Beanstalk — Reaping DeFi Bean-efits 🌱🤑
Built on Ethereum, Beanstalk is a credit-based algorithmic stablecoin protocol. Designed with the intention of disrupting DeFi and the rent-seeking collateralized stablecoin market Beanstalk relies on credit as opposed to collateral. By doing so, it aims to create a decentralized, liquid, blockchain-native asset, which is stable relative to the value of a non-blockchain-native asset.
But before we commence reaping the beans, let’s understand how stablecoins work for us to have a clear understanding. 👇🏿
An introduction to Stablecoins
Stablecoins can be touted as a critical component in bringing together the best of the decentralized, volatile, and anonymous world of cryptocurrency, and the volatility-free world of fiat currency.
The extreme volatility present in the cryptocurrency market serves as a major deterrent to its mass adoption and acceptance. Crypto’s highly speculative nature makes it attractive to several investors however, this very characteristic also restricts its use in payments and trade.
The aforementioned volatility and instability inspired the inception and design of Stablecoins. Stablecoin refers to a class of assets aimed at providing stability and steady valuation. These coins are traded on blockchain and pegged to a traditional currency like the U.S. dollar or to a commodity like gold. The arrangement essentially enables stablecoins to eliminate volatility and achieve a relatively stable price, unlike other coins that experience massive volatility.
The peg/price stability is achieved via collateralization or through algorithmic mechanisms, different stablecoins deploy different methods to achieve said stability. Stablecoins can be categorized into the following groups
1. Fiat-backed coins
The most popular amongst all, fiat-backed coins refer to coins backed by fiat currencies such as the US Dollar. Examples include USD coin (USDC) and Tether (USDT). Under this method, a custodian/centralized organization/central issuer holds the fiat collateral/currency in proportion to the number of coins in circulation. This is done in order to guarantee the issuance as well as redemption of the coins. However, this setup is largely centralized and subject to government regulation and intervention.
2. Crypto-backed coins
Crypto-backed coins are similar to fiat-backed coins with the exception of the underlying collateral being another cryptocurrency in place of a fiat currency. In this setup, there is no central entity/custodian as the coins are issued on-chain employing smart contracts and are therefore decentralized in nature. Their purchase entails users over-collateralizing their position meaning, a coin of higher value is locked in to issue a lesser valued stablecoin. The over-collateralization serves as a buffer against the collateral coin’s volatility. A popular example belonging to this category is DAI.
3. Commodity-backed coins
As the name implies, these coins are collateralized with commodities like precious metals/oil/real estate. Gold is the most popular commodity to be collateralized, as it enables individuals to invest in gold sans the hassle of actually buying or storing it. Examples in this category include Tether Gold and Paxos Gold (most liquid gold-backed stablecoins). These coins facilitate investments in assets that would otherwise be out of reach for certain retail investors.
4. Algorithmic coins
These coins maintain price stability by using specialized algorithms and smart contracts instead of being backed by any real-world asset/commodity. The algorithm is designed to burn/remove or mint/create new coins to modulate the supply and maintain equilibrium.
The popularity of stablecoins is surging owing to their ability to offer the best of both worlds- the privacy and speed of the cryptosphere, and the stable valuations of traditional money however, one cannot ignore the problem of CENTRALIZATION in the case of fiat-backed coins and OVER-COLLATERALIZATION in case of the other coins.
Stablecoins have obviously found product market fit in DeFi, but existing stablecoins can’t scale to meet the demand.
Why can’t the existing stablecoins scale in order to meet the increasing demand?
The answer is COLLATERAL REQUIREMENT. As mentioned, the existing types of stablecoins require some collateral to be locked. An increase in demand for stablecoins means an enormous amount of collateral needs to exist. The problem is there just isn’t sufficient collateral (on-chain as well as off-chain) to meet this demand.
The lack of collateral means that there is a huge shortage of stablecoins in DeFi today compared to the demand. Basic economics tells us that when you have a shortage of supply, you get a higher price. That “higher price” shows up in the borrowing and lending costs which are now almost 10%(!) and rising.
In essence, the lack of collateral restricts the scalability of collateralized stablecoins. This phenomenon has resulted in limited supply and high borrowing and lending rates.
Now, imagine a scenario where an algorithmic stablecoin maintains price stability through a credit-based model as opposed to the existing collateral-based model.
Beanstalk is DECENTRALIZED, COLLATERAL-FREE, and credit-based. In the following section, I am going to take you through how Beanstalk protocol works, how it maintains the peg, and some important terminology.
Operational Mechanics of Beanstalk
Beanstalks operations are supported by the following ERC-20 standard tokens issued by the protocol
This is the protocol’s collateral-free, credit-based algorithmic stablecoin.
This is the yield-generating governance token. The amount of stalk a user holds will determine the percentage allocation of newly minted beans in the protocol.
Vested Stalk. Seeds yield 1/10000 Stalk every Season.
*Season is native to Beanstalk and is their timekeeping mechanism, each season lasts 1 hour. 1 Day has 24 seasons.
Beanstalk’s design is inspired by projects like ESD and Basis Cash however, it innovates on several aspects to provide users with a working algorithmic stablecoin that prioritizes decentralization with a novel peg mechanism.
How does Beanstalk Work?
Beanstalk has taken the farming terminology beyond and further and in order to understand the working, we need to familiarize ourselves with the following terms -
- USDC:ETH and BEAN:ETH
By utilizing the aforementioned Uniswap liquidity pools Beanstalk creates a decentralized price oracle. The protocol’s oracle, as well as tokens, are inherently censorship-resistant. The utilization of the USDC:ETH pool enables Beanstalk to minimize exposure to the centralized operators of USDC. The price of Bean is considered to be equivalent to a dollar when the ratios of the two pools are identical. The utilization of time-weighted average price (TWAP) by the oracle increases the cost of price manipulation.
