Introduction
Liquidity is essential for any thriving blockchain ecosystem. Cardano has a developing ecosystem with many of the necessary primitives already built out: decentralized exchanges (DEXs), native stablecoins, money market protocols including borrow/lend and collateralized debt positions (CDP), and liquid staking tokens. Each of these primitives on their own help push an ecosystem from the development stage into the flourishing and mature stage. Stablecoins play a unique role in any cryptocurrency system as a means of onboarding new users with a fiat pegged token and volatility protection. However, without deep liquidity the true value of the Cardano decentralized finance (DeFi) ecosystem cannot be realized, and a critical mass of liquidity is necessary to encourage broader adoption. This proposal outlines the use of treasury funds to boost stablecoin liquidity, creating a stronger foundation for DeFi. Increasing stablecoin reserves not only expands liquidity but also attracts new users and reinforces confidence in the chain — offering a solid hedge against volatility and supports Cardano native stablecoins.
High level overview
- The Cardano treasury should dedicate 3.33% of treasury funds (50 million ada) to purchasing fiat backed stablecoins, spread out over 12 monthly purchases.
- A 3rd party will be hired to manage funds. Funds will be placed in a contract that specifies a monthly release mechanism, along with revokable access to funds if the community determines funds are being mismanaged.
- The market maker will propose mechanisms for converting treasury ADA to stablecoins, including DCA through CEXs or OTC deals. A specific focus of the stablecoin strategy should be focused on minimizing the ADA price impact of minting stablecoins.
- DeFi protocols with at least 250,000 ADA worth of a stablecoin may apply to be recipients of minted stablecoin. The DeFi Custodian has an obligation to be responsible and transparent with regard to equitable distribution of stablecoins to DeFi protocols.
- The DeFi Custodian must propose strategies for distributing fiat to DeFi protocols to increase access to and exchange of stablecoins, reducing the cost of borrowing and exchanging stablecoins.
- Fees generated should remain in protocols as they accumulate. Opt-in farming rewards should not be used to help encourage natural liquidity, but farming rewards earned should be used to purchase additional stablecoins.
Motivation
Introduction
There is a strong need for better liquidity, especially stablecoin liquidity, in the Cardano ecosystem. Deep stablecoin liquidity helps to serve as an on/off board mechanism for new users as well as a safe haven from market volatility. The Cardano community as a whole benefits from deep stablecoin liquidity, and thus it makes sense to bootstrap this liquidity with funds from the Cardano treasury. In addition to providing mechanisms to onboard new users, deeper liquidity in decentralized exchanges will help stablecoins keep their peg since the stablecoin peg is a function of exchange fees and slippage, where slippage is inversely proportional to liquidity. As liquidity is bootstrapped, a positive feedback loop will be created bringing more professional market makers on chain. We see this consistently in traditional finance and in other blockchain ecosystems. Market Makers are more willing to quote tighter spreads and provide more liquidity into an asset once there is sufficient liquidity in that asset. Liquidity begets liquidity. This will also spur more DeFi innovation, bring more developers and retail participation into the cardano ecosystem, and benefit everyone involved in Cardano.
Another reason to use treasury funds for stablecoin liquidity is to support the significant efforts of those protocols that have developed a native stablecoin on Cardano blockchain. Cardano has had difficulty attracting established stablecoins, leading to efforts to establish stablecoins natively on Cardano. Both Cardano and these protocols benefit by supporting home grown stablecoins, and the treasury should help to support these projects but allocating funds to minting stablecoins.
Stablecoin Reserve
Stablecoins suffer from the ‘stablecoin trilemma’:
- Stability – maintaining a reliable and resilient peg.
- Decentralization – avoiding reliance on centralized entities.
- Capital Efficiency – minimizing overcollateralization or complex mechanisms to back the stablecoin’s value.
Fiat backed stablecoins tend to be capital efficient (1 USD invested in Treasury Bills, money market funds, banks backs 1 stablecoin) and stable. However, these tend to be more centralized than CDP backed stablecoins and algorithmic stablecoins. Given the desire to deepen on chain liquidity and create a thriving ecosystem, fiat backed stablecoins make the most sense (especially given their dominance in other thriving blockchain ecosystems).
Building out a stablecoin reserve is no easy task. The Cardano Treasury only has ADA currently as a reserve asset. ADA needs to be sold for USD, and then the stablecoins must be minted. The treasury will need 1 or more third party providers to facilitate this transition.
