DeFi's Holy Grail: A Risk-Free Rate on a Stablecoin

MakerDao was unarguably revolutionary in that it enabled true decentralised digital cash, a token with stable purchasing power. In a way, it was using a market mechanism to control the supply of money, replacing that monetary policy tool for Central Banks.

Our research group, Cambridge Cryptographic, has been looking into how the other monetary policy tool of Central Banks, namely a risk-free interest rate, can be achieved on-chain.

We have achieved a solution which we outline in our whitepaper here:
A market determined risk-free interest rate on a stablecoin

In a nutshell, we are proposing that:

  1. Validators need to have deposits of stablecoin in order to earn block/staking rewards, and as such, will pay a “risk-free rate” to delegators (delegation means 100% guarentee of retrieiving the principal).
  2. To ensure the token security model is not broken, we use a 2 token system, where validators maximise their revenue by holding equal proportions of unstable (native) tokens, and stablecoins

We believe this is a significant breakthrough as it allows:

  1. Purely DeFi portfolios to optimise returns for ANY level of risk
  2. Traditional financial/risk models to be applied to DeFi (the risk-free rate is the most important parameter)
  3. Fractional reserve banking to be built ontop of decentralised money (the risk-free rate has potential to be counter-cyclical)

Implementation-wise, this may require implementation at the consensus protocol level, although if a smart contract can control how its “fees” are distributed, it can also work that way.

At this stage we are looking for feedback rather than aiming to build it. Eager to hear what people here think.


Thanks so much for sharing this! It’s great to see folks thinking about these topics.

A few quick remarks:

  1. Tether doesn’t back DAI any longer. I see this a lot where people read white papers or articles from a year or more ago and they’re just hopelessly outdated now. Things move quickly in crypto.

  2. MakerDAO (and no stablecoin issuer I am aware of) doesn’t control how nodes are run or incentivized, or have any control over consensus mechanisms.

  3. Incentivizing nodes to hold a mix of stable and non-stable assets doesn’t seem like it’s actually a “market determined risk free rate.”

  4. It’s not clear to me that this would create a risk-free rate as denominated in fiat, though perhaps in the native token of a consensus mechanism it might. I would need to think through the transmission mechanisms you are describing, but in dollar-denominated terms, I think this may have the potential to be pro-cyclical, which would obviously have different implications.

  5. I’m not clear how all this arbitrage works without the ability to generate the native token/stablecoin from thin air to defend targeted basket proportions on behalf of node operators. That’s obviously a problem for a stablecoin with a peg, as this would mess around with the size of the monetary base. I’m fairly certain the value of the stablecoin could only be maintained with the aid of capital controls on the economy utilizing this mechanism, or else the peg would have to be abandoned.

Let me know if my (quick) read isn’t catching what you’re pitching! Just my first take.

Welcome to the forum!

1 Like

Thank you so much for your feedback! In response to your remarks:

  1. We will correct this. Thanks for the pointer.

  2. Yes we are aware Maker is not a standalone blockchain consensus protocol. That being said, we posted here because we saw that the Maker forums have the sort of insights/expertise that would be able to give feedback like yours. As for other stablecoins, Terra, Celo, and a few more have the stablecoin mechanism baked into the consensus protocol.

  3. To elaborate, the way we see the market determined risk free rate working is:

  • Nodes are incentivised to hold both stable and non-stable assets
  • Nodes will purchase time-limited delegation of stable assets from delegators on the open market (delegators get a risk-free return). This is different from the way it usually works with delegated PoS where Nodes just share rewards pro-rata with delegators.
  • For some consensus protocols, node selection to a committee happens in epochs. For those cases, we envision a dutch auction like mechanism where the pool of stablecoin available for delegation are auctioned. Nodes will bid, ultimately ending up with a market determined rate.
  1. Can you elaborate on what you mean by the first part of your comment? The risk-free rate will be paid in the native token, which can be instantly converted to any unit such as fiat/stablecoin via swaps/dex. The key is that it is risk-free. As for pro-cyclical, this is actually a selling point in that the demand for the stablecoin is self-generated by the system! This is as opposed to current DeFi where they have to layer applications ontop to get that demand. Furthermore, we think that in a completely decentralised economy, the stablecoin is base money, and you will still have fractional reserve.

  2. Yes we agree this would be a problem if too much stablecoin is “locked up”. But we have reason to believe that what we finally end up with will be reflective of our current economy where the only stablecoin that is locked up will be akin to the reserves that commercial banks hold at the Central Bank.

Thanks for your warm welcome

Edit: our whitepaper currently is quite succinct as to convey the core idea. We have noted the points you think needs clarification and will make sure to answer these in further documentation.