Explaining Arkadiko 2.0: Redemptions

Hello Arkadians

A couple of weeks ago we shared our plans for 2024 in a previous blog post.
Part of those plans is a major upgrade to Arkadiko by reworking a core piece of the protocol: Arkadiko Vaults.

Arkadiko Vaults allow users to deposit STX and xBTC tokens and mint the Arkadiko stablecoin USDA. This allows long exposure to your favourite digital asset while accessing extra liquidity in the form of a stablecoin.

There are a couple of reasons for the upgrade, the main two being

1. the arrival of continuous stacking which enables liquid staking tokens as collateral
2. need for increased stability measures for USDA

This blog post dives into the second reason and explains our solution to keep USDA nice and stable around 1 USD.

Redemptions

A new mechanic that is being added to Arkadiko Vaults comes in the form of Redemptions.

In short, a redemption is the act of using USDA to pay off the debt of an open Arkadiko Vault and receiving equivalent STX or xBTC tokens in return. This mechanism enables anyone to provide stability to USDA by buying it on the open market under 1 USD and subsequently exchanging it for 1 USD worth of collateral in an open Arkadiko Vault. This means that there will be an economic incentive to perform this type of arbitrage, making sure that USDA does not fall in value under 1 USD.

Redemptions are not a new idea and have been successfully used in Liquity as means to provide peg stability.

Inner workings

So how exactly are Redemptions implemented in Arkadiko 2.0?

Arkadiko Vaults are ordered by collateralization ratio which is the ratio between the value of your assets in your Vault and your active debt.

Some Vaults are more healthy than others, meaning that they have more room for their collateral assets to decrease before being flagged for liquidation. In general, our protocol tries to avoid liquidations as much as possible, as they incur a hefty penalty of 10% to the Vault owner’s assets.

Redemptions are permissionless in the sense that anyone can trigger a redemption. The process goes as follows:

1. A redeemer queries the current least healthy Vault and receives back the amount of debt in that Vault.
2. The redeemer then uses USDA to pay off the debt in the Vault.
3. USDA is always valued at 1 USD by the protocol and based on the oracle price of the asset, the correct amount of collateral is taken from the Vault and sent to the redeemer.
4. That Vault has now become more healthy as it has its debt paid off in exchange for collateral assets.

Note that a Redemption can also be partial and does not have to pay off all the debt in the Vault.

Ofcourse, this process of Redemptions is only profitable for the redeemer if he is able to purchase USDA somewhere for less than 1 USD. For example, a redeemer would take 1000 USD worth of STX and uses it to buy USDA. He then triggers a Redemption and receives back more than 1000 USD worth of STX, generating a small profit. It is possible because somewhere, there exists a market, currently in the form of Liquidity Pools where USDA is purchasable for less than 1 USD.

Now in order not to enter a negative spiral of Redemptions, a dynamic Redemption fee is used. This fee starts at 0.5% and increases each time a Redemption takes place. If no Redemptions have taken place for some time, the fee decays slowly back to its initial base fee of 0.5%.

A changing dynamic

This introduction of the Redemption mechanism has some serious consequences for current Arkadiko Vault owners. The system is designed to always take the least healthy Vault as its Redemption target. Vault owners can avoid being redeemed against by keeping their Vaults sufficiently collateralized. Unhealthy Vaults pose a theoretical risk to the protocol as they draw liquidation liquidity when they need to be liquidated and this liquidity is finite.

The main benefit will be a stable USDA that should always trend back to 1 USD because of the economic incentive to trigger a Redemption. If USDA is not at its soft-peg, then it is possible for somebody to have a profitable Redemption.

Usually, the knowledge that a Redemption mechanism exists is enough for users to confide in the system and not sell USDA at a serious loss, as they know it will be arbitraged to 1 USD again. So the presence of Redemptions means that they will be needed less often than if there was a non-protocol native way to arbitrage USDA. Redemptions are a soft-peg mechanism which should be needed less often than the hard-peg mechanisms such as buying and selling in liquidity pools.

Liquidity Pool

After upgrading to 2.0 and monitoring the performance of the Redemption mechanism, we’ll launch and support a StableSwap liquidity pool that enables low fee, low slippage swaps to USDC. Together with the STX/USDA liquidity pool on Arkadiko Swap, these will be the main liquidity sources for USDA. They will be the price source for USDA and will be used by redeemers and borrowers to exchanges assets back and forth depending on their objective.

We hope you have found this post instructive and are now completely ready to enjoy that sweet and stable USDA. As always, we would greatly appreciate your feedback and support in the relevant Discord channels, where we meet the community and discuss new ideas.