Decoding the Stability of Djed: A Closer Look at Cardano's Algorithmic Stablecoin Protocol
Updated: Jan 18
Djed is a stablecoin developed by IOG, the company that created the Cardano blockchain technology. In stablecoins, the value of the cryptocurrency is pegged to the value of a real-world asset, such as the US dollar. This helps to prevent the large price swings that are commonly seen with other cryptocurrencies like Bitcoin.
Normally, a dollar can buy different amount of goods or services based on time and place, because it is not backed by a physical or gold reserve. Inflation happens when there is more money than goods and services available, making each dollar worth less over time. Stablecoins are created to fix this problem. They are intended to have a stable value over time, like a digital version of a dollar.
Djed is an example of a stablecoin that is intended to be used in the Cardano ecosystem. It operates like a digital bank, automatically buying and selling other stablecoins in order to keep its value stable. Overall the goal is to have a more stable currency that can be used for trade and purchase goods and services, similar to using a coin in a vending machine.
Djed - What Is It?
Djed is a stablecoin developed by IOG. The name Djed comes from an ancient Egyptian symbol that represents stability. It's similar to how a pillow can provide cushion against something hard, Djed is meant to provide a buffer against big changes in value.
The Djed protocol is currently in testing and is scheduled to launch on the Cardano mainnet in January 2023, after it has undergone a full audit. The Djed will have a transparent reserve which will be available on the blockchain, meaning that you can see the amount of ADAs in reserve and the total supply at any time. It is like having a glass box where you can see the amount of money inside and that it's being held safely.
Djed is like an independent central bank, it works to control the amount of coins in circulation to keep the value stable. Unlike traditional central banks that are controlled by a single entity, Djed uses a decentralized algorithm, meaning no one person or group controls it. It's like having a group of people make sure that the vending machine only gives you the right amount of change without anyone manipulating it.
IOG has partnered with COTI to develop the user interface and link the stablecoin with smart contracts. COTI has its own consensus algorithm called Proof of Trust (PoT) which is based on machine learning, its like a advanced version of checking a coin if it's fake or not.
After Djed launch on the mainnet, Djed will be integrated with other key partners and decentralized exchanges. These partnerships will help increase the reach and use of Djed as a stablecoin. Djed will be backed by ADA instead of traditional fiat currency, like USD. This means that its value will be determined by the value of ADA and not by governments or central banks.
Djed is unique in that it brings back the reserve standard model, similar to the gold standard, with its own algorithm. It's like having a bank that has a digital reserve of gold to back its currency instead of paper money.
A Brief Overview of the Protocol
Djed is like a vending machine for stablecoins, it maintains the value of Djed to be always $1. You can put ADA in, get Djed out and redeem your ADA back later at the current exchange rate. For example, if the value of ADA increases to $2, you'll get back $0.5 for every $1 Djed you redeem.
The process of getting Djed and redeeming ADA is fully automated and decentralized, similar to how a vending machine automatically dispenses candy when you put money in and returns change when you put money in. Additionally, ADA will never be destroyed, it will just be locked in a smart contract.
There's a secondary token called Shen, which acts like a buffer to absorb the ups and downs of ADA value. This is like having a shock absorber on a car that smooths out the bumps of the road to ensure the car is stable. Shen's value is initially set at 1 ADA, and it will be used in the reserve to maintain the value of Djed.
The algorithm will redeem Shen and return ADAs when the ratio between Djed and Shen is greater than 400%, and will not mint new Shens if that ratio is greater than 800%. This means that for every Djed minted, there will be between 4 and 8 Shens in reserve, making the Djed more stable, like having a large cushion. This ensures that there will always be enough reserves to maintain Djed's parity with the USD.
The Djed Protocol has three different types of fees:
Minting Fees: Fees for creating new Djed and Shen coins.
Burning Fees: Fees for redeeming Djed and Shen coins and getting ADA back.
Operational Fee: Fees for the maintenance and operation of the protocol.
All fees are paid in ADA and are used to increase the reserve ratio. This is like putting money in a piggy bank that earns interest. Shen holders can also redeem rewards by burning their Shen, similar to cashing in a savings bond.
Operational fees are also paid in ADA, then converted to COTI coin periodically. This is like using different type of currency for different purposes. COTI coin will be sent to the COTI Treasury, like a piggy bank for specific use.
The Djed Protocol supports two types of Djed:
Djed minimal: a simple and easy-to-use version, which is already implemented on the Ergo blockchain as SigmaUSD.
Extended Djed: a more advanced version with additional benefits, such as a continuous pricing model and dynamic commissions to keep the reserve ratio at the optimal level.
When you buy Shen, you are essentially making a loan to Djed buyers, in return you will earn ADA profit. Djed buyers pay fees to mint them, and in exchange, they are covered against ADA price drops. They can return Djed at any time to get more ADAs. It's like getting a loan from a bank and paying it back with interest to the people who gave you the loan. Djed holders don't earn delegation rewards from stakepools, similar to not earning rewards from a savings account but their funds are protected from the volatility of ADA prices.
A Real-World Example
Let's say the value of ADA is $1, and Bob wants to buy $4,000 worth of Shen. He will pay 4,000 ADA, and the protocol will mint the Shen, adding it to the reserve. Now, anyone can create Djed.
Now, let's say Alice wants to buy $1,000 worth of Djed. She will have to give up 1,000 ADA, bringing the total reserve to 5,000 ADA ($5,000).
Even if the value of ADA drops to $0.1, the algorithm can redeem holders' Djed at their request, returning the corresponding amount of ADA at a rate of 10 ADA for every $1 of Djed. This means that holders will receive 10*0.1 = $1 for every Djed they return.
The Shen/Djed ratio is 600% (4,000 / 1,000 x 100). If the ratio between the reserve of Shen and Djed in circulation is less than 400%, the algorithm will not allow the exchange of Shen to its holders, (return of ADAs).
When someone buys Shen, they are essentially making a loan to Djed buyers. If the market value of ADA increases, the Shen holders will earn a profit in ADA. But if the value of ADA drops, it may not be profitable for them to sell, and the algorithm will not allow it if the ratio is below the 400% minimum. In this case, it may be more profitable to buy Shen.
It is important to note that outside of the protocol, two parties can still transact Shen for ADA, in an independent operation. Overall, the Djed and Shen system is designed to protect against changes in the value of ADA, and the algorithm ensures that the value of Djed remains stable at $1, even in cases when the value of ADA drops significantly.
A Few Final Thoughts
The Djed stablecoin has three main uses:
Allow ADA holders to trade with a stable value, similar to trading with a stable currency
Keep the value of their funds stable in the long term, like keeping your money in a savings account
Speculate by buying Djed when the value of ADA drops and then selling Djed when the value increases, like buying low and selling high in stock market.
Investors have a new financial tool with Djed, by providing a reservation service by investing their ADA in the purchase of Shen, in exchange for an uncertain return on investment. The risk involved is not being able to access their ADA at a given moment because the reserves are less than 400% of the currency, and they may not be able to change their Shen.
Djed was designed to be used in real-world trading but also has a speculative component, like investing in stocks. A well-designed protocol can sustain its success over time. It's like having a sturdy boat that can handle the rough seas and will be reliable for a long voyage.