Djed vs UST Algorithmic Stablecoin | COTI CEO, Experts & Community Explain Why Cardano’s Coin is Best
12 min read
Currently, there has been much concern in COTI’s and Cardano’s communities about Djed’s ability to maintain its peg in light of the recent UST’s demise. Djed, a Cardano crypto-backed, algorithmic stablecoin, is in the testnet phase and soon will be released to the mainnet. COTI and Cardano enthusiasts, eagerly waiting for Djed’s release, have been blindsided by UST’s freefall and wonder if Djed could meet this same fate.
In this blog post, you will get insights from the COTI CEO, Shahaf Bar-Geffen, Analysts, and Reddit Community members who will attempt to answer these pressing questions. Knowledge is power, and in this case, may help with your anxiety over Djed.
Djed’s Development History
–> Early in 2021,IOG, Ergo, and Emurgo teams have been working on the implementation of the Djed algorithmic stablecoin contract to test different models.
There were two versions of Djed:
Minimal Djed: this version is designed to be as simple, intuitive, and straightforward as possible, without compromising stability.
Extended Djed: this more complex version provides some additional stability benefits. The main differences are the use of a continuous pricing model and dynamic fees to further incentivize the maintenance of the reserve ratio at an optimal level.
The first implementation of a Djed stablecoin contract was SigmaUSD on Ergo. This was the first algorithmic stablecoin deployed on a UTXO-based ledger in Q1 2021.
This initial version was subject to a reserve draining attack by an anonymous user who owned a large number of ERGs (Ergo’s native coin). The attack was ultimately unsuccessful, and it is estimated that the attacker lost $100,000.
To further discourage such attacks, this initial deployment of Minimal Djed was replaced by a version where the fee was set to 2%, the oracle updated every 12 minutes, and every oracle update was allowed to change the price by at most 0.49%, unless the price difference was greater than 50%. This provided stronger resilience against reserve draining attacks.
Djed had also been implemented by the IOG team in Solidity. One version uses the native currency of the Ethereum blockchain as a base coin, and another uses any ERC20-compliant token as a base coin.
Djed: Cardano implementation
The Alonzo update to Cardano, in 2021, enables smart contracts using Plutus. Plutus is powered by Haskell, which guarantees a safe, full-stack programming environment.
Draft implementation of an earlier version of Minimal Djed is available in the Plutus language. In this implementation, stablecoins and reserve coins are native assets uniquely identified by the hash of the monetary policy that controls their minting and burning according to the Djed protocol. This implementation also assumes that oracle data such as the exchange rate is provided as signed data directly to the transactions, instead of being posted on-chain.
During the Q1 of 2021 there was also an ongoing OpenStar implementation. OpenStar is a framework for private permissioned blockchains developed in Scala. That implementation of Djed using OpenStar follows the idea of off-chain smart contract execution to have a stablecoin on Cardano that does not depend on smart contracts executed on-chain.
COTI Chosen To Be The Issuer of Djed
–> On September 26, 2021, day two of the two-day Cardano Summit 2021, IO Global (IOG), the blockchain technology firm responsible for the development of Cardano ($ADA), and FinTech startup COTI Group unveiled Djed, a new algorithmic stablecoin for Cardano that was developed by the former and is issued by the latter.
This development was a natural progression between Cardano and COTI given their growing partnerships and Cardano investing in COTI.
Djed’s use of smart contracts ensures price stabilization. Djed can be useful in decentralized finance (DeFi). It works by “keeping a reserve of base coins, and minting and burning stablecoins and reserve coins.”
Djed’s white paper states that the Djed protocol “behaves like an autonomous bank that buys and sells stablecoins for a price in a range that is pegged to a target price” and that Djed is crypto-backed “in the sense that the bank keeps a volatile cryptocurrency in its reserve.” It also mentions that Djed is “the first stablecoin protocol where stability claims are precisely and mathematically stated and proven.” (Check out this video if the white paper has you scratching your head)
In a blog post published a day before the Cardano Summit, IOG said that Djed “operates by maintaining a reserve of base coins, while minting and burning various other stable assets and reserve coins” and that “it is designed to be used for paying transaction fees on the Cardano network,” which helps to “make transaction costs more predictable, so avoiding volatile and exorbitant gas fees for users.”
