🔦Censorship Resistance in USDs

USDs prioritizes censorship resistance, ensuring that assets backing the synthetic dollar remain secure, decentralized, and free from risks associated with traditional financial systems or centralized control. Through advanced custody mechanisms and careful selection of custodial solutions, Solenes’s design minimizes exposure to centralized threats, while enhancing the security and privacy of users’ assets.

Institutional-Grade, Off-Exchange Custody Solutions

Solenes secures the assets backing USDs by using non-US, institutional-grade custody solutions. Here’s how this approach enhances censorship resistance:

1. Off-Exchange Settlement (OES) Providers:

USDs uses OES providers to hold backing assets securely. Unlike traditional exchanges, these providers allow Solenes to delegate collateral without transferring full custody to any centralized entity, thereby avoiding exchange-specific risks.

2. Technological Independence:

With OES providers, collateral only moves between custody and exchanges for funding settlement or realized profits and losses (P&L). This design reduces exposure to centralized exchange risks, while maintaining Solenes’s asset security independently of any single exchange or entity.

3. Off-Exchange Settlement (OES) Providers:

OES providers employ a bankruptcy-remote structure, ensuring that if an OES provider fails, users’ assets are protected and remain outside the provider’s estate. This further secures the assets, as they are not exposed to the credit risk of the custodian.

A. Non-US-Based Custodial Approach

USDs custody solutions focus on global compliance while avoiding US-based service providers. This approach mitigates exposure to risks linked to US regulations, which often pose censorship threats to assets held in US accounts, especially those tied to treasuries or fiat:

• Avoiding Centralized Custody Risks: US-based custodial solutions, particularly those holding treasuries or fiat assets, are subject to potential regulatory intervention. By working with non-US custodians, USDs enhances its censorship resistance and reduces susceptibility to asset freezes or intervention by US regulatory bodies.

• Risk Reduction Compared to On-Chain Stablecoins: On-chain stablecoins that rely on US-based reserves, like U.S. Treasuries, are inherently exposed to censorship risks.

By contrast, Solenes’s non-US-based OES providers reduce this censorship threat, while providing a transparent, reliable system for asset management.

B. Proven Security Track Record

While the use of OES providers may introduce a technological dependence, these solutions offer a proven track record of user fund protection compared to both DeFi and centralized financial institutions:

• Safety of OES Solutions: OES providers used by Solenes have a history of secure custody, with no recorded user fund losses. In contrast, over $7 billion has been lost in DeFi hacks, and more than $15 billion in CeFi institutions in recent years.

• Enhanced Security vs. Fully On-Chain Solutions: Although fully on-chain stablecoins offer transparency, they often carry risks linked to centralized holdings, especially when they rely on fiat assets held in traditional banks. Solenes’s OES-based approach combines decentralization with security, offering a lower-risk profile for censorship-resistant value preservation.

4. Underlying Derivatives: Mechanisms Supporting USDs Stability

To maintain USDs’ stability, Solenes utilizes derivatives markets to manage the volatility of collateral assets effectively. By taking a "delta-neutral" approach, Solenes uses offsetting short derivatives positions against the natural long position from the collateral backing USDs. This section explains the key derivatives mechanisms and the types of contracts Solenes employs to secure USDs’ value.

A. Overview of Solenes’s Derivatives Strategy

Solenes trades derivatives on major centralized exchanges, supported by off-exchange settlement providers. The protocol’s primary motivations for engaging in derivatives trading include:

• Opening Short Positions on Minting: When a user mints USDs, Solenes opens a corresponding short position to offset the collateral’s long exposure.

• Closing Short Positions on Redemption: Short positions are closed when a user redeems USDs, adjusting the collateral’s exposure.

• Managing Unrealized Profit and Loss (PnL): The protocol dynamically adjusts derivatives positions across exchanges to lock in gains or manage risks.

• Optimizing for Risk and Efficiency: Solenes’s algorithm adjusts positions to account for exchange-specific contract structures and to maximize capital efficiency.

While derivatives options vary between exchanges, Solenes algorithmically tailors its approach based on available contract types and capital efficiency, adapting its strategy to maintain optimal collateral stability.

B. Types of Derivative Contracts Used in Solenes

1. Futures Contracts

• Definition: A futures contract is an agreement to buy or sell an asset at a specific price on a predetermined date. Futures can be settled physically (delivering the underlying asset) or in cash.

• Collateral Options: Futures contracts can be margined with either crypto assets or stablecoins, such as USDT or USDC, offering flexibility in collateral types.

