Reserve’s goal is to facilitate the creation of money that does not inflate, by bundling stocks, bonds, gold, real estate and more into an index, and use that as money.
Reserve Protocol is a permissionless stablecoin platform where any individual or company can create and configure their own asset-backed currency (“RToken”) for their primitives and asset types.
A RToken is composed of a basket of potentially yield-bearing assets and are overcollateralized by RSR stakers. Note that RTokens do not have to be USD pegged stablecoins, and instead can be pegged to any basket of assets.
Staked RSR serves as an overcollateralization fund for RTokens in the event of collateral defaults. In return for putting their capital at risk, RSR stakers get a share of RToken collateral yield and RToken parameter governance power.
Currently, Reserve is most commonly used for bundling DeFi assets together to create yield-bearing USD stablecoins and other composite assets (eUSD, ETH+).
The success of Reserve Protocol’s long term vision hinges on the widespread tokenization of real world assets, in which stocks, bonds, real estate, commodities, and other assets are digitized and put on-chain.
Introduction
In a financial landscape often characterized by growing wealth disparities and political uncertainty, Reserve Protocol emerges as a potential equalizer, offering an alternative approach to the way we store wealth and use money. Reserve Protocol aims to do this by allowing for the creation of currencies that generate yield from diversified sources and outpace inflation. The vision is for these stablecoins to be used widely as currencies and for everyday people to get access to safe, diversified yields that only the wealthy can usually afford.
Reserve Protocol utilizes two types of tokens: RTokens and RSR (Reserve Rights) governance tokens. RTokens are stablecoins composed of a basket of yield-bearing assets and are overcollateralized by RSR token stakers. RSR tokens can be staked to any RToken for overcollateralization purposes in exchange for a share of RToken collateral yield and governance power over the RToken parameters.
The key benefits of RTokens are insurance for token holders, mint and redemption of tokens at any time given the necessary collateral, compounding revenue that is shared with stakeholders, and proof of reserves available on chain 24/7. In comparison to the depegging of other stablecoins, Reserve aims to solve this challenge by always maintaining proof of reserves on chain and overcollateralization mechanisms that err on the side of financial prudence and transparency.
As such, the Reserve Protocol emerges as an interesting DeFi player with "RTokens," which are 1:1 asset-backed stable currencies. The Reserve Protocol enables insured and configurable stablecoins. RTokens can be stablecoins/flatcoins, an on-chain savings account, a tokenized index, or a new stablecoin backed by real world assets. Though as of now, collateral options for RTokens are limited to nearly $40 billion or so of on-chain defi assets, in the future, RTokens could be backed by the forthcoming trillions of dollars of tokenized stocks, bonds, real estate and other commodities that are expected to tokenized on chain in the near future. The long term vision for Reserve is that someone could build a reserve currency that is backed by a diverse basket of inversely correlated assets and be stable over decades or centuries, outside of the manipulation of governments and financial institutions.
Example RToken backed by a variety of tokenized RWAs and on-chain assets
As seen by recent events with the Silicon Valley Bank collapse and the FTX exchange fraud, trust between financial institutions and individuals is easily broken. In both of these cases, a financial institution that was considered one of the biggest and most “trustworthy” places to put assets in, failed to effectively manage risks or engaged in reckless lending and investment practices, leading to significant losses. Although we all wish that banks would act in our best interests, it is hard to see what happens behind the scenes and depositing money in a bank is trusting a third party with what could be an individual’s entire savings. The idea that we must rely on institutions to keep our assets safe whilst they possess excessive leverage, engage in speculative activities, or eschew proper risk assessment, is inefficient and potentially harmful.
At a glance, Reserve Protocol sounds like a perfect solution to cryptocurrency volatility and risk of asset misplacement by traditional financial institutions. However, in this research piece, we consider the technical offerings from an objective viewpoint––reviewing its insurance mechanisms, governance structure, and potential in relation to real-world assets. As we delve deeper into the Reserve Protocol and RTokens ecosystem, we believe Reserve Protocol is a good step towards a worthy goal of a decentralized stablecoin, while keeping capital efficiency and risk control concerns in mind, with potential to redefine traditional financial paradigms. However, given that the existence of real-world assets on chain is still relatively new, the overall success of the Reserve Protocol lies in its ability to attract engaged community members to create high-quality collateralized asset baskets on chain with the optimal governance structures that maximize benefit for all parties involved.
