TL;DR: Rebase tokens are designed in a manner that the circulating supply is elastic and can be expanded (positive rebase) or contracted (negative rebase) at will. This mechanism is known as “rebase.” We’ve seen all kinds of rebasing protocols such as those having an abundance of highly inflationary tokens that have proven counter-productive for the protocol’s sustainability.
On the other hand, the rebase methodology is being used by IB-Tokens (Interest Bearing) the likes of aUSDC from AAVE and USD+ from Overnight Finance, and is a frictionless process to distribute fees to holders — in doing so, the value of your accumulated tokens constantly appreciates.
Introduction to Rebases
Rebase tokens were initially introduced as a mechanism to counter price fluctuation. In doing so, the token’s smart contract mints or burns more tokens depending on the situation with the aim of restoring equilibrium without having to worry about the user’s holdings.
A rebase mechanism ultimately means that while your token quantities remain changed, the end goal is to focus on price stability with such a mechanism. In recent times, this has expanded to also serve as a mechanism to reward token holders with lucrative APYs. This means that the tokens held in your wallet either decrease or increase to regain price stability or to offer incentives for users to hold the token respectively in such a scenario.
Let’s start with the basics. A rebase token is a smart contract. The smart contract is logic-automated that contains wallet addresses and their current balances. When a user adds a token to a wallet (e.g. Metamask) — they add the address of this token. Metamask calls the token’s smart contract and asks for the current balance of its wallet address. The smart contract then returns the current balance of the wallet’s address.
The key takeaway here is that your wallet doesn’t “hold” your funds, but it’s just a combination of the token address and your wallet address. The current balance of your tokens is held on-chain inside the smart contract and can always be retrieved with an API call.
The Ampleforth Stablecoin: Originating Rebases with Price Targets
This was initially introduced by the infamous algorithmic stablecoin, Ampleforth (ticker: AMPL). The stablecoin has a price target of $1 and is soft-pegged to the corresponding target. The protocol employs a rebase mechanism which is scheduled every 24 hours.
The mechanism introduces a rather non-intuitive approach to achieving stability for a stablecoin and works in an unprecedented manner. For example, if the price of AMPL is above $1, the supply expands whereas if the price is below $1, the supply contracts. Users holding AMPL will witness a change in their token quantities after the occurrence of the subsequent rebase. Conversely, no rebases occur if the stablecoin succeeds in achieving its soft-peg of $1.
What does this mean for the user? Well, if you’re bullish on AMPL and anticipating it to stay above peg, you would acquire the stablecoin in hopes of your $ value held increasing owing to positive rebases. On the contrary, holding AMPL below $1 can also prove fatal. Frequent negative rebases mean your held tokens keep decreasing all the while AMPL is below its peg.
However, Ampleforth has decreased in prominence owing to a general resentment around algorithmic stablecoins after a cascading sell-off on the UST token — the general flaw being it lacks subsequent collateral to maintain a stringent peg. The market cap of AMPL shared below is an indication of how wild the Ampleforth ride has been.
Taking Rebases a Step Further: Olympus DAO’s Bonding Mechanism
Olympus DAO led the infamous “Olympus Bull Run” and saw an influx of its forks popping up across DeFi. At one point in time, the two most prominent Olympus-Based protocols (i.e, Olympus & Wonderland) had as much as $4B in market cap cumulatively — representing their popularity as an initial hyped concept.
Unlike AMPL, Olympus had a treasury where at any point the floor for the protocol’s native token — OHM — had a floor of $1. Seems like a collateralized stablecoin, right?
Well, that’s not the case as even their website itself describes Olympus as an alternative to stablecoins. Moreover, the OHM token has never traded anywhere close to its floor of $1. The reason? Excessive buy pressure for OHM means that there are no immediate mechanisms to have the token trade at the floor price and there exist no upper price limits as well to have it trade at its floor.
Launched in May 2021, it has an All-Time-High of $1,314 and has only currently reached its All-Time-Low of $12.14 indicating how volatile rebase tokens can be.
The protocol pursues an aggressive inflationary mechanism whereby holders earn exorbitant inflationary APYs — this constantly expands the circulating supply. With a ceiling as low as $1, many have labeled it to be “unsustainable” with the narrative that 79,000% APYs aren’t sustainable (yep, you read that right, that’s the APYs from Olympus as of currently).
