The crypto industry is experiencing a strong proliferation of stablecoins, which serve as an tangible, applicable use case for wider blockchain adoption. In a high-level overview of these tokens in an article, located here, we discuss the current landscape and different models a stablecoin can express. In light of analyzing the outlook for stablecoins, we realized several vulnerabilities that other products exhibit and sought to create something more appropriate in the spirit of expanding an open, decentralized financial system.
With that, our company is excited to announce our first product — the Neutral Dollar. We blend a combination of interdisciplinary topics such as economics, finance, and statistics to offer a token that has lower volatility along with on-chain transparency, thereby being able to provide the best utility purposes out of any other stablecoin in the market.
The Neutral Dollar
On the surface, the Neutral Dollar is an aggregate basket that represents a collection of several stablecoins. By design, the Neutral Dollar is intended to be equal quantity weighted. For example, 5 DAI, TUSD, PAX, and USDC in total would comprise 20 Neutral Dollar (NUSD) tokens. One benefit of having a basket built with these tokens is that the amount of the underlying components to the total supply of Neutral Dollar is verifiable on the blockchain.
A natural question is to wonder why creating another stablecoin with underlying stablecoins is a good idea. Aggregation seems like a simple concept, but doing so can surprisingly demonstrate key advantages.
Proving the Benefits of Aggregation
There are many different stablecoin models, and it’s impossible to fully assess the solvency or credit risk of an individual stablecoin whether it’s fiat-backed, crypto-backed, or algorithmic. A common way to assess the potential uncertainties with a stablecoin is to observe its price fluctuations, also known as an asset’s volatility or standard deviation. By aggregating several different stablecoins together into a basket (can also be referred to as a portfolio), one can actually limit the amount of counterparty exposure and thus the overall price movements. This benefit from aggregating several different assets can be measured by a concept called diversification.
The diversification benefits from an aggregated basket is dependent to the individual weights and volatilities of the underlying components. The beauty of this calculation shows that the overall portfolio volatility will never be greater than that of its most volatile constituent, but can and will likely possess a lower risk profile not achievable by any individual component. We can show this by demonstrating the diversification effect through a range of possible covariance values. In this didactic, equal-weighted portfolio example below, we calculate the possible range of portfolio standard deviations from two assets whose volatilities are both 20% respectively. Included in this comparison is also the correlation between the two assets, which is simply a grounded measure between -1 and 1 of the covariance values.
The table above shows that the range of portfolio volatility values in this example can range from 0–20%. This specific case demonstrates that the portfolio is more stable than the underlying assets when the correlation is less than 1. In simpler terms, one asset in your portfolio may zig while another may zag, which helps your aggregate instrument maintain consistency. This is what governs our proposition for the Neutral Dollar as a better behaving stablecoin.
For our purposes we found this diversification benefit to take into effect positively even despite most cryptocurrencies being fairly correlated with one another — our Neutral Dollar product experienced less price fluctuations than any individual constituent when we aggregated them together. Below is an empirical analysis of the price fluctuations of underlying stablecoins compared to our basket.
This chart shows that from our analysis a basket of stablecoins possesses a lower volatility than any of the individual constituents under our protocol. When the Neutral Dollar’s stability is compared to any of the other stablecoins, it possesses at least 28% less volatility — indicating a meaningful improvement.
Our team was also concerned how our aggregate product would behave in events where the constitution of the Neutral Dollar was not equal quantity weighted. We tried to address our question with simulation to assess the stability of the basket, and the results were promising.
Above is a graphic of a volatility surface that depicts the % of volatility increase relative to the weighting of our basket in extreme conditions. Even in an extreme weighting situation, the requirement for the volatility of a Neutral Dollar token to increase 28% would have to be quite large. Our team has concluded that even large imbalances to the composition of the Neutral Dollar still make it less volatile than any single stablecoin in the market today. If any newly traded stablecoin exhibits low volatility and isn’t strongly correlated to the rest of the constituents, we can simply add this as a constituent into our Neutral Dollar basket and likely create a even more stable stablecoin. The reconstitution of the basket gives us the ability to lessen any price fluctuations, and gives our product a constant, competitive advantage no matter what new competition arises.