The COTI team believes that “stablecoins are a ‘killer app’ that will be adopted by a large number of crypto users for settling payments and covering fees.”
Shahaf Bar-Geffen, the CEO of COTI Group, had this to say:
“The stablecoin ecosystem has matured tremendously over the past few years. Blockchain participants are using stablecoins to engage in everyday transactions because they allow monetary value to be exchanged in a seamless manner, regardless of the sender and recipient’s location. I believe that adding the Djed stablecoin to the Cardano blockchain will significantly improve how transactions are settled on the platform.“
And IOG Co-Founder and CEO Charles Hoskinson stated:
“The Djed stablecoin could be a game-changer in the crypto space, appealing to an entirely new audience at a time when the industry is already experiencing astronomical growth. Djed shares our commitment to formal verification, proving a robust method of combating price volatility of crypto markets.
“COTI has been a long-time partner of the Cardano ecosystem. It’s great to have them on board with this new venture.“
Djed’s Reserve Coin, Shen, Was Introduced
–> On February 3, 2022,COTI announced the name of the Reserve Coin, mentioned in the White Paper, will be Shen. The purpose of Shen is to act as a reserve coin for Djed. In their words, Shen will act as “— a unique mechanism that will maintain the efficient pegging of stablecoins while providing an incentive to token holders in the long term”
By utilizing a reserve, base fees can be charged, collected, and pooled for transactions facilitated by the underlying stablecoin. Reserve Coin holders then get a share of this transaction pool as an incentive for their participation in maintaining the stablecoin peg ratio.
By buying and selling Shen, users are able to maintain Djed’s USD currency peg while earning a share of transaction fees in the reserve pool. Since the Reserve Coin is a tradable asset, holders can also profit from the short-mid term price fluctuations as an added incentive.
Before the launch of Djed, COTI will be implementing Shen to serve this function of maintaining Djed’s peg and liquidity stability.
Djed’s Public Testnet Version Has Been Released
–> On May 4, 2022, in a blog post COTI announced that the public testnet version of their decentralized algorithmic stablecoin has been released.
The blog post went on to say that this release allows them to “test the main functionalities of the protocol in a fictitious and safe space using trial funds and will “give everyone an opportunity to understand the dynamics of the protocol without incurring any risks.” It also mentioned that “SundaeSwap, Minswap and WingRiders are starting to test Djed through test pools on their platforms.”
The COTI team reminded everyone that “the Public Testnet’s purpose is to test all aspects of the release” and that they “expect some technical issues to arise.” As for the Public Mainnet version, they are planning to release it in June.
How Djed Is Different From Other Algorithmic Stablecoins
The Djed stablecoin is designed as an asset pegged to a fiat currency (USD), along with a governing algorithm. This approach provides a stable means of exchange. But Djed is not limited to being pegged to the dollar. It can work with other currencies, as long as there are oracles providing the contract with the corresponding pricing index.
Djed is the first coin to use formal verification to eliminate price volatility
Peg upper and lower bound maintenance: the price will not go above or beyond the set price. In the normal reserve ratio range, purchases and sales are not restricted, and users have no incentive to trade stablecoins outside the peg range in a secondary market.
Peg robustness during market crashes: up to a set limit that depends on the reserve ratio, the peg is maintained even when the price of the base coin falls sharply.
No insolvency: no bank is involved, so there is no bank contract to go bankrupt.
No bank runs: all users are treated fairly and paid accordingly, so there is provably no incentive for users to race to redeem their stablecoins.
Monotonically increasing equity per reserve coin: under some conditions, the reserve surplus per reserve coin is guaranteed to increase as users interact with the contract. Under these conditions, reserve coin holders are guaranteed to profit.
No reserve draining: under some conditions, it is impossible for a malicious user to execute a sequence of actions that would steal reserves from the bank.
Bounded dilution: there is a limit to how many reserve coin holders and their profit can be diluted due to the issuance of more reserve coins.
