Gyroscopic Stability

Gyroscope is a new stablecoin design that, like a physical gyroscope, remains stable as the surrounding environment changes. Its reserve of capital acts like a spinning disk, maintaining a dollar target.

Gyroscope experiences “friction” if assets in the reserve lose value and users swap Gyro Dollars for the underlying reserve assets. Drawing on the reserves makes the stablecoin “wobbly” as the spinning disk slows, similar to a physical gyroscope. But crucially, also like a physical gyroscope, it can be “spun” back up, with high reserve yields and inflows to the stablecoin boosting the reserve.

The Gyroscope Mechanism

The Gyroscope reserve is an all-weather portfolio, diversifying not just price risk but also counterparty, censorship, and regulatory risks. In doing so, it maintains the original value propositions of DeFi.

Yet since any optimal all-weather crypto portfolio that balances these risks will retain price-risk, Gyroscope needs more parts than just a reserve fund.

It uses a closed arbitrage loop on the upside: if the price rises above the peg, more stablecoins can be minted and sold on the market, with the proceeds growing the reserve.

On the downside, if the price falls below the peg, things get more complex. We rely on a similar, but further controlled, arbitrage loop to support the peg.

  • If the reserve value covers 100% of the stablecoin supply, as should be the case most of the time, then this arbitrage loop is unlimited. Stablecoins can then be bought on the market and redeemed for $1 worth of reserve assets.

  • If the reserve value falls below 100% cover, then the peg is supported by the alignment of incentives among users and speculators in a currency peg game.

In this latter case, the Gyroscope design provides two rational reasons for users and speculators to support the peg by holding Gyro Dollars. They can rationally bet that either (or both) the reserve will recover as yield accrues and the crisis subsides or mass redemptions will subside. In either case, the Gyroscope redemption design elegantly returns the redemption rate toward $1. The addition of a complementary leveraged loan mechanism (discussed below) adds a third rational reason for participants to support the peg.

Peg defense by economic design

Gyroscope is explicitly designed to deter speculative attacks on the peg.

First, in times of crisis, it makes it in users’ interest to wait to redeem rather than sell at below par-value. By waiting, users will get a more favourable redemption rate. In turn, this makes any speculative attack less profitable.

At the heart of this design is an economic game. The intuition is as follows.

Users form beliefs about the fundamental value of the stablecoin. These are based on the value of the reserve and how widely accepted and used the stablecoin is. But users also form beliefs about the beliefs of other market-participants (and so on). Gyroscope coordinates these beliefs. Since the value of the reserve is observable on-chain, as well as the rules governing how it will be used, rational users then implicitly agree on whether to attack or defend the peg since they only win by being in the majority.

As a result, with a big enough reserve and with enough acceptance of the stablecoin, the value of the stablecoin will be stable at $1 in a wide range of market conditions. While the peg could break in extreme settings, by design the reserve is difficult to deplete in the short to medium run, and — provided the cryptocurrency ecosystem recovers — will eventually recover.

Complementary Stability Mechanisms

Gyroscope also incorporates several complementary stability mechanisms, which work together with the core Gyroscope mechanisms to strengthen stability.

Integration with Leveraged Loans

Part of the Gyro Dollar (GYD) supply can be created through over-collateralized loans (collateralized debt positions, or CDPs), akin to Dai creation in Maker. The primary issue with the Maker design was its susceptibility to deleveraging crises, such as occurred on Black Thursday. These deleveraging crises act like short squeezes on Dai, causing Dai prices to appreciate significantly in crises, leading to higher volatility and spiraling collateral liquidations.

Maker patched the Dai system after Black Thursday by embedding exchangeability with USDC through the Peg Stability Module (PSM). The core Gyroscope provides a decentralized means to replace a PSM-like mechanism while maintaining defense against deleveraging spirals. The core Gyroscope mechanism will allow exchangeability of the stablecoin with ~$1 worth of assets, which is the necessary addition of the PSM. At the same time, it allows the diversification of all risks in the reserve (and so doesn't rely on custodial stablecoins solely) and the flexibility to survive even if reserve values fluctuate. In comparison, if USDC failed, the Dai PSM (and Dai) would fail.

The leveraged loan mechanism also complements the core Gyroscope mechanism. It provides another way in which Gyroscope participants can rationally support the peg if the reserve becomes under-collateralized. In particular, if the GYD price ever falls significantly below $1 (e.g., if there is a significant cryptocurrency crash), then CDP holders will be able to deleverage their CDPs at a discount. This has the further effect of reducing the GYD supply and returning the GYD price toward $1.

Recapitalizing Actions

The reserve can be recapitalized through auctioning governance tokens or future reserve yields. Governance is incentivized to do this at opportune times as opposed to solely as last resorts in the middle of a crisis. If times are good, and governance token valuation is sky high, governors are incentivized to auction off new tokens early to boost the reserve. Just like Tesla’s issuance of new shares at an all-time-high on 8th December 2020. See reserve securitization in the white paper.

More coming soon.