Roadblocks and the Need for a Better Solution
To be clear, the concept of aggregating assets into a basket is not a novel idea. The qualities of diversification is conventional wisdom for those knowledgeable in investing. The difficulty lies in maintaining and rebalancing the product in response to supply and demand. A traditional example to highlight is with an exchange-traded fund (ETF). An ETF is an aggregated, diversified product that can be traded intraday. However, to create new shares of an ETF represents a large barrier in that somebody (a market maker) would have to seek and purchase the underlying components, possibly through various exchanges, to construct an additional share. This delivery of assets makes the creation and redemption process of an ETF difficult to interact with given the sophistication required to source components in response to individual underlying price fluctuations of assets.
In addition, there lacks infrastructure to provide an opportunity to exchange assets. For example, say Alice likes to invest and currently holds a position in Apple stock. She now wants to sell out of her position and enter a trade to buy Microsoft stock. In this scenario, Alice must liquidate her position in Apple into cash only to convert it into Microsoft stock. Now if Alice also has a large position in Apple, she may find it difficult to exit her position because certain exchanges may not be liquid enough for her to give a reasonable execution price. These real world limitations of fees, fragmented liquidity, unnecessary conversions, and slippage are all issues that prevent Alice from properly managing her investments. The use case for a better solution to swapping is left much to be desired.
An Innovative Design
What distinguishes our construction from any currently existing framework is that our team has cleverly devised a mechanism to effectively rebalance, aggregate liquidity, and allow token swaps in our basket without bearing large costs. The design was intended to overcome and address problems seen in the traditional markets, and empower users to participate on our platform so long as they hold any stablecoin that the Neutral Dollar supports. This removes a large barrier in which anybody can go between positions interchangeably with less friction. A participant no longer has to go into the market and purchase underlying components to construct a basket, but can mint new supply by delivering only a single constituent. He or she also has the ability to swap stablecoin tokens for one another. The Neutral Dollar system is built to be liquidity- and exchange- neutral, which results in a much larger liquidity source for people to interact on.
The rebalancing of the Neutral Dollar product is done via a continuous pricing mechanism that adjusts to ensure consistent weighting for each component relative to our overall basket, as a result from activity on our platform over time. Not only have we shown that the Neutral Dollar can endure a great deal of imbalance while still maintaining stability in extreme situations, but we’ve also determined that underlying components of the Neutral Dollar will lean towards appropriate weighting due to profit-seeking behavior from participants that aid in driving the underlying liquidity.
Our team simulated behavior in response to historical price fluctuations, backtesting the system design. We found that the weights of each stablecoin in the Neutral Dollar basket are range-bound over time based on our continuous pricing methodology, and that the aggregate volatility is still less than any individual component. In addition there are controls in place to make sure that behavior to provide this underlying liquidity for the Neutral Dollar basket is not adverse, and that the resulting product is delivering on its value proposition.
The Neutral Dollar structure solves many core problems observed with stablecoins. Many exchanges’ stablecoin reserves have a huge liquidity imbalance problem from a lack of natural market forces, being too exposed to one stablecoin versus another. As a result, users may find it difficult to trade into other stablecoins due to this fragmented liquidity. The Neutral Dollar construction process and equal quantity design provides a rational incentive to balance collateral, provide liquidity, and mitigate counterparty risk. Our basket has been tested to be robust under various market conditions to address the needs from supplies and demands. In addition, we have shown that our aggregate product can also tolerate scenarios where collaterals of stablecoins are imbalanced. Lastly, we’ve simulated that the weighting of the Neutral Dollar components will converge towards stability by liquidity providers in response to our pricing mechanism. Our team intends to launch a better product for end-consumers, a service for users to interchange stablecoins for one another efficiently, and a solution for exchanges to balance their reserves.
We believe that a lower volatility instrument is the main driving point for a stablecoin. This aspect will make the Neutral Dollar a stronger case for a store of value, medium of exchange, and digital trading instrument. Our stablecoin has the ability to scale while maintaining lower volatility and full collateralization on-chain, which no other stablecoin can properly do today. Because of its low volatile nature, we hope to also broaden dApp usage related to remittance or lending services. Our protocol aims to ensure value preservation, interchangeability, and transparency through the system.
The Neutral Dollar exhibits all the traits that make a stablecoin effective, making it the standard that other stablecoins have to rival against. Our team hopes to educate and inspire others to utilize our product, progress crypto adoption, and participate in our ecosystem.
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