Hey DEFI TIMES community,
The Polkadot ecosystem is growing faster than ever before. The launch of parachains in summer 2021 will mark the beginning of a new blockchain era: composability and interoperability.
Parachains are still in development. As of now, the Rococo testnet is already live, but we still have to wait before they can be implemented to the actual Polkadot blockchain.
However, many projects already announced that they would launch on Polkadot, and some of them even have a token on the Ethereum blockchain that will be migrated later. So, you can already profit from the Polkadot hype today!
The lowest hanging fruit when investing in Polkadot projects is to look at existing Ethereum based projects that have reached product-market fit. After that, you can find similar projects on Polkadot.
Polkadot will have its own Maker, Uniswap, and Synthetix. On Monday, we analyzed the Uniswap of the Polkadot ecosystem: Polkastarter.
Today, we want to introduce the Polkadot version of Maker: Acala, which allows you to create decentralized stablecoins (aUSD). You can use aUSD in the interoperable DeFi ecosystem of Polkadot.
This project is not something to ignore! Let's explore how it works!
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How Acala works
Acala allows you to create decentralized stablecoins (aUSD), a sound currency used across the Polkadot blockchain and beyond. Users create aUSD by providing more collateral than the value minted (over-collateralized).
The collateral can be any currency, whether Polkadot native or not. It could potentially even be bitcoin, which is transferred to the Acala parachain.
Every aUSD is backed in excess by a crypto asset and is stabilized against the US Dollar, through the Honzon Protocol - a dynamic system of Collateralized Debt Positions (CDPs), on-chain governance and incentivized key actors. The CDP mechanism design is inspired by the first decentralized stablecoin project MakerDAO, which has become the DeFi building block in the Ethereum ecosystem. Together with a set of incentives, supply & demand balancing, and risk management mechanisms, as the core components of the Honzon stablecoin protocol on the Acala Network, the value of an aUSD token is pegged to the value of a US Dollar, with relative stability.
The collateral for aUSD can be either Polkadot native or bridged from other chains, for example, Bitcoin, Ether, or ERC-20 tokens. The minted aUSD can also be used across all kinds of blockchains Polkadot connects to, which increases the utility of aUSD.
aUSD can be transferred across all other parachains making it the leading stable currency on the Polkadot network. The interoperability of aUSD will boost liquidity across parachains to the degree that would not be possible with single-chain assets.
Every CDP holds the collateral together with the associated debt position. The collateral cannot be withdrawn until the aUSD is paid back. CDPs are always over-collateralized to ensure that aUSD is sufficiently backed.
The CDP process
1. Depositing collateral
First, the user sends a request to the Honzon protocol by depositing collateral that will be used to create aUSD. The user can choose between several multiple assets to create the CDP. However, you can only use one particular asset at the same time.
2. Borrowing aUSD and opening CDP
The user would send a request to borrow the desired amount of aUSD tokens, capped by the quotient of the value of the crypto assets deposited and the collateral-to-debt ratio. The Honzon protocol would lock the asset deposited, then mint the aUSD tokens accordingly, and mark the same amount as a debt in the CDP. The locked collateral will not be released until the outstanding debt in aUSD is paid.
3. Paying back aUSD and stability fee
If the user wants to close the CDP, he has to pay back the outstanding aUSD and a stability fee, which is the cost of borrowing. You can pay the stability fee in ACA or in aUSD, which will be automatically converted to ACA.
4. Closing the CDP
After the user pays everything back, he becomes debt-free, and the CDP is closed by the Honzon protocol. Then, the system transfers the collateral back to the user.
The protocol's native token is ACA. It has three core use-cases across the Acala ecosystem: Utility token, governance of the network, and contingency solution.
1. Network's utility token
You can use ACA to pay for transaction fees, stability fees, and liquidation penalties. To close a CDP, some ACA tokens are required to be paid as the Stability Fee.
Note that you can use any kind of asset to pay for transaction fees. If you use wrapped bitcoin to pay for fees, the system automatically exchanges them to ACA in the background, which is then burnt. Therefore, ACA could become a deflationary token as the demand for the parachain increases.
Not only the transaction fees are burnt but also the liquidations penalty. The liquidity penalty is a fee raised when a CDP is liquidated due to under-collateralization. The liquidation fee is collected and used to burn ACA.
2. Governance of the network
ACA holders have the right to decide on protocol parameters (such as Stability fee, Debt Ceiling, Liquidation Ratio, and Liquidation Penalty), as well as network upgrades. The elected on-chain General Council will decide on whether the network upgrades are approved or not.
3. Contingency solution
In the case of a Black Swan event, the system will dilute the ACA supply and sell the newly minted tokens on the open market, which it will use to recapitalize any under-collateralized CDPs.
Acala aims to issue decentralized stablecoins similar to the way Maker works. Acala and Maker's core difference is that aUSD can be used across all parachains and other blockchains.
Therefore, Acala will enhance cross-chain liquidity for the whole DeFi ecosystem. It also solves Maker's scalability problems, relying on ETH 2.0 to ship to reduce DAI transaction fees. Acala, on the other hand, builds on the scalable Polkadot infrastructure.
There are two main reasons to use Acala:
1. A sound, stable, and cheap currency (aUSD), borderless transfer across all blockchains connected in a network (made possible by Polkadot).
2. Users can pay transaction fees in any currency. Users do not have to pay them in ACA as the costs are converted to ACA in the background.
Acala still relies on the development of parachains, which will be launched in summer 2021. So, you can't buy ACA tokens. Even the presale date is not announced yet. Nevertheless, it is certainly a project to keep an eye on when Polkadot finally launches.
All information presented above is meant for informational purposes only and should not be treated as financial, legal, or tax advice. This article's content solely reflects the opinion of the writer, who is not a financial advisor.
Do your own research before you purchase cryptocurrencies. Any cryptocurrency can go down in value. Holding cryptocurrencies is risky.