The Story Behind Yama
The motivation behind building this protocol is to make something actually useful to people. DeFi has the potential to change this world and meaningfully help billions of people. However, it has been plagued by numerous protocols that marginally iterate on tokenomics without improving the core product. Most of the money in this industry is spent on speculation and ponzi schemes. Yama aims to change this.
The status quo
Stablecoins are one of the strongest use cases of DeFi. Many people and businesses use stablecoins to transact internationally or in countries with high inflation. Despite this, existing stablecoin designs are inefficient and have not had any significant innovation since MakerDAO established the PSM in 2020. This limits their utility.
Broadly, there are three types of stablecoins:
- CDP-based (collateralized debt position) stablecoins such as Dai. You can create a vault, put $150 of ETH into that vault, and borrow $100 of the stablecoin against the collateral locked in that vault. Because the stablecoins in circulation are overcollateralized, this approach effectively maintains price stability. Moreover, due to the speculative nature of the crypto market, there is significant demand for leveraged positions, which CDP protocols provide. The problem is that stablecoins usually don't support the tokens that people want to leverage up on as collateral. Consequently, the demand for the loans isn't enough to sufficiently increase the supply of the stablecoin. As a result, capital efficiency is usually limited.
- Algorithmic stablecoins such as the now-defunct UST. The general rule is that there's no external basket of assets backing the stablecoin, and the protocol relies on other market forces to maintain price stability. UST's approach is to burn another asset (e.g. LUNA) to mint the stablecoin, and you can mint the original asset by burning the stablecoin. The protocol is at risk of a depeg if too much capital flows out. There are other approaches to this, such as Beanstalk, where users lend money to the protocol to protect the peg, but the fundamental characteristics are the same. The benefit to algorithmic stablecoins is that they are decentralized and no collateral has to be locked up, so there's increased capital efficiency. The problem is that because there's no collateral, the peg is much less secure.
- Fiat-backed stablecoins like USDC and USDT. These stablecoins are backed by off-chain cash and liquid bonds. They're generally multichain, very stable in price, and capital efficient, but they are also centralized. Nonetheless, people usually use fiat-backed stablecoins when accepting payment for services.
No existing stablecoin is good at everything. CDP-based stablecoins have a lack of capital efficiency that limits their popular use. The nature of algorithmic stablecoins doesn't let people build the trust necessary for wider usage, and trust is necessary for any stablecoin to succeed. Fiat-backed stablecoins don't let you leverage your position by borrowing against your assets.
Established stablecoins have experimented with different ideas. Some have failed and others have succeeded. Fei introduced Liquidity-as-a-Service and Dai pioneered the concept of a collateralized debt position. We are grateful for these experiments, as they have shed a light on what works and what doesn't.
Meanwhile, numerous stablecoin projects have created new designs without fundamentally changing the process. For instance, some CDP-based stablecoins have implemented a process in which the collateral is yield farmed, but this does not intrinsically differ from accepting yield-bearing assets as deposits. Several projects have implemented algorithmic stablecoins in different ways but involve a similar value transfer process. The overwhelming majority of stablecoin projects are forks or introduce surface-level design changes.
True innovation is uncommon.
Still, there exist problems that are not being adequately solved. The collapse of UST has a left a gap in the Cosmos ecosystem whose impact still has not been overcome. Most decentralized stablecoins tend to be based on a single chain, which defeats the purpose of a stablecoin being a universal standard for settlement. Existing CDP-based stablecoins are not capital efficient, but fiat-backed stablecoins don't allow you to leverage up. Many such problems have not yet been addressed.
The missing piece is a stablecoin that actually provides the most value. A stablecoin that considers historical market trends to maximize utility. A stablecoin that takes a pragmatic approach to product-market fit. Not surface-level design changes.
Let's walk through the rationale behind Yama's design.