Safety & Security Features
RSR Overcollateralization as an Insurance Mechanism
RSR (Reserve Rights) token holders have the option to stake on a RToken of their choosing, thereby providing governance and acting as the first-loss capital in the event of a collateral default. In return, RSR stakers receive a portion of the revenue generated by the RToken through its yield-bearing collateral.
With the RSR staking mechanism, RTokens can become overcollateralized: each RToken has more value backing it than its face trading value. This overcollateralization serves as a resilient safety mechanism against unexpected depeg/default events. Note that collateral default is defined as when a collateral asset depegs from its tracking token’s price by a certain % that is set by governance: eg: if cUSDC drops in value such that 1cUSDC = 0.9USDC. Let’s walk through how RSR is used to help prop up the value of RToken holders in collateral default events.
When the price of 1 collateral asset depegs from its target asset’s value by a configurable % parameter but the price of other collateral assets are still holding, the RToken is now considered undercollateralized. To bring the RToken back to full-collateralization, the protocol will 1) sell the failing collateral to purchase a predetermined healthy backup basket/emergency collateral basket. There will still be a shortfall in the RToken’s value since a defaulting collateral was sold. Then, to fill the remaining hole left by the failing collateral 2) RSR tokens would be sold to make up the shortfall by buying a predetermined basket of “healthy” assets. Here’s a simple example illustrating the mechanism:
A RToken is backed solely by USDC. The predetermined healthy backup collateral is USDT. USDC has depegged to $0.95, triggering a default event. The protocol sells off all of its USDC for USDT, but a 5% shortfall remains. To reach 100% collateralization, RSR tokens are seized from the RToken’s RSR token pool to buy more of the healthy backup collateral, USDT.
RToken Default Event Recovery Mechanism Visualized (Note: in steps 3 and 4, faulty aDAI collateral is sold to buy emergency collateral basket)
In the case where RToken collateral defaults and the net collateral is <100% of its target price even after the RSR pool is completely spent through the backup purchase mechanism described above, RToken holders receive proportional distribution of the collateral rather than 1st come 1st serve. In other words, as the size of the collateral pie shrinks, everyone gets their corresponding proportion of the total collateral, rather than operating on a first-mover basis where some may not be able to withdraw any money at all.
Why would someone stake RSR to a RToken? What mechanisms ensure there is enough RSR liquidity to protect RToken defaults?
RSR stakers participate in each individual’s RToken’s governance, ensuring balanced risk/reward tradeoffs (over 20 parameters). RToken holders may also want to govern and control the parameters of their RToken and protect their position.
RSR stakers get a portion of the RToken basket’s yield, set by governance. (eg: RSR stakers on eUSD receive 100% of collateral’s yield). Weekly updates on RSR staking APYs can be found on Reserve Protocol’s Twitter.
High APYs when there is low RSR liquidity in a RToken
Seizureship of RSR tokens to fill failing collateral decreases the size of the RSR staking pool, leading to higher APYs for the staking pool since RToken collateral yield is shared among a smaller pool. This higher APY serves as an incentive to attract RSR deposits back to a healthy level.
Unstaking delay period
Furthermore, to prevent RSR stakers from running away with their tokens in the event of a collateral default, unstaking RSR from a RToken has a delay of anywhere from 7-30 days, configurable by governance. Note that when one initiates an RSR unstaking, the staker receives no yield. This is to discourage the repeated unstaking and redepositing/staking of RSR tokens to a RToken. Furthermore, RSR stakers can’t unstake until a default event is considered resolved by the protocol.
RSR Value Accrual
How do RSR stakers get financially rewarded and receive the yield from collateral? When a user stakes RSR to a RToken, RSR gets locked up and they get stRSR in return representing their stake. Yield for the RToken is fully generated by its underlying collateral. This yield is then used to market-buy RSR which is then distributed to stakers.
