Just over one year ago, in February of 2021, Inverse Finance DAO launched DOLA, a new stablecoin pegged to the U.S. dollar. The vision was simple. We wanted to create a world where decentralized stablecoins are used by everyone in daily transactions. But we knew that to realize that vision, the world would need a better stablecoin. Under-collateralization, centralization, and flawed stabilization strategies afflict many of the largest stablecoins today, creating systemic risk for everyone. So we set out to create a stablecoin you can trust.
Unlike most other stablecoins, DOLA is fully decentralized, fully collateralized, capital-efficient, and transparently managed. Not only that, but the DOLA peg to the U.S. dollar is maintained through cross-chain interest rate management, or what we call the DOLA Fed. We think these features make DOLA more sustainable, trustworthy, and productive than any other stablecoin available.
In this post we’ll share more about stablecoins, their flaws, and how DOLA solves some of the biggest risks in the current stablecoin market. We’ll answer some basic questions, including:
What are stablecoins and why do they matter?
How does decentralization make DOLA more trustworthy?
Why is DOLA fully-collateralized?
How is DOLA capital efficient?
How does the DOLA Fed keep DOLA stable?
How does INV support the DOLA ecosystem?
What are stablecoins and why do they matter?
Whereas the value of many cryptocurrencies fluctuates dramatically day-to-day, stablecoins have a fixed price relative to another asset, often the value of the U.S. dollar. Stablecoins are the lifeblood of decentralized finance (DeFi). They make peer-to-peer transactions possible, they enable cross-border lending, they allow DeFi projects to engage in long-term financial planning, and they provide a stable place for investors to store their capital without taking it off-chain. Without stablecoins, many of the innovations of DeFi would not be possible.
The two largest stablecoins by market capitalization are Tether (USDT) and USD Coin (USDC) both of which are pegged to the U.S. dollar. The total market capitalization for all stablecoins today is over $180 billion, up from just $38 billion one year ago. The dramatic growth in stablecoin utilization has inspired the governments of nine countries to launch their own central bank digital currencies with 21 others either piloting or developing their own stablecoins.
How does decentralization make DOLA more trustworthy?
Some stablecoins, like USDC, or government-operated stablecoins, are centralized. That just means that the entity operating the stablecoin is centralized, and therefore subject to particular risks and vulnerabilities. Centralized stablecoins can be censored, for example, by a government imposing sanctions or regulation of free speech. They are also vulnerable to hacks and other security breaches targeting the assets backing them. When a stablecoin is operated by a country's government, that government can manipulate or inflate the currency in much the same way that governments manipulate fiat currencies. There is also the possibility the government-operated stablecoins could be used to surveil citizens. Finally, the operation of centralized stablecoins is often opaque. For example, Tether claimed that USDT was fully backed by fiat currencies, when in fact it was not.
Because of these risks and flaws, we believe that stablecoins should be fully decentralized. The DeFi industry, we believe, is only as durable as its weakest link, and reliance on centralized stablecoins threatens the entire DeFi industry. That’s why DOLA, unlike all centralized stablecoins, operates in a permissionless environment using Ethereum smart contracts. The smart contracts behind DOLA are operated by a decentralized autonomous organization (DAO), Inverse Finance DAO, with thousands of token holders who collectively make decisions via votes – what we call on-chain governance – that themselves occur on decentralized smart contracts. The collateral that backs DOLA is available for anyone to see on a decentralized blockchain, as is the open source smart contract code behind DOLA.
Why is DOLA fully-collateralized?
The most resilient stablecoins maintain their value through collateralization. This means that the stablecoin is backed by another asset held in reserve or as collateral. For example, for every $1 of USDC in circulation, USDC claims that there is $1 of US dollar fiat currency or US dollar-denominated assets held in reserve.
Still, fiat-backed stablecoins like USDC are prone to the risks of centralized stablecoins mentioned earlier, which drove the need for a better form of fully-collateralized stablecoin: cryptocurrency-backed stablecoins.