The innovation here? The protocol has pursued a mercenary liquidity acquisition policy buying its LP tokens to increase “protocol-owned liquidity” and other prominent blue-chip assets (eth, dai, etc) within its treasury. The process is known as “bonding” and involves the user providing the protocol with non-native cryptocurrencies in exchange for a vested bond, paid out in OHM. The bonds utilize a market algorithm to determine the discounted % that users get and there exists a plethora of such bonding opportunities.
An aggressive bonding policy by Olympus has also massively surged the protocol’s treasury to the point where the collateral has exceeded way beyond $1. In fact, with 23,717,679 tokens in existence, the protocol has a whopping $304,777,216 in treasury balance. This means that the collateral amounts to $12.85 per OHM token in existence. In some cases, the protocol has also seen its treasury value exceed its market cap though there are no mechanisms to keep the two in sync.
Interest-Bearing Tokens: Fully Collateralised Tokens adopting a Rebase Mechanism
IB Tokens (or Interest-Bearing Tokens), such as aUSDC or aDAI are interest accumulating tokens continuously going up in value as you hold them. They represent a share in a lending pool that grows in size as borrowers pay interest on them. IB tokens can be traded, used as collateral, composed by developers into structured products, or sent to cold storage for safety — the possibilities are endless!
IB Tokens constantly accrue value and increase in value because their underlying assets are loaned out to borrowers. Such tokens are always 100% collateralized and can be redeemed for their corresponding collateral. Examples of IB tokens include Crypto-assets lent out on Money Markets: AAVE & Compound being the most prominent.
They adopt a rebase mechanism to avoid being staked in a Gauge Pool in order to be eligible for such rewards. Users earn passive lending fees as rebases from IB Tokens regardless of whether it is in your wallet or used in a Liquidity Pool. Moreover, the passive appreciation model also holds the benefit of making your Health Factor on a Lending Protocol “healthier” over time owing to the lending fees appreciating your collateral.
Hence, they enshrine capital efficiency and it is exactly for this reason that Curve/Balancer have recently integrated such token models. The ability to increase Yield-incentives whilst simultaneously retaining collateralization is a narrative that only IB tokens with the use of a rebase mechanism can match.
IB tokens have gained prominence and are seeing increased integration within DeFi over plain vanilla stablecoins. For example, Balancer has introduced a weighted Gauge Pool comprising of aUSDC, aDAI & aUSDT — such a pool methodology provides liquidity providers with more APRs as opposed to conventional pools/tokens.
However, the downside is that IB-Tokens are largely limited to those offered by Lending Protocols and the APYs offered by them are largely insignificant to provide a material boost to Liquidity Providers. For example, lending USDC on AAVE, Polygon only rewards the holder with a mere 1.67% boost.
This ultimately means that incorporating IB Tokens in DeFi hardly achieves their purpose of providing significant rewards as Yield-Farmers are constantly on the search for higher Yields across the ecosystem.
USD+: Adding On to this Mechanism and Further Improving Capital Efficiency
Previously we touched on inflationary concepts of Rebases being immensely volatile and then introduced the concept of IB Tokens with the conclusion that they were capital efficient but this was “not enough.”
The ability to offer lucrative rewards while maintaining a risk-averse scenario has been pondered upon lately. The only method to provide a significant boost for Liquidity Providers is if the APYs were higher.
The solution? USD+ adopts a similar method to what we’ve seen being used by IB Tokens and pays its yields via a rebase. The stablecoin is fully collateralized like typical lending tokens on Money Markets; however, the difference here is that it deploys its collateral across a spectrum of low-risk Liquidity Pools as opposed to lending out its collateral on Money Markets like AAVE.
Owing to the above, USD+ yields the holder 8–12% APY and can be used in DeFi protocols — compare this with AAVE which yields a mere 1.67% on aUSDC.
With capital efficiency being of the utmost importance in DeFi, USD+ certainly delivers on this and can be used seamlessly across any DeFi protocols or investment methodology (such as Liquidity Provisions, use in a Money Market, etc).
Another upside of USD+ is that it provides a given Liquidity Pool with a significant forced appreciation (averaging around 3–4% in a 50/50 Liquidity Pool) owing to passive rebases from USD+ increasing underlying token quantities — illustrated in the infographic below.
Rebases: A Hit or a Bust?
Users within DeFi certainly prefer capital efficiency and collateralization. The abundance of rebasing tokens “going bust” has certainly proved this as exorbitant daily rebases are in no way sustainable.
It is for this reason that DeFi has turned its eyes to the magic of IB Tokens and that of USD+ to maximize their DeFi investments.
