Zephyr Protocol and Djed: An Analysis

How does Zephyr Protocol implement Minimal Djed and what are the differences?

In the emerging world of decentralized finance (DeFi), stablecoins are the backbone, providing much-needed stability in a highly volatile market. A variety of stablecoin models exist, each with their own strengths and weaknesses. In this article, we will introduce Zephyr Protocol, a new player in the stablecoin field, and compare it with existing options.

Introducing Zephyr Protocol

Zephyr is a digital currency that combines the principles of privacy and stability. Grounded firmly on the proven Minimal Djed protocol, in combination with the powerful privacy-preserving features of Monero, Zephyr introduces the first private, reserve-backed stablecoin system. The Djed protocol, which draws inspiration from AgeUSD, is a collaborative brainchild of Emurgo, IOHK, and the Ergo Foundation and has been successfully implemented in a number of crypto projects with great success.

Minimal Djed Overview

The Djed stablecoin protocol utilizes three tokens — Base coins (BCs), Stablecoins (SCs), and Reserve coins (RCs). Reserve providers contribute BCs to the reserve, receiving RCs that represent their equity share. SCs are minted when users contribute an equivalent BC value to the reserve, provided the minimum reserve ratio (typically 400%) is met.

Zephyr Protocol represents a customized implementation of the Minimal Djed stablecoin protocol. Every implementation has its pros and cons, and it’s crucial to acknowledge these, along with the distinctions between Zephyr and its counterparts.

The Minimal Djed system is solid but open to enhancement through “Extended Djed” or “SigmaUSD Improvement Proposals” (SIPs).

• Extended Djed is outlined in the Djed whitepaper.
• Information on SIPs can be found here.

Zephyr vs. Other Djed Implementations

Zephyr diverges from other Djed implementations primarily in two areas: privacy-focus and a native chain infrastructure.

Privacy-Focus: Being constructed from Monero, Zephyr Protocol allows every native asset (ZEPH, ZephUSD, and ZephRSV) to inherit Monero’s privacy features. This ensures hidden transaction destinations and amounts, resulting in a private stablecoin protocol — a significant evolution towards true “digital cash.”

Native Chain Infrastructure: Zephyr Protocol is built on a native chain, not via smart contracts. While Djed implementations using smart contracts have functioned well, the native chain approach offers greater freedom and control to serve and enhance the stablecoin protocol directly.

Zephyr Protocol’s Djed Modifications

Oracle Pricing

One of the crucial mechanisms that need to be in place is to prevent “oracle front-running,” where users exploit discrepancies between the oracle price and the “real price” on an exchange, also known as a reserve drainage attack. Another way to think of this is a “delayed price” vs the “real price”.

Zephyr Protocol implements dual prices for all assets — a spot price and a moving average (MA) — and charges fees for actions to mitigate this risk. While the spot price represents the “real price,” the MA signifies the “delayed price.” Using these dual prices mitigates potential “front-running” and provides anti-price manipulation protection.

For regular users, these measures provide benefits in stable market conditions when the deviation between spot and MA prices is low. However, during periods of high deviation, actions could lead to less favorable outcomes.

Reserve Provider Incentives

Zephyr Protocol acknowledges the importance of incentivizing reserve providers for the critical role they play in the protocol’s health.

• Divergence Between Spot and MA Prices: The divergence between the two prices results in bolstering the reserve whenever actions are performed.
• Transaction Fees: All actions, barring adding value to the reserve, attract a fee, which is subsequently added to the reserve, thus directly benefiting the reserve providers.
• Block Reward: Leveraging the advantages of a native chain, Zephyr Protocol can directly reward reserve providers by adding a portion of the block reward to the reserve, creating a pseudo staking reward mechanism.

At its core, becoming a reserve provider is akin to entering a leveraged position where providers stand to gain when Zephyr’s value appreciates. The added incentives ensure that the reserve’s value can increase even in a sideways market or a slightly bearish market. This aspect is key to encouraging users to become reserve providers.

Looking Ahead

Zephyr Protocol aims to incorporate and research several improvements to Djed that aren’t included in the initial mainnet launch or aren’t directly covered by our changes.

Dynamic Fees

Introducing dynamic fees that can increase when the protocol reserves are low, and decrease when the reserves are healthy could prove beneficial.

Capital Efficiency

Due to the over-collateralized nature of the protocol, there is inherent capital inefficiency. We could look at reducing the standard minimum reserve ratio of 400% if we determine it to be more conservative than necessary. The reserves could also potentially be invested, lent, or staked, although these actions could introduce additional risks or centralization.

Flexible Reserve Coin Trading

Currently, when the reserves are below 400%, users can’t redeem their reserve coins and their share of the reserve. Allowing reserve coins to be traded on the open market, even at a price below the minimum buying price of RCs, wouldn’t drain the reserves and would provide liquidity to reserve providers.

Debt for Equity Swap

When the reserve ratio is less than 100%, any stablecoins redeemed can only be redeemed for what is in the reserve. Implementing a debt for equity swap could avoid this “haircut” for stablecoin redeemers. Alternatively, the protocol could be indebted to the stablecoin redeemer, and more of the block reward could be diverted to cover the debt.

Conclusion

While there are always areas for improvement and growth, Zephyr Protocol’s unique blend of privacy and stability, along with its innovative solutions to challenges, positions it as a promising player in the DeFi landscape.