• Use in Solenes: Solenes can use futures to establish short positions with an expiration date, locking in a price and hedging against collateral volatility until the contract expires.

1. Perpetual Contracts

• Definition: Unlike traditional futures, perpetual contracts have no expiration date. Instead, they use a "funding rate" mechanism to keep the contract price close to the underlying asset’s index price.

• Funding Mechanism: If the perpetual contract price exceeds the asset’s index price, long-position holders pay a funding fee to short-position holders, incentivizing the contract to align with the index price. Conversely, when the contract price is below the index, short-position holders pay long-position holders.

• Use in Solenes: Perpetual contracts allow Solenes to maintain a continuous short position without needing to roll over contracts, ensuring ongoing delta-neutral hedging.

C. Key Differences Between Futures and Perpetual Contracts

• Expiry and Settlement: Futures contracts have a set expiry and settle at that point, while perpetual contracts remain open indefinitely.

• Funding Mechanism: The funding rate mechanism in perpetual contracts tethers the contract price to the underlying asset’s spot price, reducing large price deviations. Futures contracts, however, can diverge from spot prices and only align upon settlement.

• Contract Details: Each perpetual contract has unique characteristics, such as the funding rate, which varies across exchanges based on market conditions. Futures contracts, on the other hand, follow a fixed expiry and can be settled at prices that differ from the index price.

Basis Spread and Funding Rate Mechanisms

• Basis Spread: This is the difference between the spot price and the futures price. Solenes capitalizes on the basis spread to create additional revenue, as this spread can generate positive returns when futures prices are higher than spot prices.

• Funding Rate: Perpetual contracts use funding rates to maintain alignment with the underlying asset price. When long demand increases, funding becomes positive (longs pay shorts), providing Solenes with revenue on short positions. This dynamic plays a key role in stabilizing the backing for USDs.

D. Inverse vs. Linear Contracts: Key Concepts in Solenes’s Derivatives Strategy

In managing USDs stability on the Solana blockchain, Solenes employs both inverse and linear contracts. Each type has unique characteristics that impact how Solenes hedges against volatility in the underlying collateral. Here’s a breakdown of these contracts and how they fit into Solenes’s strategy.

Linear Contracts

• Definition: Linear contracts are straightforward derivatives where the price is expressed as the value of the underlying asset against the base currency. For instance, a SOLUSDT linear perpetual contract is quoted in USDT, with all margin and profit and loss (PnL) calculations also in USDT.

• Payout Calculation: The payout for linear contracts follows a simple formula:

This linear structure means that profit or loss is directly proportional to the price movement of the underlying asset.

• Usage in Solenes: Linear contracts are effective for hedging assets where the base currency matches the collateral. Solenes uses these contracts to provide a straightforward hedge, as they offer predictable, proportional returns based on price changes.

Inverse Contracts

• Definition: Inverse contracts, in contrast, are quoted with the underlying asset as the base currency, meaning the contract’s value is expressed in terms of the underlying asset itself. For example, a SOLUSD inverse contract would have each unit worth $1 of Solana at any price. This structure is useful when hedging dollar-denominated amounts against volatile assets like SOL.

• Purpose: Inverse contracts enable effective hedging of dollar values in environments where the underlying asset fluctuates significantly. They are particularly useful for managing exposure to USD while maintaining collateral in Solana-based assets.

Convexity in Inverse Contracts

Inverse contracts introduce convexity, meaning that the profit and loss are not linear but instead reflect a non-linear relationship with price changes. Here’s how it works:

• Payout Formula with Convexity:

This formula means that profit or loss is more pronounced depending on the direction of price movement, as compared to linear contracts.

• Example: Suppose a trader goes long on 50,000 SOLUSD contracts at an entry price of $10,000.

• If the price rises to $11,000, the profit is: 50,000×(1/10,000−1/11,000)=0.4545 SOL50,000 \times (1/10,000 - 1/11,000) = 0.4545 \, \text{SOL}50,000×(1/10,000−1/11,000)=0.4545SOL

• If the price drops to $9,000, the loss would be larger due to convexity: 50,000×(1/10,000−1/9,000)=−0.5556 SOL50,000 \times (1/10,000 - 1/9,000) = -0.5556 \, \text{SOL}50,000×(1/10,000−1/9,000)=−0.5556SOL

The non-linear nature of inverse contracts allows Solenes to manage USD exposure more dynamically, especially valuable when price volatility impacts the value of collateral backing USDs. By balancing both inverse and linear contracts, Solenes effectively maintains a delta-neutral position to stabilize USDs in a variety of market conditions on Solana.