Upcoming CGP: Increase target level of stable holdings in the reserve

Thanks @Tobi , @0xLeo , @markbarendt - much appreciated on the input.

A few points to add:

1. Collateralisation Levels
@Tobi , earlier this year we had a time where reserve collateralisation dropped close to 2X.

2. I don’t see a basis for arguments of increased complexity
We already have 5% as a stables target (currently DAI) in the reserve. Increasing to 20% doesn’t substantially change operational complexity (provided there is sufficient liquidity in stables, see new new note below).

There is a tendency on this forum to use complexity as a reason against proposals. Indeed it is a good reason, and we should seek ways to simplify CELO. That said, arguments of increased complexity should be laid out clearly with the new approach versus the baseline. I think @Tobi and @0xLeo you did that well on DAI versus USDC, but I have a different view of how to compare baseline and new risks.

3. Evaluation of Risk
I agree that increasing stables in the reserve increases the exposure of the reserve to depegging of those stables. However, it is a matter of balancing new risk against the current risks.

Current Risks
The current risk is that we have a reserve that is ~97% crypto and 3% stable. That is a very crypto weighted portfolio. I know of very few people or organisations with such a one-sided weighting of their assets.

Being so heavy in crypto subjects the reserve to heavy drawdowns in crypto market crashes. Mathematically, this is highly punitive to long-run performance (see Spitznagel’s volatility tax: https://www.universa.net/UniversaResearch_SafeHavenPart4_VolatilityTax.pdf).

Side note: Such arguments are the reasoning behind 60:40 equity-bond portfolios. The complementarity of asset movements reduces drawdowns, which strongly pulls up average returns. Dampening drawdowns is even more critical to the Celo reserve because we are collateralising cStables.

New Risks
Under this proposal, we are putting 20% of our reserve subject to stable depegging risks. Yes, that is a risk, but it applies only to 20% of our portfolio.

BTW, DAI and USDC survived all previous market crashes. cStables would almost certainly be undercollateralised if we had a crash like 2018/19 today. So, even if we aren’t covering the most extreme scenario, we are covering a lot more scenarios than we are today.

All in all, this proposal brings the benefit of meaningful (but not complete) crash resilience via moving the reserve from an extreme 97:3 crypto:stable weighting to a target 80:20 crypto:stable weighting - and this is at the cost of putting 20% of our reserve at depegging risk in extreme scenarios (scenarios in which, btw, today’s Celo reserve would anyway certainly become undercollateralised).

Collateralising stables with other stables
@Tobi , I think this is an important question and there is a degree of truth. Some notes:
a. We are not collateralising stables with stables 1:1. Rather, we are collateralising with an 80:20 portfolio of crypto:stable assets. cStables will vary as a portion of the reserve.
b. While this may reduce decentralisation at the margin, we have to be realistic that a much bigger lever for decentralisation is to start putting the reserve directly under the control of governance (rather than a multisig). I plan to post shortly on a proposal for that (as you know, and thanks for the great feedback). I think this point is not apparent to the broader community and is under-appreciated.

USDC vs DAI
Good points are raised on this matter too. @roman and I are revisiting the choice of USDC vs DAI and plan to post shortly. There are meaningful liquidity benefits to using USDC over DAI (which means the reserve can be rebalanced faster with less slippage). Further, since the stable target is limited to 20%, we limit the portion of the reserve that is subject to depeg or regulatory risk - whether it is USDC or DAI.

Coupling
Worth bringing this proposal back to a bigger picture of what we are trying to do at CELO and how a lot of these proposals are coupled. Two specific points:

  • Thinking about decentralising the reserve to governance is critical (proposal upcoming). If we were more decentralised with that, then regulatory issues (e.g. in considering DAI vs USDC here) would reduce.
  • Over the next year we plan to bring forward many proposals such as a) expanding and/or launching cStables, b) finding credibly sustainable ways to give cStables more economic (and possibly voting) power. Right now the reserve is so crypto heavy (97-3 in crypto-stables) that in most new proposals, the forum asks the question: “But what if this proposal increases risks to cStable collateralisation?”. This will always be a good question to ask but, right now, by not having better stable collateralisation, we are slowing many of our other proposals. Adding a greater stable proportion to the reserve isn’t a complete solution, but I see it as a valuable step as we then move to ii) decentralise the reserve to government, and iii) add other forms of capital - especially natural capital - to the reserve asap.
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Good morning,

I think using ‘crypto’ in the vernacular sense here in the crypto world is skewing the conversation about the real risks involved.

From my perspective stables are truly just as much ‘crypto’ as the Celo coin or ETH or BTC.

