Stablecoins came under scrutiny after Terra collapsed. For the first time, investors and regulators were asking how much trust we can have in these products. The last few weeks have shown that most stablecoins are indeed stable and that companies like Tether can redeem customers with actual US-Dollars.
Cardano is looking forward to releasing its own stablecoin in partnership with Coti. What is Djed and how is this stablecoin possibly more resilient than others?
Djed is an algorithmic stablecoin
In order to peg the value of Djed to the US-Dollar, there are two other tokens involved. The first one is ADA the native cryptocurrency to the Cardano blockchain. Each time a user wants to mint Djed he has to send ADA to the smart contract. If he should choose to redeem Djed the smart contract will return ADA according to the current dollar value at the time of redemption.
Unlike other algorithmic stablecoins the Djed smart contract won’t burn or mint ADA but instead build up a pool of ADA. The Djed token on the other hand is minted when ADA is sent and burned when Djed is redeemed for ADA.
It is possible that a situation could occur where the dollar value of the pooled ADA is lower than the stable dollar value of Djed tokens in circulation. This is why there is a second token involved called Shen.
Shen is a reserve coin that is not pegged to a specific asset and its price is fluctuating instead. Its purpose is to cover the collateralization rate, and the fluctuation as well as to ensure stability. Users mint Shen with ADA but are not allowed to redeem Shen if the pool is below the reserve ratio. If the reserve ratio remains at a maximum, the smart contract won’t allow to mint Shen.
In effect, Djed holders enjoy a priority to redeem ADA. In return for providing stability to the pool, Shen holders get rewarded with ADA that is deducted from the fees when minting or burning tokens.
So why is Djed supposed to be more stable?
The idea is to overcollateralize Djed somewhere between 400 % and 800 % with Shen as the reserve currency of the system. But since the Terra crash has revealed that algorithmic stablecoins carry risks the developers also built in two mechanisms to support the system. When the reserve ratio is dropping below 400 % the system limits actions:
- Djed holders can only redeem for ADA but cannot mint additional Djed
- Shen holders cannot burn Shen but can support the reserve ratio by locking ADA and minting Shen
In return, if the ratio is above 800 % minting of Shen will be prohibited and Shen holders can only redeem their tokens for ADA.
It is believed that this system will prove a lot more robust than the solution that Terra has presented. It is in fact very different in its approach and technology. What is even more important is that Cardano needs a decentralized stablecoin to help its ecosystem to thrive. The public testnet went live on May 4th and it will be exciting to see if Djed is going to be resilient as promised by Charles Hoskinson and Coti.