Gyroscope: A Self-Stabilizing, "All-Weather" Reserve-backed Stablecoin
The Gyroscope stablecoin ($GYD on testnet, or the Gyro dollar) aims to be fully-backed by a portfolio of reserve assets, selected specifically to stratify the major risks that stablecoin systems tend to be vulnerable to. This “all-weather” reserve works in tandem with a thoughtfully designed algorithmic pricing mechanism for stablecoin redemptions to form a system that claims to be maximally resilient to all risks across DeFi. Complementary stability mechanisms in the form of leveraged loans and reserve recapitalizing actions further strengthen the system’s stability.
Gyroscope’s mission is to build robust public infrastructure for DeFi. The protocol’s founding team (‘Faster Than Light’ Labs, or FTL Labs) has begun to execute on this mission by developing a stablecoin for DeFi protocols and power users seeking the best decentralized stability. Since ~2018, members of FTL Labs have published a series of academic papers that formalize DeFi and stablecoin primitives, and synthesize models from computer science, economics, and finance to form a more complete understanding of both the technical and economic risks these systems face. These efforts have culminated in the development of the Gyroscope protocol and a stablecoin ($GYD) that’s designed to be maximally resilient not only to price risk, but also to censorship, regulatory, counterparty, oracle, governance, and bank-run risk.
Gamified Testnet, Current State, and Roadmap
The Gyroscope white paper was released in December of 2020, followed by the launch of a gamified testnet on the Kovan network in April of 2021. This game consisted of multiple levels that players (i.e. testnet users) could complete to test the protocol’s design and resilience against a number of threats, including simulated attacks and crashes. By completing each level, players earned virtual points that signify their early adoption and contributions to the protocol. Notably, completing Level 2 of this testnet game involved executing arbitrage trades to accrue enough Gyro dollars to purchase a Gyro NFT that represents membership in the “Gyronaut Corps”.
These NFTs were used as a first iteration of the protocol’s voting mechanism. Each NFT holder was given a vote in the protocol’s first governance proposal, effectively bootstrapping the Gyroscope DAO (Gyro DAO) from this community of early testers.
The protocol’s first governance proposal was passed by an overwhelming 99.8% majority of the 6,945 voters who participated, successfully accomplishing the following three objectives:
- Ratify Gyroscope’s core researchers and development team as FTL Labs, and give them a mandate to develop the first version of the Gyroscope protocol.
- Ratify a proposed, high-level governance token distribution (65% to the community, 35% to the core development team).
- Inaugurate the initial Gyroscope DAO multisig (a 3/5 multisig controlled by contributors to both Gyroscope and DeFi more broadly, including Tarun Chitra, Mathijs van Esch, Hart Lambur, Fernando Martinelli, and Tom Walton-Pocock).
Gyroscope is currently undergoing code audits while its users have the opportunity to complete a series of Sybil challenges designed to prevent a single user from creating multiple digital personas that would give them outsized power to influence Gyro DAO governance decisions. FTL Labs plans to deploy the first set of AMM’s on Polygon in the next few weeks, alongside additional code audits, and Ethereum mainnet launch later in 2022.
Tokenomics & Mechanism Design
As of the time of writing, Gyroscope has not yet launched on Ethereum mainnet. The project’s roadmap indicates this likely won’t occur until late Q2, 2022.
That said, the core team has written an article on the decentralization of token distributions, in which they review the token distributions of several notable DeFi projects that demonstrated a high level of rigor in their initial token allocation decisions, had a clear community orientation, and/or had a large user-base. Their findings were that these projects typically allocate ~59% of the initial token distribution to the community, and reserve the remaining ~41% of issued tokens for a group they call “Core Development” (made up of the founding team, advisors, and investors). Adhering to their strong community orientation, and recognizing the critical importance of decentralization to a stablecoin’s legitimacy, FTL Labs proposed that Gyroscope governance tokens be distributed as follows:
- 65% vested to the community,
- 35% granted to the core development team (FTL Labs) to be used in furthering protocol development (with all tokens coming out of this allocation being subject to a lock-up schedule consistent with industry standards), and
- 2% inflation per year after 4 years, that will be unlocked to the community treasury.
The community of Gyro NFT holders ratified this token distribution with the passing of the protocol’s first governance proposal.
Mechanisms as Lines of Protocol Defense
The protocol’s central feature is its US dollar-denominated stablecoin, $GYD (on testnet) or the Gyro dollar. The Gyro dollar’s price is stabilized by multiple mechanisms, or lines of defense, built into the protocol; namely, an “all-weather” reserve, algorithmic price bounding, and additional mechanisms that allow reserves to recover, or asset-backing to expand.