RSR Value Accrual and Slashing Mechanisms
RSR token value comes from staked RSR yield and the value of governance power on any RToken. Though RSR is in nature a volatile asset, its exposure to a RToken and its potential default is isolated to the RToken the RSR is staked on - RSR can only be seized if the RToken it is staked on defaults. Each RToken will have its own risk profile depending on the riskiness of its collateral, and thus will attract RSR stakers of different risk appetites.
It is important to note that RTokens have isolated RSR overcollateralization pools and collateral default events are verifiably predictable given their on-chain presence - this shields other RTokens and RSR overcollateralization pools from exposure.
eUSD - The Resilience of RSR Overcollateralization
eUSD, a RToken backed by yield generating USDC and USDT derivatives, demonstrated the resilience of Reserve’s safety mechanisms as it was able to remain its peg despite the SVB bank run and USDC depeg in March 2023. After 24 hours of USDC derivative collaterals (saUSDC and cUSDC) trading below peg, they were auctioned off leaving eUSD 98% collateralized. Then, staked RSR was seized to make up the difference, resulting in a quicker repeg to $1 than USDC or DAI throughout the event. More details on the recovery here.
Furthermore, though stakers took some damage due to the RSR slashing back in March, stRSR yields on eUSD have already surpassed the slashing, demonstrating the high profitability and long-term resilience of stRSR.
Mitigating Depeg Risk
Reserve Protocol has a 1:1 minting and redemption mechanism that allows users to swap between a RToken and its collateral backing. This mechanism ensures that a RToken price will be pegged to the value of its collateral basket as market participants will naturally take advantage of arbitrage opportunities when prices of a RToken deviates from its collateral’s NAV (net asset value).
Further, the protocol’s proof of reserves on chain guards against death spiral bank runs. A lack of transparency in the issuer’s reserves have threatened stablecoins in the past. For example, Tether (USDT) dropped to $0.98 following FTX’s implosion due to doubts from holders about whether reserves were large enough to back the stablecoins in circulation. Reserve eliminates this opacity through 24/7 proof of reserves and verifiably predictable recovery. Users can confirm for themselves that there are sufficient reserves backing RTokens with at least a 1:1 exchange ratio, ensuring true trustlessness of their pegs.
RToken Insurance vs Defi and Tradfi Insurance?
MakerDAO’s Insurance for DAI
DAI is an overcollateralized USD stablecoin where users deposit some asset (ETH, stETH, wBTC, LP tokens) and get DAI in return.
MakerDAO insures the 1DAI:1USD peg, but does not protect DAI holders when their collateral defaults / falls below a threshold price. Instead, DAI holders face no protection––only receiving warnings––as the collateral in their vault gets sold to liquidators at a discounted price. However, we can still compare the safety mechanisms of DAI and RTokens.
There are multiple mechanisms that act as insurance for DAI in events of default:
Collateral Auction
When the value of a user’s collateral drops under the value of collateralization ratio, sell collateral for DAI through a liquidation process.
Maker Surplus Buffer (Insurance for 1.5% of total DAI supply)
If the liquidation process fails to fill the hole, then the Maker Buffer DAI pool (which holds a portion of protocol revenues from liquidation penalties) is responsible to cover the hole. With a total DAI supply of 4.69B and Maker System Buffer holding ~70M DAI, this means that Maker Buffer insures only 1.5% of total DAI.
Debt Auction (Mint MKR and exchange for DAI) If the Maker Buffer mechanism does not fill the hole, then the protocol will mint MKR tokens and exchange MKR for DAI (effectively burning DAI) until the value of collateral matches the value of DAI. This is commonly known as a Debt Auction. In March 2020 when leading crypto assets lost 50% of their value in less than 2 days, MakerDAO resorted to this Debt Auction mechanism, minting MKR in exchange for DAI. While the auction successfully collateralized the stablecoin, MKR lost more than 60% of its value during the events.