MakerDAO’s DAI stablecoin is the most well-known example and today has over $9 billion in circulation. Every DAI is backed by either USDC (22%), Ethereum, or another currency like WBTC.
DAI’s success spawned another class of stablecoin backed by little or no collateral at all: algorithmic stablecoins. While algorithmic stablecoin projects like UST or FRAX may enjoy the at-will printing of new stablecoins similar to methods of well-known fiat currencies, their ability to maintain parity with the U.S. dollar, commonly referred to as “maintaining the peg” is a matter of great controversy. More on this below.
In designing DOLA – and like DAI – we chose the more durable path of full collateralization. Full collateralization offers investors the peace of mind that their stablecoin can be redeemed for an asset of actual value in contrast to stables backed by nothing more than a software program. In notable contrast to MakerDAO, which allows the use of USDC as backing for DAI, Inverse maintains little or zero centralized assets in its treasury. So while stablecoins like DAI may profess to be “decentralized”, as long as their backing consists of censorable or cancellable assets like USDC, those claims to decentralization fall flat in proportion to the use of centralized stablecoins for backing.
Full collateralization, as I’ll explain below, offers greater long-term reliability for maintaining a stablecoin’s USD peg.
How Is DOLA Capital Efficient?
One critique of fully collateralized stablecoins like DOLA or DAI is that they are capital-inefficient because they require over-collateralization. For example, every DAI you borrow from MakerDAO is actually over-collateralized, meaning for every $1.00 in DAI there is approximately $1.56 in backing. This over-collateralization is required to allow for volatility in underlying assets like ETH. Some investors are understandably concerned about the opportunity costs associated with transacting in fully-collateralized stablecoins for this reason and may prefer uncollateralized stablecoins despite their risks.
DOLA addresses this capital-efficiency critique in three ways.
DOLA addresses this capital-efficiency critique in three ways.
DOLA collateral is yield-bearing
- Unlike MakerDAO and DAI, all assets deposited as collateral in Inverse’s Anchor protocol become yield-bearing. ETH and other assets staked in Anchor are in turn loaned to borrowers and Inverse shares a large portion of the interest earned with the depositor. On MakerDAO, your deposited collateral does nothing for you.
DOLA is a yield-bearing stablecoin
- The DOLA that you borrow can be staked on Anchor and receive interest or deployed in other yield-bearing strategies. And you can borrow DOLA, deposit it, and borrow again against your original staked collateral to maximize profits.
Yield-bearing assets can be staked.
- A third way DOLA addresses capital efficiency is through the staking of yield-bearing assets themselves, as in the case of Lido Finance’s stETH product. So a strategy here is: stake ETH on Lido to receive stETH or buy it, stake the stETH on Anchor as yield-bearing collateral and borrow DOLA against up to 85% of the value of your staked stETH.
How does the DOLA Fed keep DOLA stable?
For a USD-pegged stablecoin to be, well, stable, it has to maintain a low price variance relative to the USD.
To maintain the USD peg when an algorithmic stablecoin price rises above $1.00, either arbitrageurs arb the price back to $1.00 or the operator mints more stablecoins, creating new supply which pushes the price downwards. That’s easy and we do this with DOLA, too.
It is much harder, however, to bring the price of a stablecoin up when it falls below the $1.00 peg. This can and does happen during market downturns. Some algorithmic stablecoin operators respond by cashing in governance tokens to buy the stablecoin, hoping it will cause the price to rise back up to $1.00. But problems can arise because the supply of governance tokens is limited. In such a scenario, stablecoin operators might be tempted to print more governance tokens, causing the governance token price to drop. In such a scenario, an algo-stablecoin “bank-run” is possible. This method of stabilization has not been fully stress-tested because we have not yet experienced a prolonged bear market in which algo-stablecoins experience this downward spiral where their pegs slip below $1.00 over an extended period.