Beanstalk’s Decentralized Autonomous Organization (Silo) is used to create a decentralized governance mechanism that offers passive yield to bean owners. Bean and LP tokens can be deposited in the Silo to earn Stalk and Seeds. Individuals with stalk holding can vote on Beanstalk Improvement Proposals and receive a portion of new Beans minted.
Users who deposit LP tokens receive twice as many Seeds per Bean deposited as Bean deposits.
Field is the decentralized credit facility of the protocol. It is basically the lending arm of Beanstalk. The protocol is able to maintain price stability by relying on a decentralized community of lenders.
Adoption of the following steps helps in the maintenance of protocol security
- Seeds yield Stalk every Season.
- If users want to withdraw their deposit from the Silo, they have to forfeit the associated amount of seeds and stalk. Moreover, once users opt for withdrawal (this can be done at any time), their assets are frozen for 24 seasons (~24hrs) before they turn liquid at the start of the 25th season.
The stalk is the governance token and the seed is the vested stalk, and these are ought to be used by the protocol users aimed at creating stability. The users get the beans deposited plus the extra beans earned but forfeit the stalk and the seeds. However, this might change in the future with newer use cases for stalk and seed.
- The Stalk system enables Beanstalk to create an opportunity cost for leaving the Silo.
How does the lending work
When Beanstalk wishes to issue debt, there is Soil in the field. Soil is the protocol’s willingness to take on debt.
Beans that aren’t deposited in the Silo can be lent to Beanstalk in exchange for Pods.
Pods are the native debt asset of Beanstalk (think of these as bonds). The number of Pods grown is determined by the prevailing Weather.
Weather refers to the interest rate of sowing beans in Soil. Weather remains constant during a Season but may vary between Seasons.
Pods are redeemable for 1 Bean when the TWAP of Beans > $1 over a Season on a First In, First Out (FIFO) basis.
It is imperative to know what these terms mean, in order to understand the mechanics behind the ability of the protocol to maintain the peg.
The above image explains the mechanism wonderfully, however, I am going to try and break it down further.
To achieve stability, Beanstalk relies on its decentralized community comprising of Depositors (Silo Members), Lenders (Bean Farmers), and arbitrageurs. Buying Beans, transferring them, depositing them in the silo (buying equity) or lending in the field (buying debt) all contribute to Beanstalk keeping its $1 peg. At the beginning of each season variables like Bean supply, soil supply, and the weather are updated after careful evaluation of the oracle price and debt level.
When the price of Bean > $1 (intention is to bring it down)
Beanstalk mints more Beans to increase supply, and lowers the interest rate aka Beanstalk weather (this brings down the incentive to lend to Beanstalk) to bring the price back to a dollar. The newly minted beans are split equally (50/50) between the Depositors (Silo Members) and Lenders (Bean Farmers). So half of the Beans are distributed to Stalk holders and deposited in the Silo and the other half are used to pay off the debt to creditors (Pod harvesting).
If in a period of 24 consecutive Seasons, the Bean price is too high and the debt level is excessively low, Beans are sold directly on Uniswap to bring the price back to a dollar.
When the price of Bean < $1 (intention is to bring it up)
Beanstalk increases the soil supply and raises the weather to incentivize the issuance of debt. As mentioned, Soil represents Beanstalk’s willingness to issue debt, so Bean farmers can come to sow their Beans in exchange for Pods. The sown Beans are immediately burned reducing the supply and increasing the price back to a dollar.
The interest rate of Pods is determined by the weather at the time of sowing. The interest payment is made on a FIFO basis and Pods are liquid assets but aren’t redeemable until they are harvestable. At the time of harvest, one Pod can be redeemed for one Bean each.
Harvesting — Explained
When the Beans supply grows, 50% of it is used to harvest Pods. Harvesting is done on a FIFO basis implying, Pods at the front of the line are harvestable first. The use of FIFO on the blockchain is verifiable and therefore, trustless in nature. Once the Pods are Harvestable, Farmers can claim their Beans in exchange for the Pods.
Now we know how Beanstalk works, let’s figure out how to make money on it! 🤑
Making money on bean.money
There are two ways in which you can profit from the protocol.
The first way is by buying equity (Stalk that you can stake in the Silo) and the other is by lending to the protocol (buying debt in the form of Pods from the Field). For a detailed guide on the same, click here.
The choice is always yours but I do want to point out a few things that you might want to consider -
Depositors (Silo Members) vs Lenders (Bean Farmers)
Depositing Beans in the Silo earns a passive interest with no action required from the depositor. The Beans deposited earn Stalk and Seed. Earnings are directly proportional to the number of Beans deposited. Liquidity Providers for the BEAN:ETH pool on Uniswap can deposit their LP tokens in the Silo. To encourage LP for the pool, LP depositors get twice as many Seeds per Bean deposited compared to Bean deposits. Withdrawals are simple, with the assets being frozen for only a day (~24 seasons).
Sowing Beans in the Field enables Farmers to earn Pods that are harvestable on a FIFO basis encouraging people to sow Beans as soon as the Weather raises and the returns are good. The sooner a user decides to jump on board, the sooner the user will be paid out. The thing with this setup is, your return is guaranteed and based on the weather at the time, however, the time of your return is not defined.
Thus, you have the option of staying liquid by depositing Beans in the Silo, or you can opt for a much higher rate of return by choosing to sow Beans in the Field with a risk of being illiquid for an undefined period of time.
Beanstalk’s ability to maintain peg rests on the protocol participants. Thus, it is extremely important for the protocol to align the incentives of all participants. If Beanstalk fails to attract creditors, it will fail on its ability to maintain the peg. However, I would like to point out that the protocol has done a decent job so far.
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