UXD Protocol Review
UXD is an interesting idea, but I will pass on UXP (its governance)
I love analyzing new projects and I think it is important to call out the bad one. UXD Protocol caught my attention for three reasons:
- I often trade the delta neutral basis
- Stablecoins is an exciting area
- Several well-known funds invested in UXD
I will dissect what I like about UXD it and what I do NOT like. Does the economic of the token make sense? Spoiler: it does NOT, it is a cash grab 💸
What is UXD Protocol?
From their doc “UXD Protocol is an algorithmic stablecoin backed 100% by a delta neutral position using derivatives”
What is a delta neutral position?
You buy 1 BTC spot and sell 1 BTC perpetual swap, that’s it. You do not have any exposure to the direction of the underlying, you make/lose money based on other factors.
So when you deposit an asset (say BTC) on UXD Protocol you receive back the UXD stablecoin. In the background, UXD short the swap, keeps your dollar on the exchange accruing interests and issue you the UXD stablecoin.
Why would anybody buy 1 BTC and sell 1 BTC on the perpetual swap?
Because most of the time it’s a profitable trade, small profit but surely profitable. Say you borrow 56k @ 7%, you buy 1BTC and you short 1BTC-PERP on Bitmex where the average funding is 11.5%
At the end of year 1 your pnl will be:
- 3920 USD paid to borrow
- 6440 USD received by shorting the swap
Total gross profit
- 2520 USD which is exactly and only 4.5% (11.5% — 7%)
This is only theoretical though and it’s assuming no fees, no spreads and everything working smoothly, let’s check more in details under the hood.
Ok so UXD Protocol does the trade for us but how does it work exactly? The venue they use is Mango which I am heavy user and a big fan. There is no clear discussion on how their execution is is implemented but let’s just assume it’s done naively via market order:
you pay the bid-ask spread two times, when you mint (sell BTC/PERP) and when you redeem (opposite trade) so that’s around 50$ X 2= 100$ if liquidity is good (remember Mango is quite new and on-chain). With market orders you also pay the taker fee (0.09bps) four times, so that’s another 100$ for trading 1 BTC as above.
Total gross profit is now
- 2520 minus (100 bid/ask + 100 fees) = 2320 USD (now circa 4.25%)
Getting smaller innit? I wish it was over but problems do not finish here.. Let’s dig deeper
As they proudly announced on Twitter, they raised 57M USD with a public sale of 3% of the tokens to fund the Insurance Fund. Famous investors included Alameda, Multicoin, Defiance and basically all the usual names you find in every seed round, but bear in mind they got 15%. This is not bad per-se but it’ll be useful later.
https://twitter.com/UXDProtocol/status/1459736479513681920
Now let’s understand where the value of UXP (the governance token) comes from, as per their documents
Let’s clarify, so when the funding is positive (most of the times) it is split among ALL UXD holders, when it’s negative the insurance fund is used to cover interest rate payments. Do I read that correctly?
Let’s try to visualize the payoff of the delta-neutral basis trade if I do it with my own account, assume that I borrow (pay) USD at 7% the payout is linear and just a function of the realized funding rate on BTC-PERP. For example if the average rate I receive is 10%, my profit will be the difference so 3% on the capital deployed. If the average rate on BTC-PERP is exactly 7% I get nothing, if less than 7% I actually have a loss. Historically swap funding rates have been in the range (7–12%)
Ok so let’s look at the payout from the point of view of people that bought UXP, remember that:
- 100% of the insurance fund was contributed by the 3% public sale, this means all losses are born by that 3% that bought in the IDO.
The swap funding premium is distributed to THREE goups:
- part flows back in the Insurance Fund
- part goes to UXD dollars
- part goes to ALL the UXP holders. This includes team, investors and the public too (3%).
Furthermore, nowhere it’s mentioned how much goes to the former and latter.
Let’s try to visualize this and let’s say for simplicity that 100% of the funding goes to UXP holders. How does your return look like if you bought in the IDO? Ok, you put the $$$, bear 100% of the downside risk and have only 3% of the upside potential returns. It looks like this.
For those of you familiar with derivatives this is how the payout of a short put option looks like, unlimited downside and limited upside.
Now let’s say you are participated in the Private round and put 3M (real numbers from https://www.coindesk.com/business/2021/09/02/uxd-raises-3m-to-bring-algorithmic-stablecoins-to-solana/) in exchange for 15% of the UXP tokens, how does your payout look like?
By the way I spent lot of time but it’s difficult to understand where those 3M funds flow.. is it the insurance fund? Is it the team? I believe the latter — but let’s go back to the payout. So no downside as the funds did not go to the insurance fund but 15% of the upside, how does it look like?
For those of you familiar with derivatives this is how the payout of a call option looks like, limited downside (premium paid) and unlimited upside.
When you plot Public vs Private round returns this is how it looks like, essentially losses are socialized among the Public investors and they have very limited upside.
My idea is that buying UXP at current price is a clear -EV trade, in layman terms, there’s high chance you will lose money.
All the above is not to say that UXP/UXD is a scam, l I really like the idea of a stable coin backed by a delta-neutral position, but the underlying tokenomics of UXP does not seem sustainable in the short nor in the long term. There’s no need in the market for such a product and they have no hedge in doing the basis trade compared to everybody else.
PS: don’t you think that this thread being longer than the actual white paper is another red flag?
Thanks for reading and see you at the next review!