We propose dedicating 3.33% of treasury funds (50 million ADA) to develop a stablecoin reserve for the Cardano treasury. Treasury funds will be deposited into a contract that permits time unlocks for ADA to a market maker (called the ADA Market Maker in this proposal) responsible for purchasing stablecoins over the course of a year. The stablecoins will be allocated to DeFi protocols to earn yield. Each month 10-15% of yield will also be streamed back into this smart contract, with the remainder being reinvested into participating DeFi protocols. The Cardano Treasury has the ability to remove access at any point from the ADA Market Maker.
Third Party Providers
There are three necessary third party providers needed to execute the development of the Cardano stablecoin reserve. They may all be 1 entity, or multiple entities.
- ADA Market Maker: a third party market maker will need to be hired to facilitate the swapping of ADA for USD. This market maker will have guidelines, similar to an investment management agreement/guidelines, which dictate the allowable terms of swapping from ADA to USD. This could be on centralized exchanges, decentralized exchanges, or OTC deals. The ADA Market Maker is responsible for executing the purchase of USD at the best possible prices. This means the market maker will request for quote (RFQ) multiple counterparties (could be individuals, hedge funds, private equity funds, liquid token funds, etc.) with the terms of the deal. Then they will pick the best quotes (lowest discount from spot / highest ADA price in USD) conditional to the terms specified by the Cardano treasury. OTC deals tend to occur at a discount from spot. The Cardano Treasury should consider terms for these deals such as: what discount from spot is allowable, is there a lock associated with the deal (vesting, cliff etc.), can 1 counterparty take 100% of the deal or multiple counterparties, etc. A legal agreement must be put in place to hold the ADA Market Maker accountable and liable for proper custody and best execution practices.
A potential concern for large scale selling of ADA for fiat is ADA price impact, and we present a brief analysis under the ADA price impact section.
- Stablecoin Market Maker: a third party market maker will facilitate the swap/minting of USD for the stablecoin (assuming all fiat backed stablecoins at first). Likely this will be facilitated by the protocol itself. This step requires the USD exchanged from ADA by the ADA Market Maker to deposit that USD into the proper custodial accounts. The stablecoin protocol will then have custody of the USD and mint the stablecoin on chain, depositing it into a separate smart contract (stablecoin smart contract), which can hold any CNTs since multiple stablecoins will be sent to this contract. The protocols should only be able to send stablecoins to this contract. Research on the backing of each stablecoin is necessary. Ideally the fiat back stablecoins are backed by US Dollars held in backs, treasury bills, or low risk money market funds that only invest in government issued short term paper like treasury bills.
- DeFi Custodian: a third party custodian will be required to manage the stablecoin liquidity provided on DEXs and potentially other protocols. This custodian will be able to access the stablecoins and ADA in the stablecoin smart contract and remove them to provide liquidity and other DeFi actions with these assets. The DeFi custodian must propose a plan for responsible stewardship of stablecoin liquidity, describing how liquidity will be split across DeFi protocols to maximize impact while also demonstrating impartiality for how funds are distributed. They must demonstrate an openness to including protocols with sufficient liquidity and an established history of trust and success, and a description of how new protocols may apply to receive liquidity along with selection criteria must be included in the proposal to become the DeFi custodian. The DeFi custodian will also be responsible for rebalancing liquidity distribution as needed, as well as paying back a percentage of protocols fees back to the stablecoin reserve for purchase of additional stablecoins. A legal agreement must be put in place to hold the DeFi Custodian accountable and liable for proper custody.
A proper due diligence is required for all counterparties. This includes operational due diligence (understanding the counterparties processes for custody, trading, relationships, accounting, company balance sheet/income statement to understand their solvency, etc.). Also, specifically for the DeFi Custodian, an additional investment due diligence is required. This would include understanding their strategies, their on chain market making capabilities, their technical expertise, etc. Once a third party is selected for each role, a legal agreement must be put in place, in addition to strict guidelines on the process they must follow. A Due Diligence committee should be hired and compensated to vet third party providers for all roles. This committee should be made up of people with traditional finance expertise, Cardano development expertise, stablecoin expertise, DeFi expertise and most importantly risk and technical expertise. This committee should be compensated after their recommendation is completed.
Each third party will earn fees for their role. Ideally these are flat fees or percentage of assets managed fees. The DeFi Custodian may just earn a flat fee paid monthly for the management of assets. However, many investment managers may require an asset-based fee. This would be a fee that is charged as a % of assets managed. The Stablecoin Market Maker may not charge a fee at all if it is the protocol that does the USD custody and minting of stablecoins. Many times, these protocols earn fees by investing the USD in yield bearing assets (like money market funds, treasury bills, etc.). The ADA Market Marker should earn a flat fee as well, paid monthly from the execution of ADA to USD. It’s possible the ADA Market Maker will want to earn a percentage of each swap executed. This set up is possible but requires deeper research on understanding the game theoretics on how this type of fee can be manipulated. Performance based fees are much trickier to execute appropriately. There is a need for high water marks, hurdle rates, specific KPIs, etc. This would require much more research of a third party requiring this type of compensation.
