Reflecting on Arkadiko
It’s been a while since we’ve put forward our thoughts on the developments in the space and we think it’s a good time to evaluate what has happened and how Arkadiko might adapt to an ever-changing landscape.
Back in October we launched Arkadiko, the first and most complex system of smart contracts on the Stacks blockchain, implementing three core use case of Decentralized Finance. We launched USDA, an over-collateralised stable coin backed by PoX-STX. We launched the first decentralized exchange on Stacks, Arkadiko Swap and enabled liquidity pools and token swaps. We combined our stable coin with liquidity providers tokens to allow for staking and yield farming. DIKO, our governance token, as well as the main layer 1 base asset STX were able to be used in liquidity pools. The resulting liquidity provider token that represents your liquidity position can be staked on our ‘Stake’ page for extra DIKO rewards.
All of these concepts were completely new on Stacks. We had nothing to fall back on, no code examples, no existing liquidity and a limited initial user base. None of those things stopped us from attracting a massive 60 million USD in liquidity in the first week, with a ton of STX locked in our vaults to mint USDA and a bunch of liquidity providers farming DIKO tokens while allowing for low-slippage token swaps. DeFi on Stacks was born.
The following months we focused on battle-testing the protocol and improving the user experience. An overlooked vulnerability allowed a devious programmer to extract roughly 800k USD worth of assets from our liquidity pools. Luckily, the loss was manageable and the Arkadiko treasury made all our LPs whole again. No user funds were permanently lost and nobody suffered any financial damages. A few weeks later, an error caused by the coinmarketcap api drove our oracle crazy which advertised an incorrect STX-price, allowing for excess minting of USDA. The community was quick to spot the faulty oracle mechanism and quickly came together to implement a fix to roll back the damage. In both cases, Arkadiko’s core team reacted with pristine excellence to correct the situation and minimize losses and damage to the protocol. We’ve had some bumps in the road but came away unscathed.
While these things were happening and we were learning more about the nature of our protocol, the Stacks blockchain was flourishing. NFT projects as well as other DeFi initiatives started to pop up. The increased activity led to some congestion and lowered execution speeds and Stacks engineers implemented a fix to some of the more pressing performance issues.
More recently, the highly anticipated DeFi protocol ALEX launched. While other DeFi protocols to date hadn’t had any real impact on Arkadiko, ALEX’s launch was definitely felt in our numbers. When you provide liquidity incentives in the form of DIKO emissions, these help to attract liquidity up to a certain level, while the emissions keep flowing. This has the downside that current emissions don’t bring any guarantees about future liquidity and once a token declines in price, the returns on farming may also suffer. When there are other farming options available, as is the case with ALEX currently, the liquidity moves to a place that offers higher (possibly temporary) returns. This ‘problem’ of mercenary capital has been felt in our DeFi ecosystems and sparked a new model of liquidity creation through something like protocol owned liquidity, which is something Lydian DAO is bringing to Stacks. Either way, value in our pools have dropped as a consequence of the really well marketed launch of ALEX.
While we are on the topic of marketing, this is actually an area where we think we have had relatively poor performance. While the organic traction leading up to our launch and during the first weeks was amazing, we have not pursued any of the typical marketing techniques that you may find with other applications or protocols. Part of this is because we are mostly engineers and we believe in building quietly with our heads down to create value through the code we produce. Another part is not having the right skillset among our core contributors to really nail this well and reach a wider community than Stacks, which was our primary focus and we think have reached well..
That being said, we absolutely believe in community participation, would even say this is the cornerstone of our ethos. Therefore, we will do two-weekly community calls in our Discord for everybody to socialize, ask questions and discuss current topics. This gives all of you a chance for direct communication with the people programming the protocol. We look forward to those and are excited for the insights they may produce.
With ALEX launching as successfully as they have done, this changes the playfield on Stacks. Arkadiko’s primary product and focus was and is USDA foremost. To launch our governance token and create a first use-case for USDA, we needed a swapping mechanism which resulted in Arkadiko Swap. Our swap was always more of a means to an end instead of a full-fledged product we would be building out. With other protocols focusing more on the decentralized exchange of tokens, this market need is being filled by others and perhaps more successfully. The core metric that determines the quality of a decentralized exchange is trading volume and total value locked within the pools and ALEX is leading here. Now of course, ALEX is still in a phase where the rewards are extremely high, a common tactic used to bootstrap initial high liquidity.