At Inverse Finance we are alarmed by these kinds of governance token schemes. Seen in isolation, a scenario like this could lead to a failed stablecoin project. But, if allowed to grow to large enough circulation and DEX liquidity, an algorithmic stablecoin failure could trigger failures of entire money markets, creating a domino-like cascade of liquidity emergencies and project failures.
That’s why we maintain DOLA using our innovative lending engine called the DOLA Fed.
The DOLA Fed serves a two-fold purpose:
Managing the supply of DOLA across lending partners; and
Ensuring that DOLA maintains its USD peg.
The DOLA Fed is a DAO-controlled function that controls lending rates across chains and individual lending markets. We can stimulate demand and therefore a supply increase for new DOLA borrowing by lowering rates or we can encourage a supply reduction by raising rates. If DOLA falls below its USD 1.00 peg, DOLA that is repaid can be “burned” or destroyed which in turn reduces supply and pushes the price of DOLA back up to $1.00.
The effectiveness of the DOLA Fed was recently stress-tested following a price manipulation incident that targeted our INV governance token. DOLA returned to peg very fast and can be said to have passed the test with flying colors further supporting the architecture of the DOLA Fed.
How does INV support the DOLA ecosystem?
While DOLA does not rely on governance tokens to stimulate demand or maintain its peg, it does utilize the INV governance token for several important roles in the DOLA ecosystem.
The first is that the sale of INV provides DOLA with essential decentralized exchange liquidity that can be moved to where it is most needed. This is achieved through the sale of INV through Protocol Owned Liquidity bonds available on Olympus Finance. INV holders may stake their INV on Inverse’s Anchor money market where they will receive INV rewards, and as INV is a collateral asset in Anchor the user can borrow DOLA against their staked INV. INV is also crucial if you are involved in the Inverse Finance DAO and want to vote on one of our many governance initiatives as it is the sole source of voting power.
The INV governance token has another special quality: Revenue Sharing Rewards. Holders of staked INV will receive a portion of DOLA lending revenue generated from the DOLA Feds scattered across mainnet, Fantom, and soon other chains as well. This DOLA revenue sharing — which will is paid in actual DOLA — has several benefits; reduced INV volatility, increased demand for INV, increased protocol-owned liquidity, and increased DOLA available for lending. Positive Sum DeFi transforms what most would call a “useless” governance token into a revenue sharing machine.
INV governance token stakers will receive a share of DOLA lending revenue, encouraging users to stake INV staking and supporting protocol-owned liquidity by bonding and thereby increasing their share of INV. Unlike zero-sum uncollateralized- or undercollateralized -stablecoin projects, Inverse’s Positive Sum DeFi strategy ensures steady growth in DOLA lending while at the same time adding stability to the price of the INV governance token.
DOLA: Playing the Long Game
So to summarize, DOLA is:
Decentralized, not backed by centralized stables or fiat currency
Fully collateralized
Capital-efficient, yield-bearing
Pegged to the US dollar through cross-chain interest rate management, aka the DOLA Fed lending engine.
Does not rely on high-risk governance token pegging or demand-generation schemes
Able to expand circulation via the “positive sum” revenue generation role of INV
Managed with fully on-chain and transparent governance, Inverse Finance DAO.
DOLA is carving out an important and ultimately highly sustainable position in an industry that will see high churn with multiple projects exiting the stablecoin space in 2022–23. We launched 13 months ago and we are taking no shortcuts in making DOLA a globally competitive stablecoin. Algo stables and fractional stables may show early signs of scalability but at the cost of stability and /or long-term reliability. Fully-collateralized stablecoins like DOLA may lack the steep circulation growth of its uncollateralized competitors, but DOLA instead provides investors with something of lasting value: the peace of mind that comes from relying on a stablecoin design that is built to meet a vision where every human being on planet earth in the not too distant future can own and rely on DOLA.
Disclaimer: This content is for informational purposes only and should not be construed as legal, tax, investment, financial, or other advice.
