How To Buidl A Self-Sustaining Stablecoin Flywheel With Reserve Currency Protocols

This article is “Chapter 2” of the untapped potential of reserve currencies series and attempts to demonstrate how any reserve currency can create and sustain their own stablecoin with a self-sustaining flywheel, using VESQ, a reserve currency on the Polygon PoS chain, as a case study.
Do read Chapter 1 about maximizing the benefits of existing staking and bonding mechanics.

More Stablecoins?

Although the markets are still suffering from $UST — $LUNA PTSD, we cannot ignore the key role stablecoins play in retaining portfolio value, generating DeFi yields, and as dry powder for quick deployment.

UST has demonstrated that even algorithmic stablecoins with an 18 billion dollar market cap can unwind in a matter of hours. Meanwhile, USDT’s survival of a recent 5 billion dollar bank run demonstrated the resilience of collateralised stablecoins. However, the biggest collateralised stablecoins are centralised, which brings about uncertainties in management and transparency.

Therefore, there is a dire need for innovation in the decentralised and collateralised stablecoin niche, which is where reserve currency protocols are perfectly poised to deliver and add value.

Inspiration Taken From FEI Protocol

Reserve currencies have a lot of similarities to FEI Protocol, a decentralised stablecoin project, but what is strange is nobody talks about how similar they are.

All reserve currencies already have the building blocks necessary to transition into an algorithmically managed reserve of tokens (FEI’s Protocol Controlled Value [PCV] aka. Reserve Currency’s Treasury) which supports direct redemption of FEI at $1.

Below are some of the similarities between the two:

How Does A Reserve Currency Bootstrap The Creation Of Their Own Stablecoin?

Part I — The Accumulation

After VESQ has created a sizable treasury in the form of MATIC and ETH through the issuance of bonds, the next natural step would be to diversify the nature of bonds by allocating part of their bond $VSQ emissions in exchange for decentralized stablecoins, like DAI and MAI.

The target amount for accumulation can be $4m, 2m DAI and 2m MAI respectively, before the minting of the stablecoin “vUSD” commences.

Part II — Introducing vUSD

vUSD Mechanism

Similar to FEI’s Peg Stability Module, the VESQ treasury holds a reserve of assets in order to exchange vUSD at $1 of other assets with a fee of 10 bps (0.1%).

There are two allowed actions:

1. Mint vUSD — buy vUSD at a 1:1 ratio in exchange for DAI or MAI plus a fee of 10 bps
2. Redeem — sell vUSD back for $1 of assets, minus a fee of 10 bps.

Referencing the above diagram, VESQ would mint 1m vUSD with 500k DAI and MAI respectively. Since VESQ received a veNFT from Dystopia, it can use its voting power to not only whitelist and create a gauge for vUSD/DAI and vUSD/MAI, but also vote for $DYST rewards for the LP’s of the pool. Hence, with 0 expenditure, VESQ can ensure that the users of vUSD are compensated for their participation in the liquidity pools.

At genesis, since 100% of the pool is PCV, there is very little risk of depeg for vUSD. If the ratio of vUSD increases with respect to DAI or MAI and the value of vUSD falls below 0.99, there is an easy arbitrage opportunity and VESQ would use the reserve stablecoins in its PCV to to buy vUSD at < 0.99 and redeem $0.99 worth of DAI or MAI until the price of vUSD is >= $0.99. The second line of defense would be the utilization of the MATIC and ETH treasury to retain the peg.

VESQ can adopt a model with a debt ceiling similar to QiDao and allow minting of vUSD only if it can be done without a risk to the peg.

Part III — The Flywheel

Once vUSD is up and running, the next logical step would be to start including vUSD LP’s as bonds to increase POL (Protocol Owned Liquidity) and also further protect the peg.

Since VESQ would be the majority LP of the pool, the VESQ LP positions would continue to accumulate more and more $DYST. This accrued $DYST can be vote locked to increase the voting power of VESQ and direct more rewards to the vUSD pools on Dystopia. Since VESQ already has the advantage of having ~0.2% of the total DYST supply, this plan can easily be put into action.

Once vUSD is able to achieve significant liquidity of around 5m-8m on Dystopia, VESQ can look to provide additional use cases like opening isolated lending markets on Market.xyz similar to what FEI does with pool 8 of Rari.

All it takes for reserve currency summer 2.0 is for 1 protocol to adopt these changes and the rest would follow.

Please note that these are mere suggestions and not financial advice. vLABS is not responsible for any financial damage caused as a result of adopting this model