I think the idea you are trying to address is the ‘variable’ (risky) assets versus ‘stable’ (safe) portfolio balance. Colloquially put, it’s the stocks vs bonds vs cash idea from TradFi.

Within the crypto space, stable coins do open up different utility because of the peg to an external currency and they look good on a spreadsheet but IMO they face much more regulatory and political risks.

IMO stable coins simply don’t yet offer any better cover than variable value coins if there is a crash.

To truly mostly eliminate the crypto crash risk for the Celo ecosystem, the ecosystem needs to reach the point of being a truly profitable enterprise that interacts with the real world in a fully liquid manner.

In short people need to trust Celo even if they don’t trust BTC or ETH.

In the short term BTC and ETH are IMO as good or better than DAI.

In the medium term RWA’s like fiat and debt instruments could seriously reduce the crypto crash risks.

This is a very wise temporary measure, (pending more natural collateral being added to the reserve), and will reduce risk substantially.

Again I think language is getting in the way here.

I see how more stables may reduce volatility (a bit), but volatility and risk aren’t the same thing.

Volatility, within a normal range, isn’t really a risk to the system as a whole, it’s the norm not a threat.

So with that context, how will it reduce the real risks in a crypto crash?

IMO changing the allocation of which crypto is held appears to be more window dressing than substance.

Hi folks, @inlumino just posted a very interesting whitepaper on Near’s reserve design, that is very relevant here:

Remarks on the Near Reserve vs Celo Reserve

  • The USN design and Near Reserve is very similar to what we have at CELO.
  • One difference is that Near explicitly talk about stable capital in their reserve. Indeed the reserve has been seeded, at genesis, with $1 of USDT and $1 of NEAR for every $1 of USN (so they are starting from a ratio of having full stables backing, and then will move away from that thereafter, where USN is swappable with $1 of NEAR [same as cUSD being swappable with $1 of CELO).
  • It’s very interesting that NEAR choose USDT given the widespread perception that USDT is the riskiest of backed stables because of low public disclosure of USDT reserves
  • The USN whitepaper dedicates a full page to the topic of a “Death Spiral”. Note in particular this paragraph:

    My view is that claiming a death spiral won’t happen based on “simulations” and “historical data” is just naive. A similar narrative is present in Celo Reserve documentation. What ultimately matters for avoiding a death spiral is that there is collateral in the reserve that is closely correlated with the Stables. I recommend listening to Sam Bankman Fried (founder of FTX) on this week’s odd lots podcast. I don’t remember the timestamp but what he roughly says is that “If you have a basket of stables that are collateralised by a basket of volatiles, those stables will blow up”.

In short, I think the Near reserve will face parallel issues to the Celo reserve with respect to ensuring safety (avoiding a death spiral) when there are strong drops in Celo/Near prices. I can’t publicly find the Near reserve dashboard yet, but I think Near will have the advantage of higher stables backing in their reserve (although of course it’s possible that USDT might depeg in the worst of crashes).

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Good morning Pinotio,

I read that paper yesterday and agree that USN will face the same technical challenges as CUSD.

My thought though is that the particular type of crypto asset in the reserve isn’t the biggest factor that will matter in the case of a crypto crash.

Instead simply it’s trust.

I think it will be a matter of which particular crypto projects people trust and are most invested in themselves. Today those projects are BTC and ETH without question.

I’d suggest that if any single large cap stable coin de-pegged the likely outcome would be akin to a magnitude 9 earthquake in the stable coin market and that any stable coin, backed by other stable coins, would be in serious jeopardy even if that coin was not held directly.

In that situation I think it is likely that there would be a huge shakeout and that stable coin collateralized projects may disappear.

The only downside the Near white paper suggests for over collateralized projects that use other assets is what they called inefficient use of capital.

I think it would be wise not to follow the herd here and build the reserve on a different foundation.

In real world terms the “fiat USD” is backed by the USA’s reputation for paying it’s bills. For Nicaragua using the USD as a peg becomes a big risk, hence their motivation to use BTC instead.

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Thanks Mark,

Is it that you’re not worried about undercollateralisation of cStables? If so, why are you not worried? By definition, if the reserve is undercollateralised, it is not possible for all cStable holders to redeem their stables from Mento at par value.

This isn’t about the catastrophic (but possible) case where USDT or USDC fail - in which case it’s possible - or likely - that everything gets crushed. This is about the more mild scenario that fluctuations in crypto prices can result in cStables being undercollateralised (because our reserve has basically no assets that are correlated to stables).