–> On May 10 2022, the COTI CEO took to Twitter to point out that Djed had managed to maintain its 1:1 peg to USD throughout the recent crypto market turbulence, and proceeded to explain how Djed is different from other algorithmic stablecoins:
“Djed’s algorithm is based on a collateral ratio in the range of 400%-800% for $Djed and $Shen. $ADA prices fluctuations are offset by $Shen, covering shortfalls and guaranteeing the collateralization rate.“
“The $ADA reserve pool is not managed by market makers, but by users who mint the $Shen reserve coin and add $ADA to the pool. This provides a decentralized aspect to the $Djed mechanism. $Shen holders are incentivized to provide liquidity through fees.“
“As $Djed can be over collateralized (up to 8x), the risk of $Djed being unpegged decreases. This means that for every 1 $Djed minted, there are 4-8 $Shen in the reserve pool.“
“If the ratio falls below 400%, users will not be able to mint $Djed, and $Shen holders won’t be able to burn their $Shen. So in the event of a market dip, there is a security blanket for $Djed holders that ensures its sustainability.“
“The minting of new $Shen is also supervised in order to maintain the balances stabilized, and ensure there will always be enough $ADA in the pool to provide a dollar equivalent value to the $Djed when burning it.“
Comparison: What makes $DJED different from $UST?
As explained by COTI, Although $DJED and UST are both algorithmic stablecoins, only $DJED is over-collateralized and can prevent a death spiral by blocking the burning and minting of coins. When it comes to UST, users could have always redeemed $LUNA for $UST and vice versa. Therefore, UST can be under collateralized. Every $UST in circulation reduces the circulation of $LUNA. $DJED is over-collateralized (up to 8X), which decreases its risk of being unpegged. This means that for every 1 $DJED minted, there is 3–7 dollars worth of $ADA in the reserve pool, meaning that the $DJED contract has enough funds to buy back all the $DJED stablecoins in circulation for 1USD worth of the backing asset, thus maintaining the peg, and would still have funds left in the reserve.In addition, the base tokens ($ADA) are not minted when $DJED is burned, so even if the price of $ADA decreases, the total supply of $ADA won’t increase as happened with LUNA.
The recent volatility in the market is a battle test for the robustness of algorithmic stablecoins. And through the recent market turbulence Djed kept Its 1:1 peg to USD Throughout!!
As of Tuesday, May 10th, $UST lost its $1 peg for the second time in three days, falling as low as $0.65 according to CoinMarketCap, while at the same time, $Djed kept its 1:1 peg to USD.
To better understand how the Djed mechanism works, watch the video below:
How did $Djed manage to keep its peg?
The short answer is that $Djed is very different from any other algorithmic stablecoin in the way it’s built. $Djed has an algorithmic mechanism that is unique and that is specifically designed to protect its value in different scenarios.
The long answer is as follows:
$Djed’s algorithm is based on a collateral ratio in the range of 400%-800% for $Djed and $Shen. ADA prices fluctuations are offset by Shen, covering shortfalls and guaranteeing the collateralization rate.
The ADA reserve pool is not managed by market makers, but by users who mint the $Shen reserve coin and add ADA to the pool. This provides a decentralized aspect to the $Djed mechanism. $Shen holders are incentivized to provide liquidity through fees.
As $Djed can be over collateralized (up to 8x), the risk of $Djed being unpegged decreases. This means that for every 1 $Djed minted, there are 4–8 $Shen in the reserve pool. If the ratio falls below 400%, users will not be able to mint $Djed, and $Shen holders won’t be able to burn their $Shen. So in the event of a market dip there is a security blanket for $Djed holders that ensures its sustainability. The minting of new $Shen is also supervised in order to maintain the balances stabilized, and ensure there will always be enough ADA in the pool to provide a dollar equivalent value to the $Djed when burning it.
Why was the 400% ratio chosen for stabilizing $DJED?
Here is the answer given by COTI: With 400%, the protocol can tolerate an instantaneous crash of 75% in the price of the underlying asset ($ADA). Looking at historical prices of $ADA, 75% seems like sufficient protection from an instant crash of price as it’s a very unlikely scenario.
DJED IN ACTION: What Happens When Djed’s Reserve Ratio Goes Below or Above Its Collatoral Ratio?
$Djed’s algorithm is based on a collateral ratio in the range of 400%-800% for $Djed and $Shen. So what will happen if the ratio decreases below 400% or increases above 800%? Read below to find out.
The reserve ratio is under 400%:
In this case, the smart contract will prohibit minting any new $Djed. In addition, $Shen holders won’t be able to burn their $Shen at any time while the reserve ratio is below 400%.
