Liquidity is essential for any thriving blockchain ecosystem. Cardano has a developing ecosystem with many of the necessary primitives already built out: decentralized exchanges (DEXs), native stablecoins, money market protocols including borrow/lend and collateralized debt positions (CDP), and liquid staking tokens. Each of these primitives on their own help push an ecosystem from the development stage into the flourishing and mature stage. Stablecoins play a unique role in any cryptocurrency system as a means of onboarding new users with a fiat pegged token and volatility protection. However, without deep liquidity the true value of the Cardano decentralized finance (DeFi) ecosystem cannot be realized, and a critical mass of liquidity is necessary to encourage broader adoption. This proposal outlines the use of treasury funds to boost stablecoin liquidity, creating a stronger foundation for DeFi. Increasing stablecoin reserves not only expands liquidity but also attracts new users and reinforces confidence in the chain — offering a solid hedge against volatility and supports Cardano native stablecoins.

High level overview

• Amount - The Cardano treasury should dedicate 3.33% of treasury funds (50 million ada) to purchasing fiat backed stablecoins, spread out over 12 monthly purchases.
• Management - A 7 entity committee will manage the treasury reserve using a multi-signature wallet (4 of 7 signature validation) to hold and deploy funds to protocols. The committee will be composed of 4 community members and one representative from each of the 3 founding entitees (Cardano Foundation, IOG, and Emurgo). The committee will be responsible for working with protocols to convert ADA to fiat backed stablecoins and deploying liquidity. A specific focus of the committee will be analyzing approaches of deploying ADA to stablecoins in a way that minimizes ADA price impact.
• Ownership - The stablecoin reserver will remain in the ownership of the Cardano Treasury, but will be managed by a committee.
• Revenue - ADA in the reserve waiting for deployment will be staked to earn interest while deployed over the 12 month period. 15% of fees generated from protocols will be withdrawn from the respective protocols and sent back to the treasury, while the remaining 85% of fees will remain in the protocol to accumulate.
• Deployment - DeFi protocols with at least 250,000 ADA worth of a stablecoin may apply to be recipients of minted stablecoin. A maximum of 2 or 3 protocols may be used per DeFi category to help minimize fragmentation. Applicants should make a strong case for the use of their protocol, including a a description of historical success, security, dedicated support for handling issues, and features of the protocol that will maximize the value to the Cardano treasury if liquidity is deployed to the protocol. New protocols will not be excluded for having limited history, but must make a strong case in other areas of the application.
• Strategy - The committee will deploy funds on a monthly basis in a way that minimizes ADA price impact and fees. A specific focus should be on deployment of liquidity that can be "passively" managed, meaning frequent adjustements are not needed.
• Transparency - The committee is responsible for either creating a monthly report or building a dashboard to describe the ADA held in reserve, the funds deployed to protocols, and all fees and other costs associated with managing the treasury. The committee may partner with an existing protocol to develop a dashboard to provide live updates of the stablecoin reserve for the Cardano community.
• Costs - Each member of the committee will be compensated $2,000/month in the fiat backed stablecoin of their choice ($14,000 total for all committee members). The stablecoin reserve fund will cover the costs of minting fiat backed stables, deployment of liquidity to protocols, and rebalancing if needed. The committe will also use some funds to perform KYB/KYC of 3rd parties as needed. Total costs per month should be capped at $50,000/month.
• Organization - The stablecoin treasury reserve will be formed as a non-profit in the USA for legal and tax purposes (i.e. 501c3). This will allow contributions to the stablecoin reserve to be tax deductible.

Motivation

Introduction

There is a strong need for better liquidity, especially stablecoin liquidity, in the Cardano ecosystem. Deep stablecoin liquidity helps to serve as an on/off board mechanism for new users as well as a safe haven from market volatility. The Cardano community as a whole benefits from deep stablecoin liquidity, and thus it makes sense to bootstrap this liquidity with funds from the Cardano treasury. In addition to providing mechanisms to onboard new users, deeper liquidity in decentralized exchanges will help stablecoins keep their peg since the stablecoin peg is a function of exchange fees and slippage, where slippage is inversely proportional to liquidity. As liquidity is bootstrapped, a positive feedback loop will be created bringing more professional market makers on chain. We see this consistently in traditional finance and in other blockchain ecosystems. Market Makers are more willing to quote tighter spreads and provide more liquidity into an asset once there is sufficient liquidity in that asset. Liquidity begets liquidity. This will also spur more DeFi innovation, bring more developers and retail participation into the cardano ecosystem, and benefit everyone involved in Cardano.