The first of these lines of defense is a so-called “all-weather” reserve of assets designed to stratify all of the major, known risks that could destabilize the system. This is achieved by storing reserve assets in a series of segregated “vaults”. If any of the assets within a given vault were to default (i.e. go to zero), or the infrastructure or smart contracts holding the assets in that vault were to be exploited (i.e. hacked), the failure of that individual vault would not cascade throughout the system. By stratifying risk across vaults in this way, the protocol protects itself from what’s known as contagion, or composability risk, and attempts to eliminate single points of failure in the system.
All proceeds from the issuance of Gyro dollars go to fund this reserve, and the reserve aims to contain sufficient value in assets to back at least 100% of the value of issued Gyro dollars at any given time. The assets held within reserve vaults are predominantly other stablecoins at this time, however that may change as the protocol evolves.
An analogy can be drawn here between the Gyro Dollar’s all-weather reserve and the spinning disk of a physical gyroscope. In a physical gyroscope, the spinning disk’s angular momentum causes its orientation in space to remain stable, despite the movement of its surroundings. In the Gyroscope system, the value of the all-weather reserve stabilizes the price of 1 GYD at the dollar price target, despite the volatility that may exist in the broader crypto and DeFi ecosystems. In a physical gyroscope, friction causes the spinning disk to slow, or to lose some angular momentum, and become wobbly. In Gyroscope, this frictional force is experienced if the reserve assets backing the Gyro dollar lose value and the system becomes undercollateralized. The same wobble we see in a physical gyroscope shows up as price instability of the Gyro dollar. Crucially, however, the Gyroscope system can be “spun” back up like a physical gyroscope, by a combination of high yields from existing reserve assets, and capital inflows to the stablecoin increasing the value of the reserve.
If Gyroscope’s all-weather reserve, the protocol’s first line of defense, experiences a major shock that drastically reduces its value and results in the system becoming undercollateralized, the protocol’s second line of defense kicks in. This second line of defense is Gyroscope’s algorithmic price bounding, which essentially decreases the amount of reserve assets that any Gyro dollar holder is able to redeem 1 GYD for. This redemption price is set algorithmically by the protocol’s primary-market AMM (PAMM), and is a function of both the current reserve ratio (i.e. the ratio of the value of reserves, to the value of Gyro dollars in circulation), and the current level of stablecoin redemptions, or outflows (i.e. the percent of the total Gyro dollar supply being redeemed for reserve assets).
This mechanism of decreasing redemption quotes acts as a circuit breaker that maintains a sustainable system. While enabling stablecoin holders to exit, decreasing redemption quotes aim to disincentivize bank-runs and attacks on the currency peg by requiring users who exit while the reserve is undercollateralized, or while stablecoin outflows are unusually high, to do so at a discounted GYD price. Further, this mechanism rewards Gyro Dollar holders who wait for a downturn in the reserve’s value, or a period of excessive stablecoin redemptions, to pass in a sustainable way. As stablecoin redemptions tend towards zero or the value of the reserve assets recovers (e.g. through yield on the remaining reserve assets), the GYD redemption price algorithmically recovers back towards the 1 USD price target.
By storing all reserve assets, as well as the rules governing how these reserves will be used, entirely on-chain, Gyroscope provides users with rational, verifiable reasons to bet on the stablecoin returning to its target price following a period of instability. In doing so, Gyroscope coordinates users’ beliefs about the system’s long-term sustainability, and rational users can “implicitly agree on whether to attack or defend the peg, since they only win by being in the majority. This aims to preempt confidence crises.”
The mechanisms described above are considered Gyroscope’s “core stability mechanisms”, and function by way of two custom AMMs designed by FTL Labs; the primary-market AMM (PAMM) and a series of redundant, independent secondary-market AMMs (SAMMs).
The PAMM allows any user to mint Gyro dollars by depositing reserve assets, or to redeem Gyro dollars for assets from the protocol’s reserve. Importantly, the PAMM is entirely permissionless, with no central issuer or counterparty. The shape of the PAMM’s bonding curve defines the prices at which 1 GYD can be minted or redeemed, and is a function of both the current reserve ratio and the current level of stablecoin outflows. The white and grey lines in the diagram below depict stylized versions of what the PAMM’s bonding curve may look like when the value of Gyroscope’s all-weather reserves are sufficient to cover 100%, 90%, and 80% of the value of issued Gyro dollars (at different levels of stablecoin redemptions).