We are happy to welcome another protocol on Stacks that is filling a very specific need of doing decentralized token swaps. If that protocol is very successful at creating deep liquidity, that is even better. For example, the xBTC/STX pool on ALEX has upwards of 10 million USD in liquidity while the same pool on Arkadiko only has 500k. Our vision for a good DeFi ecosystem is decentralisation on the application layer, meaning that protocol should focus on a single vertical mostly. We have kind of violated this at the start with Arkadiko because there was nothing to re-use and build on so we had to build Arkadiko Swap. From the recent developments it does not seem like it is productive or possible to focus on rapid expansion of pairs, especially if it concerns non-USDA pairs, which are probably better served (and incentivised) by ALEX. It makes no sense for Arkadiko to send DIKO incentives towards xBTC/STX if there’s a deeper pool just a single contract away. What we would want to avoid is to fragment all the liquidity across protocols. Seeing more than 10 million USD worth of xBTC/STX liquidity on ALEX is something we can use as it improves our capability to liquidate xBTC vaults which we are launching in the very near future. Arkadiko benefits from the liquidity on ALEX, which is a great synergy between the two of us.
A missed opportunity for our protocols to work together comes through the lack of USDA presence on ALEX. They have chosen not to support USDA on their launch and we currently don’t have a timeline for when USDA could be adopted by them. We started Arkadiko to create a building block for others to use and strengthen their protocols and having a large new player come in and completely ignore it is not what we expected or were hoping for.
USDA is currently far from perfect. The efficiency of minting it could certainly be improved. This is our primary focus right now and we have some concrete protocol changes to implement this in the near future. It is up to us at Arkadiko to make USDA better than it currently is and improving the LTV is an important aspect of this. Once the quality of USDA improves, perhaps other protocols will adopt it faster in their life-cycle.
Another big issue for USDA currently is its peg. While USDA is meant to be equal to roughly a dollar and the Arkadiko Vaults always treat USDA mints this way, the external market might price USDA differently based on market demand. There are only a few sources where USDA is traded and the way we derive and advertise the peg is quite unorthodox but it’s the best we currently have. What I mean by this is that we only have regular (x * y = k)-style liquidity pools where both assets are always present in an equal proportion. What this means is that if USDA is exactly at a peg of 1 USD in the STX/USDA pool, a 1% slippage trade in either direction also moves the peg in that direction. With limited utility for USDA outside of the Arkadiko platform (no external demand) and no opportunity for arbitrage, this has led to USDA being significantly below peg. The problem is becoming bigger and bigger each week. It is structural and the process is accelerated by liquidity leaving USDA-denominated pools on Arkadiko.
Typically, the way stablecoins gain stability is by creating liquidity pools together with other stablecoins. On Ethereum, curve.fi is the market leader in these types of swaps and has done extremely well to give many stablecoins the opportunity to build up liquidity. The nature of these liquidity pools is different from the Uniswap-model (x*y=k) and allows for much higher fluctuations in asset ratios within the pool. A few weeks ago, the market (temporarily) lost faith in the stablecoin MIM, which resulted in liquidity pools on curve.fi to be seriously imbalanced. But even a 90% MIM, 10% USDT ratio would in such a case result in less than 1% slippage swap (meaning the stablecoin is theoretically close to peg). This completely different way of measuring the peg of stablecoins through the StableSwap-invariant is something we can only envy. We do not have any other stablecoin assets on Stacks to create a similar pool with. We’ve been told other major stables are coming but we’ve been waiting for a long time now. We have recently contacted leaders of decentralized stablecoin protocols on other chains to help them have a presence on Stacks and we are hopeful such a partnership could benefit USDA. Until this situation improves, we are stuck with the current way of measuring the USDA peg. But USDA is structurally healthy, over-collateralization means that USDA is always backed by assets in Vaults and if everyone was to withdraw right now and pay back their loan to unlock their assets, then USDA would return to peg quite easily. The main use case of USDA right now is to mint it and swap it against another asset on our swap and to go use that asset productively somewhere. I thought it was important to put forward these nuances surrounding USDA. The situation is not as dire as our advertised price may make it seem like.
We still have a bunch of cards up our sleeve which I will keep for another blog post. This one is already getting a bit too long and I do not want to take focus away from future, important protocol upgrades by burying them deep inside this post. It is really awesome for other protocols to exist together with us on Stacks and look forward to get USDA integrated across the ecosystem.
We thank you for your continued support and participation.