ADA Price Impact
A potential concern with this proposal is the conversion of ADA to USD having a major price impact, which is a valid concern. One duty of the ADA Market Maker is to ensure that ADA price is not significantly impacted by conversion to USD. While OTC deals can and should play a part in this, it is helpful to look at the ADA budget allocated to the stablecoin reserve with respect to CEX volume. This proposal requests 3.33% of the 1.5 billion ADA treasury (50 million ADA), dispersed evenly on a monthly basis for 12 months. This means that 4.17 million ADA will be converted per month. Looking at CEX volume, for the last 3 months Coinbase has had an average daily volume of 60 million ADA, with 1.25 million ADA representing ~6.94% of the daily volume. Spreading out sales of ADA combined with use of other CEXs (such as Binance, which has even higher daily volumes) would further reduce price impact. Thus, even not accounting for OTC deals, the amounts of ADA being converted to USD make up a small fraction of daily CEX volume and thus should not have a major impact on ADA price.
Rationale
The primary goal of this proposal is to increase the on-chain liquidity of stablecoins in the Cardano ecosystem. So the first and primary goal should be to create stablecoin liquidity pools on multiple DEXs, which may involve use of a portion of the funds to supply tokens that are not fiat backed stablecoins. There are three critically important types of pools.
- A stablecoin to stablecoin pool – ideally using the stablecoin invariant (like Curve’s) or a Concentrated Liquidity AMM invariant (like Uniswap V3) or a Discretized Liquidity AMM. These invariants allow for imbalanced pools but keep the price between 2 or more assets relatively steady even with imbalanced pools.
- ADA to stablecoin pool – given the current developments in the Cardano ecosystem, this will likely need to be a 50/50 Constant Product AMM pool. However, over time it will make sense to migrate to a Concentrated Liquidity AMM pool.
- Stablecoin lending protocols - Easy and low cost access to stablecoins are a critical component to a vibrant DeFi ecosystem. Supplying more stablecoin assets to these protocols lowers the lending rates, and decreases the barrier to accessing stablecoins.
Multiple DeFi protocols should be seeded. It will be the responsibility of the DeFi Custodian to research and understand the risks and benefits of each protocol’s implementations of these different types of pools. However, it makes sense to specify a minimum amount of DEXs (3-4) to be used, minimum TVL per DeFi protocol (to limit closure risk), along with the types of pools allowed. CLAMM pools, if not actively managed, will have much higher impermanent loss/LVR versus CPMM pools (details on different types of liquidity pools are provided in the references). Stableswap pools are best for assets with strong peg protection, but if 1 of the stablecoins depegs, you can be left will high impermanent loss/LVR and just with the lower priced stablecoin. This risk should be managed by the DeFi custodian but overseen by a risk committee hired by the Cardano Treasury.
Note that use of AMMs inherently require a second token. Thus while the treasury is focused on increasing the liquidity of fiat backed stablecoins, it will require the purchase of additional tokens to make the fiat backed stablecoins accessible. For example, a portion of the ADA set aside for stablecoins should be set aside for use in an ADA/stablecoin AMM. Likewise, a portion of other algorithmic (e.g. DJED) and synthetic (e.g. iUSD) will also need to be purchased to pair with fiat backed stablecoins to be placed in a stableswap pool. Due to the volatility of ADA/stablecoin AMMs, it will be necessary to perform rebalancing periodically to maintain high levels of liquidity and mitigate risk.
Oversight
An oversight committee that operates outside of the third parties will be responsible for receiving and analyzing reports from the different executing parties and will be responsible for delivering reports to the community. The oversight committee will perform two primary tasks:
- Due Diligence: The committee will be responsible for the underwriting of all three third party managers. The committee is responsible for the initial search, due diligence review, and recommendation. The committee is also responsible for the continual underwriting of third party managers. The role is similar to a manager research role in traditional finance. There should be a cadence to the reviews, quarterly or semiannually. The committee will ensure that the third party managers are operating within their guidelines and pursuing best practices in operations/custody and best execution.
