Originally written as a Foreword to the SPOT paper
In light of recent events, we feel it is appropriate to externalize our views on radically responsible protocol design before jumping into a detailed outline of SPOT, our forthcoming inflation-resistant store of value. Following the collapse of Terra, Vitalik Buterin posed two questions to be asked of automated stablecoins in May 2022:
The first question, we interpret as a proxy for a broader important question: Is the system’s design responsible? If an automatic system cannot wind down safely to zero users then it is likely a ticking time bomb that assumes bailout capital will intervene to avoid calamity. Such bailouts are not a luxury afforded to issuers of independent money.
The second question, we interpret as a proxy for another broader important question: Does the asset need to exist? Let’s imagine a system, pegged to CPI, that begins fully collateralized by US dollars. Let’s also imagine the dollar is experiencing price-inflation at a rate of 20% per year. Over time, such a system either becomes less and less collateralized or its token price tracks the purchasing power of the US dollar, invalidating its reason for existing.
Radically responsible protocol design is not an appeal to meet the standards of traditional finance, but rather an appeal to profoundly surpass the design standards of traditional finance.
It is too often the case that today’s DeFi developers build and deploy with the impression that moving fast and breaking things is a good practice. Given the scale of assets committed, the interconnectedness of these financial systems, and the general lack of discretion displayed by market participants, we consider this mentality to be highly irresponsible.
To embrace the path of moving fast and breaking things, is to invite catastrophe and after-the-fact regulation in an ever repeating cycle when the real opportunity presented here is to create greater financial stability through greater transparency.
As responsible stewards of decentralized finance:
Achieving this requires that we think more like mathematicians and less like scientists. We should either be happy living with a protocol’s complete space of outcomes (at least in theory) or we should return to the drawing board and continue working before deploying to the public.
Applying these standards to SPOT, yes, SPOT can gracefully wind down to zero users without bailouts. More broadly, for every conceivable market scenario, there exists an equilibrium price for SPOT that reflects the value and risk of its collateral precisely because risk is transparent. Lastly, SPOT can gracefully resume even after winding down.
What makes our purpose simple is the fact that 1) vulnerability to inflation is a monetary problem that predates the advent of blockchain technology, 2) price-inflation remains a meaningful problem today, and 3) there’s reason to believe that independent issuers of on-chain money can produce assets that compete to offer better refuge from inflation.
Without getting into the full details, we can ground these principles and demonstrate their key benefits by discussing the SPOT system’s design at a high level.
The SPOT token is simply a redeemable claim on a basket of on-chain collateral.
The price of SPOT is left up to the market and will ultimately reflect the value of what the token is redeemable for in a collateral set. If the value of the collateral set goes up, the price of SPOT will likely go up, if the value of the collateral set goes down the price of SPOT will likely go down.
In the event that there are multiple asset types in the collateral set, SPOT tokens redeem proportionally:
Since all assets are distributed proportionally upon redemption, the ratio of tokens comprising the collateral set remains equivalent before and after any given redemption. Looking strictly at the effect of withdrawals, this means the value of SPOT remains the same even as withdrawals unwind to an empty set.
There are no pegs, feedback loops, or liquidation markets used in the system’s design. However, due to unique properties of how the system’s collateral is prepared and rotated, the redeemable value of 1 SPOT token will tend towards 1 CPI adjusted dollar.
The SPOT whitepaper 1) details how collateral is prepared and rotated, 2) explains why this results in the value of SPOT claims tending towards 1 CPI-adjusted dollar, and 3) outlines a system of incentives for rotating fresh tranches in and mature tranches out.
There are several simple and remarkable components detailed in the paper that we expect to see used throughout the space and we encourage you to give it a close read.
In the end, however, the fact remains that SPOT is simply a freely redeemable claim on a basket of on-chain collateral. Catastrophic outcomes commonly associated with stablecoins like “peg-breaks’, “bank-runs”, “cascading liquidations,” and “liquidity crunches,” simply do not apply—much as they simply do not apply to Uniswap-V2 LP tokens.