatory white paper is also available.