- Risk and Treasury: The committee is responsible for monitoring the flow of ADA and stablecoins in the reserve, along with monitoring the DeFi activities of the DeFi Custodian. The committee will receive monthly reports from the DeFi custodian regarding liquidity provisioning and other DeFi activities. The committee is ultimately responsible for understanding the risks taken by the DeFi Custodian. They should meet monthly to review all assets, flows, and strategies.
The committee members should be a part of the final on chain proposal and should be compensated monthly or quarterly per member with a committee lead position that is compensated slightly more.
Stablecoin Selection
The ultimate selection of the stablecoins in the reserve is a key consideration. As stated above, there is a balance between stability, capital efficiency, and resilience/decentralization that needs to occur. The primary recommendation is to focus on fiat backed stablecoins initially, willingly allowing for some centralization in order to promote the nest peg protection and capital efficiency.
Ideally the committee is responsible for the initial selection and continued re-underwriting of stablecoins to choose from.
Preference should be given to native Cardano stablecoins in order to avoid unnecessary bridge risk.
Understanding the arbitrage mechanism to protect a stablecoins peg is key. If the arbitrage mechanism for fiat backed stablecoins requires native minting/burning, it’s highly possible that there is a time delay in arbitraging a stablecoins on chain price back to the peg. This time delay may cause on-chain depegs for a period of time as on-chain users have differing liquidity preferences. These liquidity preferences could show that on-chain users are willing to buy a stablecoin slightly above peg in order to move out of risky token exposures/repay debt/leverage, or sell stablecoins below peg in order to access debt/leverage/ risky token exposure. If the arbitrage mechanism requires a time delay, we could see price depegs from parity and that may affect high Amplification factor stableswap pools.
Risks
- Stablecoin peg risk
- DeFi protocol smart contract risk
- Custodial risks from protocols and the DeFi Custodian
- Execution risks from the ADA Market Maker
- Custodial risks of the stablecoin protocols reserve assets (USDC depeg event as an example)
- Impermanent loss/LVR on stableswaps and ADA/stablecoin pools
- Solvency/bad debt of other DeFi protocols like money markets
Historical View:
- Avalanche’s Rush Program (2021)
Strategy: The Avalanche Foundation launched “Avalanche Rush,” a $180 million liquidity mining incentive program aimed at attracting DeFi applications and assets to the Avalanche ecosystem.
Key Actions:
- Partnerships: Collaborated with leading DeFi protocols like Aave and Curve to enhance lending services and stablecoin liquidity on Avalanche.
- Incentives: Encouraged users to provide liquidity and engage in borrowing activities, leading to a rapid increase in Total Value Locked (TVL).
Outcome:
- TVL Growth: The program significantly boosted Avalanche’s TVL, reflecting increased user engagement and capital inflow.
- Stablecoin Adoption: Established stablecoins such as USDC, USDT, and DAI as prominent assets within the Avalanche network.
- DEX Liquidity: Enhanced liquidity on decentralized exchanges like Trader Joe, resulting in improved trade execution and reduced slippage.
- Optimism’s Liquidity Mining & Grants (2022) Strategy: Optimism, a Layer 2 scaling solution for Ethereum, implemented a liquidity mining program using OP tokens to incentivize DeFi activity on its platform.
Key Actions:
- Incentivization: Allocated OP tokens to liquidity providers on platforms like Uniswap to encourage liquidity provision.
- Governance-Funded Programs: Supported liquidity mining initiatives through governance proposals, aiming for sustainable growth.
Outcome:
- Sustained TVL Growth: The incentives led to increased Total Value Locked on Optimism, attracting more users and capital.
- Treasury Management: Enabled governance to reinvest yields into treasury reserves, promoting long-term sustainability.
- OlympusDAO & Protocol-Owned Liquidity (2021) Strategy: OlympusDAO introduced the concept of Protocol-Owned Liquidity (POL), where the protocol itself owns and manages liquidity, reducing dependence on external liquidity providers.
Key Actions:
- Treasury Utilization: Accumulated assets in its treasury to provide liquidity for OHM trading pairs on decentralized exchanges.
- Bonding Mechanism: Employed a bonding mechanism to acquire assets in exchange for discounted OHM tokens, increasing treasury holdings.
Outcome:
- Sustainable Liquidity: Established a model where the protocol controls its liquidity, earning trading fees and reducing reliance on external incentives.
- Market Challenges: Faced challenges during market downturns, highlighting the need for robust risk management strategies.
Lesson for the Voltaire era of Cardano: By reviewing other chains and their initiatives it allows them to see where they went right and where they can be improved, this allows them to avoid some of the pitfalls and at the same time improve on what worked on other chains.