Vader Protocol vs Terra — Why Vader’s hybrid backing makes it antifragile when compared to Terra

A stable coin is a token whose value is pegged to 1 USD. Demand for stables, as they are collectively referred to, is driven by the need to lock profits onchain instead of selling for USD and falling back on traditional finance intermediaries (banks). Onchain is preferrable because it is much more private, censorship resistant, has no limits, no seizure risk, and allows users to access & spend their funds anywhere in the world. This is why ideally stables are the optimal solution for emergency funds or savings. However, to this day, the most successful stables are centralized ones. These are coins whose minting is controlled by a third party so even though they are held onchain, there is risk that the minting party (company that controls their creation process) might create more tokens than what can actually be converted into 1 USD should shove come to push.

This brings us to Vader and Terra. Both aspire to create a decentralized stable coin whose backing and purchase power is controlled and pegged by an algorithm rather than by human intervention. Terra is an established protocol whose tokens LUNA and UST have market caps of $36bn and $9.8bn respectively. UST is Terra’s decentralised stable coin, and since its price is pegged to 1 USD, we can deduce from the market cap that a net 96 billion UST tokens have been minted so far. LUNA, on the other hand, is Terra’s governance token and it has an important role because the only way to mint UST is by burning LUNA. This burn-to-mint mechanism is a DeFi innovation that was brought by LUNA. It is this passage that has been copied by Vader, the governance token VADER must be burned to mint the stable USDV. Make no mistake though, despite this similarity in the way of minting their stable coin, the USDV is profoundly different from the UST if we look at upstream processes that guarantee value accrual in the network and ultimately, its backing.

Decentralized Stablecoins and the Burn-to-Mint model

The viability of a decentralised stable depends on 3 key processes:

1. Collateral backing: it must be possible for any user who holds one token to redeem it for 1 USD at any time
2. Balancing: a process through which new stable tokens are minted as value backing increases or old stable tokens are burned as value backing decreases
3. Utility: holders of the token should benefit from as many use cases as possible (lending, borrowing, staking etc) without having to switch network

Collateral backing and balancing are 2 processes deeply intertwined with each other. Ultimately these 2 processes ensure that stable token holders can claim 1 USD from each token they hold. In the burn-to-mint mechanism used by Terra and Vader, users can burn the most volatile token to mint the stable or they can burn the stable to mint the volatile counterparty. If we think about it, if for some reason everyone holding the stable decides to exit, they will be able to do it in 2 ways:

Option A: Buy whatever major crypto they can directly with the stable and then sell that crypto for USD

Option B: When that’s no longer possible or convenient because of low liquidity, burn the stable to create counterparty token in the burn-to-mint algorithm and then sell that token for USD.

We can see why option A is what users opt for in normal times. Option B, on the other hand, would be the prevailing method in a worst case scenario. It is here that the deep difference between the risk profiles of LUNA and VADER become evident because while UST is backed by trust dependent collateral, USDV’s backing by a hybrid of trust dependent collateral (POL) and utility driven collateral the Vader AMM. This combination makes the USDV capable of absorbing market shocks thanks to its ability to respond to changes in market conditions by changing its composition from prevalently trust driven backing (calm markets) to utility driven backing (volatile markets).

Trust Dependent Backing vs Utility Driven Backing

Before I proceed further it’s important to not get overcarried away and remind ourselves that Terra is an established platform, with a multibillion dollar market cap, and a very strong network effect as reflected by the adoption of its stable coin UST. Every Vader enthusiast needs to understand and respect the immense achievements of Terra. As of now, Vader is but a blip in Terra’s rearview mirror. Vader can however, thanks to its antifragile properties and unique architecture, get much closer or even ahead of Terra as these advantages also become more with scale.

Going back to the title of this paragraph, the main difference between trust dependent backing (TDB) and utility driven collateral (UDB) is that TDB depends mainly on trust in the underlying stable coin UST or USDV. More trust there is in the stable, more people will use it and more collateral its users will be willing to put down to mint new tokens. Utility driven collateral, on the other hand, is assets users have put down in order to be able to take advantage of profit opportunities created by that protocol. Once the opportunity comes less, the capital flees elsewhere.

In Terra, the backing of UST is ensured by burning LUNA or by the amounts of loans against crypto collateral taken in Terra’s Anchor platform. Both of these processes would be reversed if we saw trust in the UST collapse. Those who borrowed UST would be looking to return their loans in order to get their collateral back while others would burn their UST for LUNA and then sell LUNA for USD (Option A above). This is where Vader and its stable USDV have an edge over Terra because aside from trust dependent collateral, in Vader, thanks to its AMM, we also have utility driven collateral. To put into focus, we can frame it as follows:

1. there will always be some demand for low slippage (compared to the rest of the market), impermanent loss protection and slip based fees despite whether users are willing or not to keep their emergency funds in USDV.
2. there will always be some demand for $VADER as a source of access to AMM’s profit streams, despite whether users are willing or not to keep their emergency funds in USDV.

The Implications of Utility Driven Collateral

Utility driven collateral that is decoupled from trust in the underlying stable allows token holders of that stable to always be able to extract value from the token even when there is a run to the exits. Utility ensures that there is always capital for which it is profitable to stay with the token no matter what. In Vader’s case it’s not just that, thanks to slip based fees a rush to the exits actually opens up even bigger arbitrage opportunities for mercenary LPs hence attracting even more opportunistic capital from individual LPs that compensate for the lost TDB. The TDB in Vader is its treasury, and if trust in USDV falls then people will start to exit via option A and sebsequently option B. The reason this makes Vader antifragile is that while trust driven users flee the platform, such as when market wide panic kicks in, new incentives are created for profit-seeking, mercenary LPs to fill the void and profit from the increased volatility.

This ability to adapt by changing the composition of its backing from prevalently trust based to opportunistic, is Vader’s unique capability and its strongest selling point when compared to the most successful decentralized stable coin out there, the UST.

State of the Art Decentralization

Lastly, another advantage USDV has over UST is that it is built on Ethereum. Currently this may seem like a handicap from a user experience point of view because of Ethereum’s high gas fees at the moment, however with Ethereum 2.0 around the corner, there will be significant improvements on that front soon. An important advantage is that by being built on Ethereum, USDV can leverage Eth’s state of the art decentralization and all the advantages that come with it which I mentioned in the beginning: censorship resistance, seizure proof, no limits, universal access.

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