This stablecoin has to be decentralized in order to limit the risk of one entity destroying the system, so it cannot be a fiat stablecoin. Moreover, this stablecoin has to be collateralized by something such that poor market conditions don't lead to its demise, so it cannot be an algorithmic stablecoin. As a result, Yama is a CDP-based stablecoin.
We can inherit the capital efficiency of fiat stablecoins by adopting a peg stability module (PSM) which allows users to swap 1:1 from a supported stablecoin to Yama. But Maker and numerous other protocols have done this, and the market has shown people would rather use USDC than a stablecoin that's effectively wrapped USDC (DAI/FRAX/etc.). This is not enough. What more can be done to make CDPs useful?
The answer is hidden in plain sight.
The design of CDP stablecoins is usually portrayed as a weakness in terms of capital efficiency. Why would you lock up $1.50 of ETH to mint $1 of DAI when you can send cash to Circle and receive USDC at a 1:1 ratio? This perception of CDPs as a weakness has influenced many decisions in the stablecoin world, such as FRAX's partially algorithmically backed design.
But instead of being a weakness, the ability to borrow against your assets is arguably an extremely powerful advantage. People want to multiply their yield.
Stablecoin protocols like Vesta and Kokoa Finance have taken advantage of this by marketing themselves as tools to leverage exposure to yield-bearing assets. But their minimum collateral ratios (ratio of collateral to debt, i.e. CR) are relatively high, so you cannot leverage up significantly.
How can we fix this?
If you lower the minimum CR, you run the risk of the price of the collateral dropping too quickly for the liquidation auction to finish in time. Anyone can participate in this auction regardless of how much money they have (thanks to flash loans), but time is the limiting factor. To fix this, these auctions should start at 99% of the price of the collateral and drop a small percentage (~0.7%) approximately every time a new block is mined (~12s for Ethereum). It becomes quite expensive to censor more than 2 consecutive blocks, so this change allows liquidations to occur quickly and safely.
The other problem with lowering CRs is slippage. But for many yield-bearing assets (such as stable LPs), there are underlying assets that are more liquid. If well-built liquidation tooling is in place, the collateral can be converted to the underlying assets and liquidated easily. For example, 2CRV LP tokens can be converted into USDC and USDT. If the PSM relies on these tokens, then no additional security assumptions are made. A 101% CR can be set without additional risk from the potential of collateral price dropping too quickly (which would affect the PSM anyway).
It is also important to note that the volatility and liquidity of the collateral asset affects the minimum safe CR, so while stable LPs can have a 101% CR, ETH cannot. For reference, Liquity set the CR for ETH at 110%. There is always the theoretical risk that a large price drop will create bad debt.
So Yama has lower minimum collateral ratios, which means higher maximum leverage ratios. But with a 101% CR for a stable LP, there's a maximum leverage of 101x. 3% yield becomes 300%. Infinite money glitches don't exist, so what else is missing from the picture? Buy-side liquidity.
To see further, a paradigm shift is needed.
Like Gearbox protocol, people borrow money from Yama to leverage up on yield-bearing assets. But stablecoin protocols don't have "lenders", so this money actually comes from short-term resistance to downward Yama price pressure, i.e. buy-side liquidity. Usually, this is money from the PSM. When Dai's price drops, arbitrageurs buy it at a discount and use the PSM to redeem it for USDC. If too many people are leveraging up significantly, eventually the PSM funds will get drained. This will cause the CDP's price to drop and introduce slippage.
The people who have deposited USDC into the PSM are indirectly lending money to those leveraging up.
By recognizing the role of this essential value transfer, you realize the importance of incentivizing locking up money in the PSM. Give market makers some of the interest from borrowers for locking up their money in the PSM, and you strengthen the buy-side liquidity that allows for this powerful leverage. Now you've found the last piece of the puzzle.
As a result, Yama ends up being the stablecoin that most effectively aligns everyone's interests. Borrowers get the most leverage, lenders get passive yield, and the whole system provides liquidity to the stablecoin. Everyone receives value.
This is how we build the stablecoin that replaces fiat.