Babelfish: An Answer to Zero Redemptions

February 7, 2024
min read

Users who borrow Sovryn DLLR stablecoin using Zero face a persistent challenge: redemptions of DLLR paid out of their BTC collateral. Babelfish, the cross-chain stablecoin aggregator, presents a potential solution to this issue. Let’s explore this.

How Redemptions Work

When users borrow DLLR in Zero, they are actually minting new stablecoin tokens. Every borrow increases the supply of DLLR, which can put downward pressure on the price if the borrower sells the newly minted DLLR.

Zero has a mechanism to defend against this, a way to keep the value of DLLR supported from below right at 1 USD. Anyone who holds DLLR—who can’t find a buyer for DLLR at a price of 1 USD—can redeem, or cash in, each DLLR for 1 USD value of BTC. This guarantees a buyer of last resort for DLLR at its nominal value, paid out in BTC at the market price.

But where does this BTC come from? It comes from the collateral of Zero borrowers—specifically from the borrower(s) with the lowest collateral ratio. For borrowers, this is equivalent to selling their BTC for its dollar value. That’s an even trade in value, so there’s no actual loss as a result of redemption. But the whole point of borrowing is to avoid selling your BTC. So this defeats the purpose of borrowing for those users. And it does cause borrowers to lose the origination fees they paid to take out the loan. Not exactly a welcome experience for borrowers.

Why Redemptions Happen

When borrowers take out DLLR loans, they often intend to use these funds in real-world fiat transactions. To do this effectively, they need to convert DLLR into a more universally accepted currency like USD. This conversion can occur in two primary ways:

  1. Converting DLLR to a Popular Stablecoin: Borrowers can exchange their DLLR for a well-recognized stablecoin such as USDT on a different network using Babelfish and then sell it for USD.
  2. Selling DLLR for RBTC, then transferring to BTC: Borrowers can swap DLLR for RBTC on the RBTC/DLLR AMM, transfer this to BTC, and eventually sell it for USD.

The process of selling DLLR can drive down the price of DLLR value when measured in RBTC terms. Even if DLLR is sold for another stablecoin, it will drive down the price in RBTC terms. That’s because the swap goes through RBTC as the intermediate asset, using the DLLR/RBTC AMM pool to facilitate the swap. This price depreciation creates an opportunity for arbitrageurs who can purchase DLLR at a lower cost with RBTC in the RBTC/DLLR pool. They can then redeem DLLR for its full RBTC value using the Zero platform and turn a profit.


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Converting Instead of Selling

If a direct conversion of DLLR to another stablecoin is possible with minimal fee, users will generally choose to do this conversion rather than selling DLLR at a discount. The choice to convert rather than sell in turn reduces DLLR price depreciation. If DLLR is at or near full price in the AMM, arbitrageurs will have no opportunity to buy depreciated DLLR and then redeem DLLR for the nominal value in RBTC from Zero borrowers’ collateral. In this scenario, redemptions should slow or stop entirely. So how does Babelfish make this happen?

Good News! Conversion with Babelfish

Babelfish is a cross-chain stablecoin aggregator. It allows a 1:1 conversion (subject to penalties and rewards to maintain a target balance) between various stablecoins and an aggregated stablecoin called XUSD. Using XUSD as an intermediate stablecoin, you can convert from DLLR on Rootstock to USDT/USDC/DAI on Ethereum or BNB Smart Chain (BSC). The Babelfish system reduces friction in stablecoin swapping and reduces uncertainty from price fluctuations. The caveat is that the stablecoin you want in the amount you want must be on deposit in the aggregator so that it’s available to convert to. The good news is that the stablecoin liquidity for bridging out DLLR value in the form of other stablecoins is currently substantial due to a recently implemented penalty/reward system, called Balancing Curves, that promotes a balance of stablecoins in Babelfish.

Babelfish has a number of potential impacts on redemptions:

  • Lower Slippage: Babelfish acts as a pool of various stablecoins, always available for DLLR conversions. This pooling of liquidity facilitates smooth swaps and allows AMM pools to concentrate liquidity in a few stablecoins like DLLR and XUSD, which results in lower slippage on trades—the AMM pools will support higher trading volume with less price impact.
  • Reduced Price Volatility: Babelfish offers fixed-price conversions (with adjustable penalties and rewards from Balancing Curves), so conversions don’t impact the price. Since users can convert DLLR to another stablecoin for nearly nominal value, they have less economic incentive to redeem. Babelfish can also temporarily absorb arbitrage due to temporary DLLR price dips that might occur in the DLLR/RBTC Sovryn AMM pool due to large trades in one direction. 
  • Babelfish's Balancing Curves: This dynamic penalty/reward system rewards a percentage to users who deposit a low-balance stablecoin and charges a percentage to users who deposit a high-balance stablecoin. This incentivizes users to deposit the stablecoins the system needs.

Babelfish's Balancing Curves system has the potential to mitigate Zero redemptions. As it’s a relatively new feature, continued monitoring of pool balances, conversion volumes, and potential impact on AMM liquidity is required. Babelfish was able to use Balancing Curves to achieve their target percentages of stablecoins while Zero was paused. Now that Zero is unpaused, we will have to watch and see how well Babelfish can absorb and respond to the supply of DLLR people want to convert.

Babelfish could play a key role in mitigating the undesirable borrower experience of redemptions in Zero.

Bottom Line

Zero is a powerful tool for HODLers who want to tap into their bitcoin value without giving up their bitcoin. A key issue to make Zero attractive is to limit the risk of redemption. Babelfish provides an alternative way to bridge out or to arbitrage—important contributions to the ongoing effort to limit redemptions. Users are encouraged to consider using Babelfish if you want to borrow funds and convert them to fiat. Users can do this by converting DLLR to XUSD and then XUSD to a stablecoin on Ethereum or BSC. Babelfish will soon add the ability to do this conversion in one step. Users are also encouraged to earn rewards by bridging in stablecoins from Ethereum or BSC. This will maintain overall system balance and allow Zero to function with reduced redemptions.


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