Collider: a decentralized “forex” extension for the Neutrino protocol
My name is Aleksei Pupyshev, and I’m a co-author of Neutrino and Gravity protocols, projects started within the Waves ecosystem and aimed to become gateways for mass adoption of open finance applications (aka DeFi).
In the beginning of spring of 2020, a team of Neutrino developers, consisting of various organizations and individuals, published an article with a vision for the development of the protocol for the current year (“2020 Vision article”).
In this article, I present my personal proposal on the architecture, mechanics, and the technical implementation of one of the extensions described in the Vision article, called Collider.
This proposal is released for consideration and public discussion to all teams working on Neutrino, large holders of USDN, NSBT and WAVES, as well as large market makers and system players in the Waves ecosystem.
The concept of FOREX in this article is considered in the broadest sense, that is, in addition to national currencies, we include stocks, commodities, indexes and derivatives, as well as the most popular tools for margin trading, short and long positions.
One of the advantages of crypto is that ordinary people have access to capital, trading and saving strategies, without restrictions on citizenship, residence, gender, age or income. These are the so-called retail investors. This “talent foundry” often produces accomplished portfolio managers, hedge fund managers, venture investors, or influencers.
At the same time, there is a long-established and popular FOREX trading market where brokers “run the show”. However, you, as a trader, do not really own your account or funds, as you can only trade at the quotes that your broker considers appropriate at the moment. You also face many problems when trying to withdraw assets from your accounts or transfer them between different brokers, including high brokerage fees and various limitations.
The crypto market, in turn, has its weaknesses, largely caused by the underdeveloped infrastructure and product ecosystem:
- Crypto market is too correlated with BTC at this moment
- Crypto market is too small and easily manipulated
- Crypto market is difficult to understand and to calculate fundamentally important estimates, business models and forecasts, or asset prices
- Crypto market has no advanced trading and hedging tools, which exist in Forex, commodities or stock or classical derivatives markets
The infrastructural migration of the retail FOREX market to the decentralized smart contract technology seems to be one of the most important tasks for the emergence of disruptive innovations in both markets and mass adoption of crypto. By being transparent, trustless, and composable, decentralization technology can reduce counteragent risks and limits imposed by mediators, which will open the market for more retail investors.
The authors and developers of Neutrino and Gravity protocols find this goal crucial, and while the stable coin pegged to the US dollar (USDN) is already in beta and gaining popularity, the time has come to introduce new types of synthetic assets on top of the Neutrino protocol.
I propose to consider several principles which form the basis for the technical solution and the Collider architecture:
- Keep the basic Neutrino smart contract architecture as simple as possible so that it remains auditable, verifiable and secure
- NSBT (Neutrino System Base Token) token must be the core token of recapitalization, stabilization, payment and governance within the Neutrino protocol and all its extensions
- While USDN is already solving the volatility issue of the WAVES token by locking it on the smart contract, it is necessary to use the stable USDN token as a collateral for another Neutrino synthetic assets
- In no case should the volatility of new synthetic assets negatively affect the backing ratio (BR) of the main stablecoin USDN
- New synthetic tokens should retain the ability to be staked by holders, based on the same mechanisms and the underlying economy of USDN & Waves
- All actors in the system should have a simple and transparent strategy of achieving and accumulating profits, which depends on the popularity of trading for a particular synthetic asset
- The solution should be fully compatible with and support simple, fast, and safe swaps between synthetic assets
- The solution should be fully compatible with and support simple, flexible leverage trading (margin trading)
The system involves two main actors, which we will designate as BROKERS and INVESTORS.
- BROKERS take short positions and provide liquidity for synthetic assets. They have an incentive to provide a service for INVESTORS in order to earn based on commissions paid by INVESTORS.
- INVESTORS take long positions and purchase synthetic assets. They have an incentive to make a profit from the growth of asset prices. They pay fees that are transferred to BROKERS.
BROKERS are able to hedge all risks for their short position through the purchase of a real asset in the external market, thereby organising a service cash flow consisting of fees paid by INVESTORS without any market exposure.
Since all synthetic assets are secured by locking of USDN on a smart contract, which are also available in liquidity pools, BROKERS and INVESTORS can have staking rewards generated from the participation of these USDN in staking.
A BROKER can initiate the creation of the so-called Synthetic Asset Liquidity Pool (SALP) for tokenization of Gold, for instance. Pegged to the price of a gold troy ounce, these tokens can be traded on the open market, designated as GOLDN.
The general public register of possible and valid abbreviations for synthetic assets in Collider, as well as the initial creation of the token, is supervised by a special governance smart contract (COLLIDER-SC), which the NSBT holders use to vote by locking NSBT on this contract for a certain number of blocks. A similar voting process can also determine the reference smart contract (aka Nebula), which is entrusted with setting on-chain quotes for the price of the synthetic asset to USDN.
A synthetic asset can be proposed (before voting), activated (after successful voting) or traded (after creation by a SALP broker). The activation process for a new synthetic asset, which allows for the configuration and modification of basic parameters, is called New Synthetic Asset Configuration Voting (NC-Voting).
To create a new Synthetic Asset Liquidity Pool (SALP) or replenish the existing one, a BROKER should lock a certain number of USDN tokens on COLLIDER-SC.
