Bitcoin was designed in 2008 as an electronic payment system to allow people to transact directly with each other without the need for a trusted third party, i.e., a decentralized money for the internet.
The economic design of Bitcoin with a fixed supply makes it a good store of value for the long term. However, this inelastic supply causes its price to be extremely volatile in the short term, making its use as a currency inappropriate. This has led to the creation of so-called stablecoins, designed to maintain a peg with some fiat currency, the most common being the US Dollar.
The first attempts to create stablecoins date back to 2012 (Mastercoin). Tether, the largest stablecoin issuer today, was created in 2014. The number of stablecoins in existence nowadays is counted by tens.
In recent years, various taxonomies have been proposed based on the type of collateral used, peg target, and technological mechanism. Without being too strict on the classification, it is commonly accepted that there are three main types of stablecoin:
- Centralized: The common characteristics shared by all the currencies of this group is that they are issued by a traditional company which keeps reserves, in fiat currency and other assets of equivalent liquidity (such as treasury bills), for a value equal to or greater than the face value of the stablecoins issued, and that all are censurable, that is, they incorporate blacklist functions in their smart contracts that allow the issuer to seize the assets of any user at will. Examples of this type are Tether's USDT, Circle's USDC and Paxos' BUSD.
- Algorithmic: Under this category are those protocols that do not use any source of value external to the protocol itself to maintain the peg of their stablecoin, which is why from a more formal perspective they are called endogenous collateral stablecoins, in the event that they use a system of seigniorage shares, or implicit collateral stablecoins, if they use a rebase or bonding system. Examples of this type of stablecoins can be found in Ampleforth (AMPL), Neutrino (USDN), Haven (xUSD), Beanstalk (BEAN) and the infamous Terra UST.
- Collateralized: This category includes all stablecoins that use external sources of value as collateral. These sources can be stable (usually other centralized stablecoins), floating (other cryptoassets) or mixed, and depending on the proportion of value required to mint them, they can be overcollateralized or fairly collateralized. Some are issued in the form of debt, whereby the issuer pays interest to the protocol for the minted currency. The best known examples of this category are Maker's DAI, FRAX, Liquity (LUSD), Magic Internet Money (MIM) and FEI.
It is important to note that, in a broad sense, all stablecoins are collateralized, as they all need a source of value to maintain a stable price. The only real difference between them therefore lies in the nature of that source of value.
If the previous classification is taken strictly, the Geminon protocol would fall into the category of algorithmic, since its stablecoins are minted only from an internal asset, the GEX token. However, this would be inaccurate as the GEX token is not the actual source of value in the protocol.
The reason is that the GEX token acts as a proxy for the true source of value in the system, which is the collateral deposited in the GLPs. This setting is necessary as it would not otherwise be possible to use floating collateral for stablecoins without heavily overcollateralizing the protocol to absorb its volatility.
There is currently no other protocol that uses this stability mechanism for stablecoins, despite the fact that it combines the advantages of algorithmic and collateralized systems, eliminating or reducing their drawbacks:
- It provides GEX token holders with direct exposure to stablecoin issuance, which is the primary advantage of algorithmic protocols based on seigniorage shares.
- It has unlimited scalability. The lack of scalability is the main problem posed by overcollateralized stablecoins.
- It is more decentralized than most collateralized or over-collateralized stablecoins, as it has less need to include off-blockchain assets to hold the price anchor.
- It is able to hold the peg in any market condition as effectively as centralized stablecoins, avoiding the risk of a "death spiral" of algorithmic stablecoins.
The system proposed by the Geminon protocol therefore has a better balance between decentralization, security and scalability than any other existing stablecoin.
Some might argue that the proposed scheme is directly equivalent to the straight use of collateral for stablecoin issuance, and therefore the system would collapse the moment the total capitalization of the collateral is less than that of the issued stablecoins, making the value of the GEX token and therefore of the stablecoins issued against it fall to near zero, as happened with Terra UST.
All the simulations carried out of the long-term behavior of the protocol, however, contradict this theory: for all the stationary configurations with random trades in which the entire supply of GEX tokens is returned to the GLPs cyclically, the final price of the token after 1 million trades is always higher than the initial one by at least one order of magnitude. This effect can not be due to the fees, since the amount of residual collateral in the pools is also higher and deactivating them shows the same results. Such observed behavior would not be possible unless another source of value existed in the protocol other than collateral.
GLPs constitute an algorithmic mechanism of implicit collateralization.
In all existing trading systems, whether it is a stock or futures broker, a cryptocurrency exchange or a decentralized exchange (DEX), every time a trade is made there is an impact on the price, called slippage. We can think of this slippage as the entropy created by the action of trading, and it is a loss that the trader suffers in favor of the market maker that gives him counterparty. In the case of a DEX liquidity pool, that market maker is the liquidity provider.
In Geminon's GLPs, however, there are no liquidity providers. Instead, it is the GLP itself that generates new liquidity every time someone adds collateral (hence the name Genesis Liquidity). This means that all the value that is usually captured by those liquidity providers (the entropy) is instead retained within the GLP and reflected in the long-term value of the GEX token. And this is what all the simulations of the protocol show: the more the GEX token is traded in a GLP, the higher its terminal value, regardless of the direction of the trades.
GLPs are a form of liquidity bootstrapping pools (LBP), and can also be viewed as entropy capturing machines (ECM). They are the key piece in the operation of the Geminon protocol, and very especially in its value generation system. You can read more in detail about them in the dedicated chapter.