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There are certain risks inherent in any start up.

Being under collateralized for a moment or two is a “so what” moment in my mind. IMO the only reason it seems important to anyone today is a matter of marketing. The competition and Nay-sayers are driving that narrative.

Fiat isn’t over collateralized, it never has been, it does though have incredible utility.

The wild card here is trust that the system will work when I need it to buy my groceries.

For example, if CELO went “all in” and did “whatever it took” to fix the on/off ramp issue once and for all, it would create more trust than any other crypto currency simply because people like my wife could move money out when she needed it with a few clicks.

Fix that utility issue and the status of the CELO reserve on hour by hour basis will matter very little to the user.

The feds might require more backing, but if CELO fixed the on/off ramp issue I’d bet the influx of fiat would fix that and that CELO’s value would pump in concert.

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Yeah, I think the key questions are:

  1. Is it ok if it’s for more than a moment? (It’s definitely possible there is undercollateralisation for weeks, months, who knows)
  2. How do we know it’s ok for a moment?

And btw, I’m open to you being right. It’s just there’s a chance you aren’t right, and I think adding a small percentage of stables (20%) is worth any associated downsides to hedge against you being wrong.

Yes, a distinct possibility that I’m wrong is always there. :wink:

My hope is that we can find and fix the real problems rather than take an aspirin to mask the symptoms.

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We followed the discussion and want to give some input:
Tldr: Timing markets rarely works, BTC should be a decent collateral long term

Since the proposal aims to reduce BTC for another stablecoin we quickly look at BTC and its behavior in the last cycle. From its peak end of 2017 till November 2018 BTC fell ~80%. This was after a so called “blow off top” in December 2017 where BTC went down ~50% within 1 week.

Currently BTC trades ~44% down from its top back in November 2021. Therefore even if we see a draw down as bad as in 2017-18 more than half already happened. We would rather argue that the drawdown won’t be as bad due to eg. no “blow off top”, more demand via TradFi.
Overall we see the proposal to adjust the reserve here as “timing the market” in order to front run a real crash. But even in the scenario of a real crash BTC will be the asset that drops the least compared to ETH and CELO.
Looking at current numbers the reserve could drop ~78% before cUSD gets undercollateralized. Furthermore we think that a draw down of ~78% in CELO / a long lasting bear market itself will result in less adoption of the eco system and therefore demand for cUSD.

Commenting on the last few points discussed in this thread:
According to the metrics used UST is constantly undercollateralized and it’s no problem so far. Like stated the main point depends on the trust people have in the stablecoin itself. The far bigger problem in the reserve is CELO since if really everyone would try to get out of cUSD at the same time and then swap the CELO to USD they will get a haircut anyway.

All of this is of course a lot of speculation but we don’t think this is the best time to reduce the least volatile asset (out of the 3 volatile ones) in the reserve into another stable coin.

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Been chewing on this today and one other thing that stands out to me in favor of keeping BTC and ETH rather than adding DAI, is the question of liquidity.

To me it seems that BTC and ETH are arguably going to be the most liquid assets if things go really sour.

I would even hazard a guess that that is part of why Terra is loading up on BTC.

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Hi folks, and many thanks for the comprehensive input: @markbarendt , @VirtualHive , @0xLeo , @Tobi .

In short, @roman and I have decided not to proceed with submitting a CGP on this topic. Instead, I will shortly post with a proposal on reserve decentralisation.

Rationale
While I remain concerned about undercollateralisation of the reserve in the case of a crypto crash, two reasons emerged to stop pursuing the addition of stables to the reserve in favour of focusing instead on reserve decentralisation and adding natural capital to the reserve, as well as other Mento 2.0 efforts.

1. Regulatory Risks
At present, the Celo Reserve is managed by a multi-sig of trustees. If USDC or DAI is to become regulated (e.g. as a security or eMoney), it is possible that this treatment could flow through to crypto that is backed (or backed-in-part) by USDC/DAI. This is speculation at this stage. We do not yet know fully how USDC or DAI or cStables will be treated from a regulatory standpoint in different jurisdictions. Increasing the exposure of the reserve to these assets may increase risks of multi-sigs/trustees (or cStables backed by these currencies) of falling into regulated territory where compliance would be difficult.

Obviously, this point emphasises the importance of further decentralising the Celo Reserve.

2. Rationale for one stable backed by another
Why would make sense to have one stable-coin backed by another? Why not just use the first (e.g. replicate USDC natively on Celo OR bridge it from Ethereum (which is already possible)?

The answer, under this proposal, is that the backing is only temporary - to protect the reserve in a crypto downmarket - and to be phased out as natural capital is to be phased in.

