The need for stablecoins
Stablecoins are a requirement for an increasingly global economy. They allow people to store their savings and send money globally without barriers. Stablecoins also offer significantly lower fees and faster settlement compared to traditional banks.
A business owner in Kenya who wants to pay an invoice to a client in Armenia could do so easily using stablecoins. Whereas paying an invoice via traditional finance could involve three or more banks plus a lot of fees. During the transfer process, there are several parties involved that need to be trusted, and at any point, the transfer could be halted by a single centralized party.
Stablecoins are a key element to decentralized finance. Today, most Cardano native tokens are being traded against ADA. ADA is subject to market volatility and is a poor store of stable value. The lack of a stablecoin solution for Cardano has caused potential Cardano users to move away from Cardano and onto other blockchains with more thriving ecosystems.
This however is about to change, because stablecoins are finally coming to Cardano! In this article, we break down two primary methods for bringing stablecoins to Cardano and ultimately why Indigo will bring so much value to the ecosystem.
The naïve solution: bridging stablecoins
Stablecoins, such as USDT, already exist on other cryptocurrency platforms such as Polygon. A simple solution is to transfer stablecoins from other platforms onto Cardano. To do this you can use what’s called a bridge.
How bridges work
Bridges provide a mechanism to transfer assets between two different cryptocurrency platforms that support smart contracts. As an example: USDT is locked in a smart contract on Polygon. An intermediary acknowledges that the Polygon smart contract contains USDT, then signals to mint an equivalent number of USDT-representing tokens on Cardano.
These USDT-representing tokens can be redeemed back for USDT on Polygon by depositing into a smart contract on Cardano. This subsequently burns the tokens. The intermediary acknowledges this burning and signals to the smart contract on Polygon that the USDT should be unlocked and sent to the user’s specified address.
Bridges provide a big advantage of being able to bring tokens that exist in one ecosystem and introduce them into a new ecosystem. This advantage however comes at the expense of a huge disadvantage.
Why bridges are dangerous (aka how to lose 100% of your money)
In the case of a bridge that introduces tokens to Cardano, Cardano users must trust new intermediaries. Additionally, the smart contracts on both the platform being bridged from (e.g., Polygon) and on Cardano need to be utilized. This increases the attack vector three-fold: risk of the intermediary being compromised, and risk of the smart contracts on either side being compromised.
It’s due to these increased attack vectors that bridges have a notorious track record of being hacked. Unfortunately, it’s not an uncommon scenario to think you’ve been sensible by relying on supposedly decentralized finance to store your savings, only to wake up one morning and realize that your once-stable tokens now have about as much intrinsic value as a meme coin.
A user could keep their bridged stablecoins stored securely on their hardware wallet, while an attacker exploits a vulnerability of the bridge to steal the underlying assets that gave the stablecoins value.
Double centralization risk
Most bridges rely on a centralized intermediary because this is the simplest method to create a bridge. This requires a huge amount of trust in the intermediary, providing you even less security than a traditional bank due to the lack of government-level insurance.
This centralization risk is doubled when bridging a centralized stablecoin. Recent events with the Tornado Cash crackdown has shown that the value of centralized stablecoins can be invalidated overnight. Even if you do trust the centralized bridge intermediary, you then also must trust the centralized stablecoin that’s locked up on the other side.
At any point — at no fault of the users who’re using the Cardano bridged stablecoin — the stablecoins could be invalidated. Imagine waking up one morning and finding out that a government agency shut down the operations of a bridge due to an unrelated affiliation of bad behavior. The Cardano users wouldn’t be in the wrong, but they would be the victims who lose money. Cardano native tokens offer protection against this risk of centralization faced by stablecoins on Polygon, but that provides no comfort when the Cardano native token is backed up by the value of a Polygon token. Polygon in this case is just an example, any account-based blockchain such as Ethereum, Solana or Binance Smart Chain suffers the same risk.