The secondary-market AMMs (SAMMs) are a network of redundant and independent markets that concentrate liquidity within a price band defined by the PAMM’s minting and redemption quotes. When the system is fully collateralized, and stablecoin redemptions are low, the SAMMs concentrate liquidity tightly around the 1 USD price target. However, when there’s a shock to Gyroscope’s all-weather reserves, or stablecoin redemptions are high, this price band widens. Together, these SAMMs and their respective reserve pools form a highly liquid DEX (decentralized exchange) that can withstand the failure of any given pool. Both the PAMM and the SAMM designs will be further specified in technical papers that FTL Labs plans to release with the mainnet launch of the protocol.
Finally, the protocol will incorporate complementary stability mechanisms which act as tertiary lines of defense. These include the integration of leveraged loans, and reserve recapitalizing actions. Similar to MakerDAO’s system, Gyroscope allows users to provide collateral assets to the protocol in exchange for a loan of Gyro dollars. If the price of 1 GYD falls significantly below the 1 USD price target, users with loans may purchase GYD at this discounted price to deleverage their positions, and thereby reduce the supply of GYD on the open market and help drive the GYD price back up to 1 USD. Recapitalizing actions can also take place to bolster the reserve, including the securitization and sale of future yield from the reserve’s yield-bearing assets, or incentivizing governors to auction off governance tokens to fund the reserve.
From an oracle and price feed standpoint, Gyroscope currently relies on a custom built oracle design called the Triangulated Price Feed (TPF) as well as a custom implementation of the Balancer Pool LP token (BPT) oracle. Rather than relying on a single oracle provider for data and price feeds, Gyroscope’s TPF design first references multiple on-chain data sources to define a relative price level, and then cross-references that price against a variety of oracles. Further, the protocol’s custom BPT implementation provides methods for pricing LP and vault shares that are more resistant to manipulation. Together, this system of oracle guardrails is used by the protocol “to extend the scope of trust minimization and failure tolerance”. A more comprehensive technical paper and specification for the Triangulated Price Feed design will be released by FTL Labs at a later time.
In addition to developing novel stability mechanisms, Gyroscope proposes two new governance primitives that aim to better align protocol governors with the long-term interests of the protocol by minimizing governance extractable value (GEV). These primitives are referred to in the protocol’s documentation as “Conditional Cashflows” and “Optimistic Approval”, and are described more completely in this article on GEV and this academic paper on DeFi written by members of FTL Labs.
Since the protocol may generate cash flows from its operations, determining how these cash flows are distributed, and the financial incentives this creates are critical to mitigate GEV. The Conditional Cashflows mechanism would direct all operational cash flows into the protocol’s all-weather reserves by default. These rewards can only be unlocked by protocol governance at some future time, conditional on the system remaining healthy. In the event that the system becomes unhealthy, these cash flows are retained by the protocol as reserve assets that help sustain the system. Governors are therefore disincentivized to make risky decisions that could jeopardize the health of the protocol.
All other decisions made by governors would be subject to the Optimistic Approval mechanism. In short, this mechanism makes all governance changes conditional on a timelock and veto process. This can help align incentives of governors with other protocol participants, such as Gyro dollar holders in the Gyroscope system, by giving non-governor participants the power to veto any governance change they perceive as malicious or detrimental to the system.
As the stablecoin wars rage on between the likes of USDC, UST, Dai, FRAX and others, the Gyroscope protocol has been quietly building and testing an alternative class of stablecoins altogether. Winning market share away from incumbents in the already fiercely competitive stablecoin market will be no easy feat. Centralized stablecoins like USDT and USDC have strong Lindy effects and are deeply intertwined with the vast majority of DeFi protocols, while newer, less explicitly centralized stablecoins like Terra’s UST offer users an attractive ~20% yield on deposits to protocols like Anchor. So long as these yields remain high and the vast majority of stablecoin users are unaffected by centralization risks, Gyroscope may struggle to gain traction with mainstream users.
However, if and when times turn bad in the crypto markets or centralization risks materialize for a broad DeFi user group, Gyroscope may see a mass influx of new users seeking the least bad outcome. If the mechanisms supporting the Gyro dollar work as intended, and the protocol can deliver a decentralized stablecoin that’s resilient in all market conditions, Gyroscope’s user base could extend well beyond their initial target market of DeFi protocols and power users.
Regardless of the adoption or success that Gyro dollars achieve, the origin story of FTL Labs and the Gyroscope protocol are indicative of a broader trend that’s playing out across crypto and DeFi; namely, the promise of the open financial system attracting top talent from both industry and academia. The development of the Gyroscope protocol has produced multiple new mechanisms and primitives that push the frontier of the stablecoin design space forward. In the short-term, it will be interesting to see how Gyroscope’s novel mechanism design functions on Ethereum mainnet, and how the market reacts to this new and complex stablecoin design. In the long-term, it will be equally exciting to track which piece of DeFi infrastructure FTL Labs reimagines next.
Further Reading and Sources
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