Reserve Protocol and DAI are the same in that both have 1:1 asset backing of their stablecoins. Notable RTokens like eUSD and High Yield USD (hyUSD) currently have ~23% insurance % (aka the RSR overcollateralization %), which is much higher than DAI which only has 1.5% of the total DAI supply insured by its Maker Surplus Buffer. However, this is because the vaults used to borrow DAI are already themselves overcollateralized, and therefore the Maker Surplus Buffer is only used when the vault falls below a certain overcollateralization threshold. Through the 3 mechanisms listed above, DAI will likely not fall below its dollar peg due to the ability to print unlimited MKR in exchange for DAI, which is a last resort mechanism that may lead to death spirals. RTokens do not have this money printing mechanism and therefore its risk is bounded by the difference between the fully collateralized collateral basket value and the total value after RSR is seized to cover the hole left by purchasing emergency collateral basket.
FDIC insurance
FDIC insurance, provided by the Federal Deposit Insurance Corporation, is a US government-backed form of protection that safeguards depositor's money in the event of a bank failure. FDIC insurance only applies to FDIC-insured institutions.
Notably, FDIC insurance only protects up to $250,000 per account ownership category (individual, joint, retirement etc), per insured bank.
There are roughly $17 trillion of USD deposits in the United States, of which only $9.7 trillion qualify for FDIC insurance. However, the FDIC deposit insurance fund only has $182 billion, meaning that only ~1.9% of FDIC insured funds can actually be recovered. As we saw on the run on Silicon Valley Bank and the subsequent USDC depeg, Circle’s had $3.3 billion of deposits in SVB and much more of its deposits were not covered by FDIC insurance. If the FDIC had not made the exception and stepped in to insure all SVB deposits (even those above $250k), USDC holders would have lost money.
It is evident that even large, diligent companies like Circle and Sequoia Capital (which had $1 billion of deposits in SVB) need a more trustworthy and secure way to store their funds than the current best solution offered by FDIC insured banks. Storing funds in the form of overcollateralized, self-healing RTokens and working with institutional custodians like Fireblocks may be a better alternative.
Mitigating Smart Contract Risk
The Reserve Protocol has prioritized security of the protocol and its users by undergoing multiple audits conducted by the world's leading security firms:
Trail of Bits: Report date: Aug 2022, review report: (link)
Solidified: Report date: Oct 2022, review report: (link)
Ackee: Report date: Oct 2022, review report: (link)
Halborn: Report date: Nov 2022, review report: (link)
Code4rena: Report date: Mar 2023, review report: (link)
Additionally, the Reserve Protocol team is actively motivating its community to undertake their own audits by rewarding individuals who find and responsibility disclose any vulnerabilities. For example, Reserve Protocol has partnered with Immunefi for establishing a bug bounty program of $5,000,000.
Transparency and Decentralization
Transparency
The biggest selling points of the Reserve protocol are: permissionless creation of transparent asset backed money, overcollateralization safety mechanisms, and revenue sharing to users. These features give the protocol an ability to maintain the integrity and intent of blockchain tech by establishing a decentralized community full of transparency and honest management of assets.
The Reserve Protocol aims to give power to users. One of the features of the Reserve Protocol is the ability to see all reserves on-chain at all times. Unlike traditional financial systems, where reserve holdings are often opaque and managed by intermediaries, the Reserve Protocol allows users to monitor the reserves directly on the blockchain, giving them more control and security, an ultimate goal of financial services. This transparency provides users with real-time visibility into the backing of the stablecoin issued by the protocol and assurance that their assets are stable and secure.
Decentralization
Autonomous smart contracts remove middlemen and enable users to verify public code, corroborate proof of reserves, and ensure that the protocol is operating as intended. This eliminates the need for middlemen and stablecoin reserve managers, enabling a trustless environment that allows each user in the Reserve community to have the resources to be maximally informed and in control of the future of their assets through governance. Like other decentralized protocols, this can potentially lower costs and increase efficiency for users, lowering the barrier of entry to make access to resources more ubiquitous.
The protocol dynamically manages asset-backing and emergency collateral on-chain which is upgradable only through governance, allowing for management of assets to be decentralized. In governance, the parameters and compensation of RTokens are controlled by RSR Stakers by default (unless otherwise specified in a developer’s governance format), providing incentive from the RSR governance participants to keep the RToken as safe as possible, rather than taking unnecessary risk with the collateral their as staked RSR would be seized first if any of the RToken’s collateral were to default.
