Why The Standard’s Self-Redeeming Smart Vaults Redefine DeFi Redemptions

In decentralized finance (DeFi), the way protocols handle stability during market fluctuations can make or break user trust. The Standard introduces a revolutionary solution with its self-redeeming smart vaults, addressing critical issues found in traditional redemption mechanisms like those of Liquity. By shifting the benefits of redemptions from strangers to borrowers, The Standard sets a new benchmark for fairness, stability, and user incentives.

How Liquity Redemptions Work

Liquity’s redemption mechanism aims to maintain the peg of its stablecoin, LUSD, at $1. Here’s how it operates step-by-step:

1. Stablecoin Redemption: LUSD holders can redeem their stablecoins directly for ETH at the $1 peg.
2. Targeting Risky Borrowers: The protocol identifies the most undercollateralized vaults (Troves) and uses their collateral to fulfill the redemption.
3. Arbitrage Incentives: If LUSD trades below $1, arbitrageurs buy discounted LUSD, redeem it for ETH at face value, and pocket the difference.
4. Outcome: Borrowers lose their collateral without any compensation or benefits, while random redeemers profit from the discount.

The Problem with Liquity’s Redemptions

Liquity’s system creates bad game-theoretical incentives:

• Strangers Benefit: Arbitrageurs profit from discounted LUSD, not the borrowers whose collateral is used to fulfill redemptions.
• Encourages DPEGs: Opportunists may intentionally short LUSD or exploit the system to cause a DPEG, knowing they can profit from redemptions.
• Borrower Disadvantage: Borrowers bear the brunt of the mechanism, losing collateral without any added value.

While Liquity’s approach stabilizes the LUSD peg, it sacrifices borrower experience and fairness, creating misaligned incentives in the ecosystem.

How The Standard’s Self-Redeeming Smart Vaults Work

The Standard’s smart vaults solve these issues by making redemptions automatic, borrower-focused, and trustless. Here’s how it works:

1. Trigger for Self-Redemption:
   • If The Standard’s stablecoin (e.g., USDs) trades below its $1 peg, the system activates the self-redeeming mechanism.
2. Debt Reduction:
   • The smart vaults use the collateral locked by borrowers to buy up discounted USDs on the open market.
   • These discounted USDs are then burned to reduce the borrower’s debt.
3. Borrower Benefits:
   • Borrowers with the most leveraged (risky) positions see their debt repaid automatically at a discount, reducing their risk and exposure.
   • No collateral is liquidated outright, and borrowers retain ownership of their vaults.
4. Peg Restoration:
   • By reducing the circulating supply of USDs, the protocol helps restore its peg organically without harsh liquidations or outsider interventions.

Why The Standard’s Redemptions Are Superior

1. Borrower-Centric Incentives:
   • Borrowers, not random redeemers, benefit directly from discounted stablecoins. This aligns incentives and encourages borrowers to stay engaged with the protocol.
2. Eliminates Arbitrage Exploitation:
   • Unlike Liquity, The Standard doesn’t allow opportunistic actors to profit at the expense of borrowers. The system automatically ensures that the value created during a DPEG benefits the protocol’s users.
3. Automatic and Trustless:
   • The redemption process is powered by Chainlink automation, ensuring fairness and efficiency without manual intervention. Borrowers don’t need to monitor or manage their positions actively to benefit.
4. No Forced Liquidations:
   • Borrowers retain their collateral, avoiding the financial and psychological stress of forced liquidation events common in other protocols.
5. Market Stability:
   • By allowing borrowers to reduce their debt during a DPEG, The Standard ensures that its stablecoins remain stable while maintaining user trust and satisfaction.

The Game-Theoretical Advantage

The Standard’s approach eliminates the bad incentives that plague Liquity:

• There’s no motivation for actors to intentionally cause a DPEG since no external party can profit from redemptions.
• Borrowers benefit directly, creating a fairer system where stability doesn’t come at their expense.
• The protocol achieves the same goal of maintaining the peg while fostering positive user behavior and long-term engagement.

Conclusion

The Standard’s self-redeeming smart vaults represent a monumental leap forward in DeFi stability mechanisms. By using automated, borrower-centric redemptions, The Standard addresses the flaws of systems like Liquity, creating a fairer, more sustainable ecosystem.

As DeFi continues to grow, protocols must prioritize user experience and aligned incentives, and The Standard leads the way in making stability work for everyone.

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