Still, adding USDC and DAI would be a detour from Celo’s mission points of decentralisation and of natural backed assets and I think this concern comes to the fore from the community both in a real sense and in the sense of “what will outsiders think if we add USDC or more DAI”.

Where from here #1: Decentralising the Reserve
Ideally, we keep Celo in a lane of regulatory compliance where the protocol and cStables are afforded differentiated treatment as decentralised items. Decentralisation of reserve management helps with this. I will post shortly with a proposal on that matter.

Where from here #2: Getting natural backed capital into the reserve"
This is critical for the Celo mission. Further, hopefully natural capital assets are less volatile (relative to fiat) than BTC or ETH, and so this would improve reserve collateral quality. This will be a challenge but I’m hopeful the Climate Collective CGP will make good progress.

Where from here #3: Fundamentally, how do we safely collateralise fiat denominated cStables with volatile assets?"
This requires continued thought (including ideas in Mento 2.0), but might include:
a. Having a black-start procedure (i.e. some guidelines around what would happen if the reserve does become undercollateralised).
b. Potentially having a deposit guarantee scheme up to some amount (e.g. each phone-verified wallet) is guaranteed by the reserve up to a certain value.
c. Limiting minting of stables if the reserve collateralisation ratio goes below a certain limit.

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So what happens if crypto falls 80+ % before those natural assets are in place? Also, these natural assets which are less volatile… which ones are you thinking of specifically? I would like to see a chart so see how volatile they are exactly.

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What do you reckon outsiders think of Celo betting the savings of vulnerable people in developing countries on the value of bitcoin and other massively volatile crypto assets?

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Trust is an important thing John but the risks are endemic across everything that is crypto backed, including stable coins.

IMO if BTC and ETH drop 80% then all the ‘stable’ coins are going to probably de-peg and be taken down as collateral damage. They almost exclusively derive value from each other rather than from the real world.

Like it or not everything crypto is hanging on BTC’s reputation in the world.

IMO until each of the various projects in crypto find a way to derive value from real world interactions and assets we face the crypto crash reality.

Sooner or later crypto has to leave their backyard and venture out into the wild.

There is a meaningful chance that the reserve would become undercollateralised. That does not necessarily mean cStables would de-peg, but one would have to assume de-pegging risk would increase.

Finding a low volatility (relative to fiat) natural asset that is tokenizable and with comparable liquidity to assets currently in the reserve is not an easy feat. I have the same questions myself and am setting up some time to speak with members of the climate collective.

I don’t think outsiders understand how Celo’s reserve works. I would expect people associate some risk with cStables - because it’s crypto, but I doubt that retail users understand the collateralisation of the reserve.

There is a sort of mis-match in risk-profiles, because most Celo holders hold Celo as a risk asset. That there may be a small probability of cStables de-pegging (and taking down CELO with it) is perhaps not as much an issue to expected value calculations for CELO as to expected value calculations of someone holding cStables as savings.

That is a cynical take [and maybe it’s wrong, because as @VirtualHive states, if the cStables depeg it’s the CELO price that gets hit first, and then CELO owners are left holding a reserve of BTC+ETH, and they [not cStable holders] can control where that goes). In reality, I think there are many (incl. big) Celo holders that care a lot about community and cStable holders. My sense is that:
i) Many are busy and not active on the details of this forum and CGPs.
ii) Many feel (and I welcome the dissenting views) something like either a) regulatory or marketing risks outweigh risks to cStable holders, or b) adding stables would actually reduce rather than increase the stability of the reserve (which I don’t see evidence for) or c) some combination.

I don’t believe this is correct. DAI and USDC have withstood sharp market corrections, including Bitcoin and Ethereum dropping 80% from their all time historical highs. What is particularly dangerous for cStables is that it doesn’t even have to be a sudden price crash. BTC/ETH could slowly drop in value by 80% over three months… DAI would be fine because it’s liquidation mechanisms will have no issues at those time scales (in fact, they seem to work quite well even in crashes) and there is no reason to believe USDC could be in trouble then either in a slow crypto price drop. Further, per @VirtualHive 's comment, if BTC and ETH tank, it’s highly likely that CELO tanks much faster. So, in a BTC crash, you probably have a much bigger CELO crash, and CELO is half of the reserve, so the non-linearity of CELO (vs BTC/ETH) in a crash goes against the reserve.

All of this said, my sense across the community is that there isn’t strong support for this interim step.

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Well doesn’t make much sense to take their views into account in this matter, then?

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Do you really want to have that conversation John?