After that, an INVESTOR can redeem GOLDN tokens for USDN tokens from the pool within the supply limit, which is regulated by the Available Supply Configuration parameter (ASC). This parameter is set during the voting procedure (NC-Voting) by the NSBT holders and depends on the historical volatility of the synthetic asset to the US Dollar. The more volatile the asset, the less of the Available Supply of Liquidity Pool (SALP) it has, relative to the locked USDN.
If during a voting procedure the ASC parameter was chosen incorrectly, the probability of a real-synthetic assets valuation decoupling event increases, that is, when the synthetic asset has a shortage of backing in the liquidity pool and its market value on the contract may differ from the reference prices supplied by oracles. The task of NSBT holders and BROKERS is to prevent this from happening when managing the liquidity pool.
In the architecture, there are two types of system commissions that are paid as an operating profit for BROKERS from trading operations, popularisation and redemption of synthetic assets. Purchasing Fee is a commission denominated in USDN, paid in NSBT at the rate set on the Auction smart contract of the Neutrino protocol. The dependence of the fee on the purchase volume is described by the formula below:
The omega, alpha, beta and gamma parameters are configured by NC-Voting and can change over time even for the already traded synthetic assets. This formula stimulates the purchase of a large amount of synthetic tokens and stimulates the development of the secondary market on CEXs, OTCs and DEXs (with gamma equal to 0).
The Redemption Fee is a commission required to sell a synthetic asset back to the pool. This commission is set via the rules similar to the ones that determine the Purchasing Fee, however the values of the formula parameters may differ. For example: with beta equal to 0, redemption is limited and can take longer, which can make the system more financially stable.
Any number of brokers can participate in one liquidity pool; any settlements and profit sharing are determined by the share of USDN locked by a broker to the total amount of locked USDN.
The profit that results from operations is determined by the following formulas:
Let us consider the case of GOLDN. Imagine that the price of 1 GOLD is equal to 1 USDN at the moment, at the time of creation or replenishment of the pool liquidity. At one point, the price will change, and we will separately consider both of these cases at the time of redemption. For simplicity, let us omit the calculation of fees in this example.
First, BROKERS lock 1000 USDN on the smart contract, whereas the maximum available supply of the tokens for sale is 800 GOLDN. INVESTORS buy 500 GOLDN from the pool and pay 500 USDN, which immediately gets transferred from the smart contracts to BROKERS.
Alternative 1: Synthetic asset price increased
Imagine that the GOLD price increases by 10% at a time when the entire issued supply of 500 GOLDN is redeemed. Now, the value of synthetic assets is equal to X * (1 + 0.1), which is 550 USDN. This is the amount that INVESTORS receive from the liquidity pool with a profit of 50 USDN.
The BROKERS, on the other hand, only return 1000–50=950 USDN, which yields a $50 loss. However, BROKERS can open a long position on the classical market and, as a result, not lose any capital by earning NSBT tokens from the Purchasing Fee and Redemption Fee commissions, as well as on staking of locked USDN.
Alternative 2: Synthetic asset price decreased
Imagine that the GOLD price decreases by 10% at the time when the entire issued supply of 500 GOLDN is redeemed. Now, the value of the synthetic asset is equal to X * (1–0.1), which is 450 USDN. That is the amount that the INVESTORS get back from the liquidity pool, with a loss of 50 USDN.
The BROKERS, on the other hand, only return 1000+50=1050 USDN, which makes them $50 profit. However, BROKERS could open a long position on the classical market and, as a result, break even, by earning NSBT and USDN tokens on staking and commissions.
Since synthetic assets are issued through the USDN smart contract lock mechanism, both parties (BROKERS and INVESTORS) can expect staking rewards from the underlying USDN stake. The proportion of the total staking reward paid to each side is also determined through a voting by NSBT holders.
From the point of view of Collider as a product, rewards generated from staking of synthetic assets can be paid in the same synthetic assets, through the automatic mechanism of purchase from the liquidity pool and transferring to the addresses of the stakers.
Synthetics assets cross exchange
One of the principles described above, namely “7. The solution must be compatible and support simple, fast, and safe swaps between synthetic assets”, can be implemented through integration with the WaveFlow protocol at the level of smart contracts and market-making, for instance, exchange of GOLDN <-> EURN.
This solution would allow for the creation of various decentralized, self-governing liquidity markets for any pairs of synthetic assets, as well as USDN, NSBT, WAVES and so on.
However, from the product perspective, this mechanism can also be implemented through the migration of liquidity, i.e. moving USDN between different liquidity pools.
Each of the methods may turn out to be more or less profitable for traders, which means that the presence of both possibilities will establish a large set of trading, arbitrage and liquidity management strategies.
Another principle, “8. The solution must be compatible and support the simple, flexible ability of leverage trading (margin trading)”, can be implemented through the integration of smart contracts with the so-called Lombardini crypto loan protocol.
“Margin trading is a method of trading assets using funds provided by a third party. When compared to regular trading accounts, margin accounts allow traders to access greater sums of capital, allowing them to leverage their positions”
This method is not the only possible and affordable for the implementation of margin trading of synthetic assets, but it can bring a user experience similar to Classical FOREX apps.
Composability between protocols is a strong positive feature of Open Finance Apps.
The architectural solution presented in this article complies with the stated principles, opens up many business and trading strategies in the #DeFo (Decentralized Forex) market, is composable with existing DeFi protocols in the Waves ecosystem. Most importantly, it is an extension of the Neutrino protocol, which claims to play a key role in mass adoption, both within the ecosystem of waves, and throughout the entire Open Finance industry, which is possible with the Gravity protocol.