When the reserve ratio is under 400%, only 2 things are allowed:
$Djed holders can burn their $Djed and redeem them for $ADA, which increases the reserve ratio.
$Shen investors can mint additional $Shen in order to increase the reserve ratio.
What happens if the Reserve Ratio is above 800%?
In this case, the smart contract will prohibit minting any new $Shen. Burning $Shen is allowed and will decrease the reserve ratio.
MoneyZG is also known as James. He is a professional trader since 2009, a former London Stock Exchange broker, Amazon associate, and a YouTube content creator. He recently did a video where he breaksdown the differences between the mechanisms that govern Djed and UST stability in more laymens terms.
Here is a quick side by side comparison taken from the video:
Watch the video to get more detailed analysis. The picture above is nothing without the insights.
The death spiral happens when there is no longer enough money in the reserve to pay out every stable coin. (Theoretically). The moment LUNA’s market cap dipped below UST’s market cap that was all she wrote for Terra. Same thing would happen to Djed if the reserve’s value falls below the value of all stable coins issued.
But in Djed’s case if the reserve dips to holding only 4 Ada per Djed the protocol will stop issuing Djed. That’s the protection. The reason I think Djed’s approach is more secure is this overcollateralization (400%). There was never a mechanism to even bother trying to keep LUNA’s market cap above UST’s. Terra’s safeguard was to limit the number of mint/burn txs allowed per day but you can see where that got them.
[–]llort_lemmort Replies to ev00r1 elaborating on where ev00r1 got it wrong and why:
Not exactly. (referring to ev00r1’s statement “Same thing would happen to Djed if the reserve’s value falls below the value of all stable coins issued).The reason both UST and LUNA are plummeting right now is that the minting/burning mechanism between UST and LUNA is part of the base protocol which means that the protocol can mint essentially an unlimited amount of LUNA as people redeem UST for LUNA. This leads to a death spiral.
Djed is different because it is not part of the Cardano protocol but built on top of it using smart contracts. Cardano has a maximum supply and Djed will not change that. In case the Djed’s reserve value (which is ADA) falls below the value of the issued stablecoins, Djed would depeg but there would probably not be a death spiral because there is no reason for people to sell ADA if Djed depegs. So Djed would just stay depegged until either ADA goes up again or people fill up the reserves by buying Shen (which would be really cheap in that scenario).
Djed can only go to zero if ADA goes to zero and ADA will probably not go to zero because it has a maximum supply. Djed’s market cap can also never be bigger than ADA’s market cap.
The risk is in SHEN. Your taking risk buying SHEN providing reserves to DJED. But will be passively rewarded buying SHEN providing money into the reserves, risk v reward. If there is not enough reserves, SHEN owners can not sell and that’s the risk. DJED and ADA is unaffected though. ADA can’t go to zero, so it’s all on SHEN’s shoulders.
SHEN is indeed risky but there are a few more things to consider:
SHEN can only go down if ADA goes down so as long as ADA does not go down there should be no risk of either DJED or SHEN going to zero.
Even if SHEN goes to zero, DJED will not go to zero unless ADA goes to zero.
Both DJED and SHEN will recover if ADA recovers.
There cannot be a death spiral between DJED and SHEN unless ADA also goes to zero.
The relationship between DJED and SHEN is very different from the relationship between UST and LUNA.
The minting of DJED has no effect on the supply of SHEN. The supply of both DJED and SHEN should go up together while more ADA is locked up.
In summary: If ADA goes down DJED might lose its peg and SHEN might go to zero. Djed can only go to zero if ADA goes to zero. Both DJED and SHEN will recover if ADA recovers.
For everyone not understanding the above points I recommend studying how Djed works.
Of course there are additional risks factors such as Cardano becoming congested in difficult situations, centralized exchanges restricting trading or withdrawals, the time and fees it takes to move funds, the risk of bugs in the smart contracts, oracle risks (what oracle does Djed even use for its price feed?), irrational people, and all the risks that no one thought about.
The views and opinions expressed by the author, or any people mentioned in this article, are for informational purposes only, and they do not constitute financial, investment, or other advice. Investing in or trading cryptoassets comes with a risk of financial loss.
Please share if you found this information helpful so others who are also worried about Djed meeting the fate as Luna-UST can learn of Djed’s stability mechanism’s superiority over Terra.