Decentralized intermediaries are a possibility and don’t require trust, but they require you to forfeit the security safeguards offered by Cardano. A decentralized intermediary basically creates a sidechain to allow it to interact with two different platforms. Because the sidechain runs alongside Cardano, users of the bridge must rely on an untested and unproven platform to keep their savings safe. You also still must trust the centralized entity controlling the stablecoin.
The superior solution: synthetic stablecoins
Indigo offers the Cardano ecosystem a reliable method for using stablecoins while still taking full advantage of the security and decentralization offered by Cardano. Indigo is feature complete and getting ready to launch after the Vasil hard fork. One such synthetic that’ll be offered by Indigo is a USD-based stablecoin called iUSD.
What are synthetics
A synthetic asset gives you price exposure to an asset without needing to own the asset. In Indigo these synthetic assets are called iAssets. An iAsset acts the same as the asset it’s tracking. If the price of the tracked asset goes up or down, so too does the price of the iAsset.
For example, iUSD will track the price of USD, and thus will be valued at $1. Irrespective of the price of other assets in the market, iUSD will maintain its value of $1.
How Indigo synthetics work
iAssets are individually over-collateralized. This ensures that no matter the market conditions, the iAsset is backed up by collateral that’s worth more than the iAsset itself. For example, 100 iUSD could be backed up by $200 worth of ADA.
If the value of ADA drops, then under-collateralized positions undergo automatic liquidation. The liquidation process in essence replaces the under-collateralized position with an over-collateralized position. The iAssets held by users remain fully collateralized during this process.
As part of the liquidation process that’s used to maintain value of iAssets, users are given the opportunity to earn yield on their otherwise idle iAssets in the form of liquidation and staking rewards. An owner of iUSD could store their stablecoin in a hardware wallet where they can be assured that it’ll remain safe and stable, they could transact with it, trade it, or they could deposit it into Indigo to earn yield. Indigo rewards users for participating in the liquidation process because of their vital role they play in maintaining a secure decentralized stable protocol.
No counterparty risk
With Indigo’s upcoming synthetic assets, no trust is required of centralized entities. Indigo will be an unstoppable force with an inability for any group to control it. This includes the creators of Indigo (the Indigo team) — we ourselves will be community members of Indigo just as everybody else, with no authority over how the protocol will operate.
Furthermore, iUSD won’t rely on any single price source. If an event occurred that caused distrust in a centralized stablecoin such as USDT, then iUSD would be immune from such event because it’ll pull price data not only from multiple Oracles, but also from multiple price feeds of different stablecoins. If the price of USDT suddenly dropped to 0, then iUSD would remain pegged to $1.
Synthetic assets aren’t without their risks. Under extremely volatile market conditions it’s possible for synthetic assets on other blockchains to not process liquidations quickly enough to maintain protocol stability. Fortunately, we’ve designed Indigo with these scenarios in mind.
Indigo will have readily available pools of liquidity to process liquidations thanks to its Stability Pools. In addition to undergoing rigorous mathematical stress-testing and multiple audits, Indigo is also introducing more safety mechanisms to ensure stability even after unlikely black swan type events. These safety mechanisms include Indigo Protocol Owned Stability and protocol-level insurance, allowing the protocol to re-stabilize after a potential attack.
Cardano enables Indigo and we’ve been able to take full advantage of Cardano’s secure and scientifically validated platform to implement a protocol design that wouldn’t be feasible on EVM-based platforms such as Polygon.
Stablecoins are just the beginning
Indigo aims to be a pillar in the Cardano ecosystem that finally brings Cardano users a vibrant decentralized trading platform. Stablecoins are just one type of synthetic that Indigo is introducing. Unlike bridges, Indigo can create new types of assets that don’t exist on other platforms.
We’re thankful to our community for supporting Indigo’s mission to #TokenizeEverything. Although it has been challenging, we’re going to show the world that it was the right move to take this long path that’s less traveled. We could’ve taken many shortcuts along the way to bring stablecoins to Cardano sooner, but instead, we’re doing everything possible to ensure that Indigo is secure enough to fulfill the goal of bringing assets to Cardano without being just another bridge waiting to be hacked.