The launch of the stablecoin Djed on the Cardano main net is scheduled for January 2023. Djed is an over-collateralized algorithmic stablecoin developed by COTI. Djed is decentralized and it has an on-chain Proof-of-Reserve. Let's explain the basic principles on which this stablecoin works. TLDR Algorithmic stablecoin Djed works just like a central bank but without a central issuer. Djed has an on-chain Proof-of-Reserve and is decentralized. No middleman can misuse deposits. The SHEN reserve coin absorbs the volatility of ADA coins and ensures that there is enough ADA in reserve. Djed has an on-chain Proof-of-Reserve The Djed algorithm holds reserve assets. Instead of being pegged to fiat currencies (similar to USDT, USDC or USDA), it is backed by ADA (it can theoretically be backed by any other token on the Cardano network) and operates without a central issuer. Djed behaves similarly to a central bank which can control the number of coins in circulation and thus keep its value stable (stable purchasing power). The primary distinction is that Djed keeps stablecoin's value stable to a given asset (e.g USD) by controlling its supply through a decentralized algorithm. When money was backed by gold, there was money in circulation (e.g. USD) in an amount corresponding to the amount of gold held in the bank's reserve. People had to trust the central authority that they were only putting into circulation as much USD as they held in gold. With the abandonment of the gold standard, current fiat currencies are not backed by gold. Central banks monitor economic events and try to maintain stable purchasing power by controlling the amount of money in circulation. This is done at the cost of low inflation. Fiat money has stable purchasing power in Western countries in the short term but may lose value in the long term. In times of market turbulence, inflation can be higher than desired, which has a negative effect on maintaining value in the long run. The Djed algorithm maintains the value of the stablecoin at 1 USD. 1 DJED should always have a market value (purchasing power) equivalent to 1 USD and users should be able to get ADA coins of the corresponding USD value for DJED. Users can mint DJED stables for ADA coins. To mint 1 DJED, they will need enough ADA coins (or a fraction of one coin) to be worth exactly 1 USD. This means that if an ADA has a market value of 1 USD, it will be possible to mint 1 DJED for 1 ADA. If the market value of the ADA was 0.50 USD, the user would need 2 ADA to mint 1 DJED. We're neglecting the fees. Users can get back ADA by returning DJED. The Djed algorithm will burn returned DJED and give the user the corresponding amount of ADA according to the current exchange rate. If the market value of ADA rises to 2 USD, the user will receive 0.5 ADA for 1 DJED. The minting and burning process is decentralized and fully automated. ADA coins are placed in reserve during the minting of DJED. During the burning of DJED, ADA coins are taken from the reserve. Djed has an on-chain Proof-of-Reserve. Anyone can audit and see how many DJEDs are in circulation and how many ADA coins are in reserve at any time. ADA in reserve cannot be misused by a third party as they will be under the control of the smart contract. DJED stables will be backed by ADA coins much like fiat money used to be backed by gold. USD has relatively stable purchasing power, gold is more volatile, and cryptocurrencies including ADA coins are very volatile. How to deal with this? You have probably noticed that the USD value in the reserve can drop relative to the same amount of minted DJED. If there are 1000 DJED in circulation, the USD value in reserve should also be 1000 USD. As ADA coins are held, the value of USD in reserve decreases along with the market value of ADA. Let's illustrate this with an example. If the ADA value is 1 USD and users mint 1000 DJED, all DJED stables can be returned (burned) and users get their ADA back. However, if the market value of ADA suddenly drops to 0.5 USD, there will only be a value of 500 USD in reserve. For returning (and burning) 1 DJED, the algorithm must give back 2 ADA to a user. After returning 500 DJED, the reserve would be 0. The solution would be to have more ADA coins in reserve. In other words, it is needed to have an over-collateralized reserve against minted DJED. Exactly this will ensure a reserve coin SHEN. Reserve coin SHEN If there were double the number of ADA coins in reserve, i.e. 2000 ADA, the problem described above would not occur. It would be possible to burn all 1000 DJED stables and users would get back a total of 2000 ADA coins worth 1000 USD. SHEN is the reserve coin. Its value is volatile and is not backed by other assets. People can mint SHEN similar to DJED. The value of the SHEN will initially be set to 1 ADA. The Djed algorithm will only allow DJED stables to be minted if there are enough ADA coins in reserve in a certain ratio. Assume that the market value of ADA is 1 USD and that someone buys 3000 SHEN. The buyer pays 3000 ADA for the same amount of SHEN coins. This puts 3000 ADA in the reserve. Now, it is possible to mint 1000 DJED stables for 1000 ADA. There will be 4000 ADA coins (worth 4000 USD) in the reserve and 1000 DJED stables in circulation. Even if the market value of ADA drops to 0.25 USD, the algorithm can redeem all 1000 Djed from the holders and return ADA to them at a rate of 4 ADA per 1 Djed. Obviously, if the ratio of ADA reserve to DJED in circulation is below 400%, the algorithm will not redeem SHEN from holders since DJED holders have priority. The algorithm will redeem SHEN only if the ratio is above 400%. There is also an upper limit, namely 800%, from which no further SHEN can be minted. ADA coins in reserve are divided into two parts. The first part is coins that must match the USD value of all DJEDs that are in circulation. These are liabilities. The rest of the coins is equity. If the market value of the ADA is still 1 USD, 1000 ADA are liabilities and 3000 ADA are equities that belong proportionally to all SHEN holders. In our example, there are 3000 SHEN coins in circulation. Based on the volatility of ADA coins, the ratio between liabilities and equity will change. If the market value of ADA grows, there will be more ADAs in the equity part of the reserve than liabilities. At an ADA value of USD 2, 500 ADA is enough to cover the USD value of 1000 DJEDs in circulation. This means that there will be 3500 ADA in the equity part of the reserve against 3000 SHEN. In this case, it is profitable to sell SHEN. SHEN holders can get more ADA coins back when the market value of ADA increases. If the market value of the ADA drops to 0.5 USD, the liabilities will be 2000 ADA and in the equity part of the reserve also be 2000 ADA (1000 USD) against 3000 SHEN. It is not profitable for SHEN holders to sell and it is possible that the algorithm will not even allow them to do so if the ratio falls below the 400% minimum. It may be profitable to consider buying SHEN. ADA fees will be paid for DJED and SHEN minting, which will go into the reserve. This will increase the profit for SHEN holders. It may happen that DJED will lose a peg if ADA coins unexpectedly drop very low. Even 4000 ADA might not be worth 1000 USD which would correspond to 1000 DJED in circulation. DJED holders will have to wait for the market value of ADA coins to increase or hope there is demand for SHEN. It will be possible to sell DJED regardless of the de-pegging. Conclusion The examples in the article are static. In practice, the evolution of the values will be dynamic, and the minting and burning of DJED/SHEN will be continuous. Djed is just an algorithm that will behave according to clearly defined rules and it will be possible to track online the number of DJED/SHEN in circulation and ADA coins in reserve. Everyone will be able to evaluate the risk and benefits of buying SHEN. Users who want to protect themselves from a potential drop in the value of ADA can buy DJED or sell it if they think the mood of the markets is improving. Those who are able to bear more risk can buy SHEN and ensure extra profit from it. DJED is important not only for speculators but especially for users who want to use an alternative financial system. Stables are a key component for DeFi services.