The creation of RTokens enables the choice of governance to also be decentralized: developers can choose to either use the Alexios governor format recommended by the Reserve team or deploy their own contract to dictate their chosen governance structure. This allows new RTokens to not have to maintain a system given by a centralized authority and can create new opportunities for users to get involved and have control over their assets, providing security in trustless environments, optimizing distribution, and reducing points of weaknesses.
Permissionlessness
In a similar way as how anyone can create a new trading pair on Uniswap, anyone can permissionlessly create a new Reserve stablecoin (RToken). RTokens can be created permissionlessly, allowing for the selection of the stablecoin’s collateral basket, backup collateral, and governance structure. RTokens can be deployed and configured here.
We’ve seen the creation of eUSD by MobileCoin, a company building a private yet scalable blockchain, ETH+ and High Yield USD (hyUSD), and we will undoubtedly see many more innovative RTokens that have a variety of types of collateral assets (more on this in the next section).
Permisionlessness is desirable because it enables entrepreneurs and companies to innovate by bringing new primitives and asset types to create RTokens. These new assets could be Paxo’s tokenized gold (Pax Gold), Ondo Finance’s tokenized US government bond ETF (OHSG), or Matrixdock’s Short-Term Treasury Bill Token (STBT). Reserve does not have to be the center of innovation. Rather, innovative new Defi protocols and entrepreneurs can permisionlessly onboard themselves to seek more use cases for their primitives and assets by creating RTokens for their ecosystems.
However, new RTokens are only useful if they are differentiated, by offering different sources of yield or different safety parameters. Just because anyone can create their own RToken does not mean that it would be productive for everyone to do so: this would lead to a lot of low market cap RTokens and fragment liquidity, and these RTokens may only have slight variations in their baskets or parameters. Furthermore, each RToken would need to bootstrap large amounts of collateral liquidity to garner users and RToken liquidity in order to be useful/treated as a currency.
We will likely see RTokens with large market caps created by other DeFi protocols and companies, and may even see protocols whose sole purpose is to create RTokens (because a portion of collateral revenue/yield can be distributed to external addresses and not just distributed to RToken holders or RSR Stakers).
Revenue Share: 95% to RToken holders, 5% to ETH+’s RSR stakers
Looking Ahead: The Real World Asset Opportunity
Ultimately, Reserve’s long-term goal is to enable the creation of stable currencies that can maintain their value for decades. This requires a currency not backed by fiat currencies that inevitably depreciate––even stronger currencies such as the US dollar, but by a diverse basket of many different tokenized assets that can hold its value for a longer time. Possibilities include real world assets such as precious metals, commodities, debt & equities, and perhaps even more illiquid assets such as real estate, fine art, and carbon credits. (A dashboard for tokenized treasuries and soon, real estate, can be found here.)
For this vision to come to fruition, Reserve could benefit from the wide-spread tokenization of real-world assets (RWAs). While these efforts are still nascent and shadowed by ongoing regulatory uncertainty, on-chain RWAs are certainly gaining promising traction.
Traditional finance has increasingly tapped into on-chain assets for their efficiency, liquidity, transparency, and lack of middlemen costs compared to traditional markets. For example, asset manager WisdomTree unveiled nine digital funds late last year, Hong Kong’s central bank launched inaugural tokenized green bonds in February this year, around the same time that German conglomerate Siemens issued its first digital bonds. In total, issuers distributed around $1.5B in digital bonds in 2022, compared to just a few bonds the previous year. In a recent survey by BNY Mellion on 271 institutional investors, 90% were interested in putting money into tokenized products, citing removed friction and increased access for mass retail investors as benefits of tokenized assets.
As RWAs increasingly come on-chain, Reserve Protocol provides a platform for open exploration for stablecoins backed by baskets of inversely correlated assets. For everyday people with no institutional investing experience or access, RTokens represent access to wealth preservation and creation opportunities from portfolios constructed with diverse asset classes. From this constant experimentation, perhaps an RWA backed RToken will emerge as a truly ubiquitous, non inflationary stable currency that is accessible to all.
Great article 👏👏👏