Another reason to use treasury funds for stablecoin liquidity is to support the significant efforts of those protocols that have developed a native stablecoin on Cardano blockchain. Cardano has had difficulty attracting established stablecoins, leading to efforts to establish stablecoins natively on Cardano. Both Cardano and these protocols benefit by supporting home grown stablecoins, and the treasury should help to support these projects but allocating funds to minting stablecoins.

Stablecoin Reserve

Stablecoins suffer from the "stablecoin trilemma":

• Stability – maintaining a reliable and resilient peg.
• Decentralization – avoiding reliance on centralized entities.
• Capital Efficiency – minimizing overcollateralization or complex mechanisms to back the stablecoin’s value.

Fiat backed stablecoins tend to be capital efficient (1 USD invested in Treasury Bills, money market funds, banks backs 1 stablecoin) and stable. However, these tend to be more centralized than CDP backed stablecoins and algorithmic stablecoins. Given the desire to deepen on chain liquidity and create a thriving ecosystem, fiat backed stablecoins make the most sense (especially given their dominance in other thriving blockchain ecosystems).

Stablecoin Reserve Committee

The stablecoin reserve committee will be compsed of 1 representative each from the three founding Cardano entitites (Cardano Foundation, Emurgo, and IOG) as well as 4 Cardano community members. The committee should have expertise in traditional finance expertise, Cardano development expertise, stablecoin expertise, DeFi expertise and most importantly risk and technical expertise. The committee will be responsible for vetting 3rd parties, evaluating protocol applications, deploying liquidity on a monthly basis. Each member of the committee will be compensated $2000/month in the fiat backed stablecoin of their choice.

For disbursement of treasury funds, a multisignature wallet comprised of an unused address from each of the committee members will be created. The multisignature policy will be a 4 of 7 policy, meaning 4 of the 7 committee members must sign a transaction. This means that a majority of committee members must agree to a transaction and sign it, not allowing any single person to have control over the funds.

The committee must be selected and the multisignature wallet created before disbursement of funds from the treasury, so before the on chain vote a committee will be formed. Each member of the committee must publicly identify themselves to help establish transparency for committee members.

Term Limits

Community members have a maximum term limit of 2 years, after which they can re-apply for a second 2 year term.

Founding entities as a part of the initial composition of the committee may always have a representative on the committee unless impeached. If elected back after impeachment, founding entities will have the same term limits as community members.

Retirement and Impeachment

In the event that a committee member retires or their signing keys are exposed, the remaining members of the committee must create a new multisignature address with the same policy (4 of 7) that removes the retired address. This process also gives the committee the capacity to impeach inactive members of the committee.

New Committee Member Selection

When there is a vacancy on the committee, existing committee members must receive applications for interested candidates and collect community feedback on new applicants. The committee will select a new committee member in alignment with community feedback. At a minimum, 4 community members (unaffiliated with founding entities) must be on the 7 person committee.

Deployment Details

Building out a stablecoin reserve is no easy task. The Cardano Treasury only has ADA currently as a reserve asset. ADA needs to be sold for USD, and then the stablecoins must be minted. The treasury will need 1 or more third party providers to facilitate this transition.

We propose dedicating 3.33% of treasury funds (50 million ADA) to develop a stablecoin reserve for the Cardano treasury. Treasury funds will be deposited into a 7-entity multi-signature wallet which will control disbursement of funds to 3rds parties and protocols. Stablecoins will be allocated to DeFi protocols to earn yield. Each month 15% of yield will also be streamed back into this smart contract, with the remainder being reinvested into participating DeFi protocols.

Fiat backed stablecoins may need to be paired with other assets to deploy to other protocols. For example, to supply liquidity to a DEX, the funds will need to be paired with other tokens such as ADA. To that end, fiat backed stables may only be paired with other stablecoins (fiat backed, algorithmic, or synthetic) or ADA.

Stable Reserve Composition

Before discussing stablecoin reserve composition, it is important to differentiate different types of stablecoins on Cardano

• Fiat back, Cardano native stablecoins - Fiat backed Cardano native stablecoins are Cardano native stablecoins directly backed by treasury bills, money markets, etc.
• Non-fiat backed, Cardano native stablecoins - Cardano native stablecoins that are designed be pegged to USD but are not directly backed by fiat (i.e. CDP, algorithmic, etc)
• Bridged stablecoins - Stablecoins that represent a bridged asset.

With these definitions in mind, the composition limits of the stablecoin reserve will be:

• ADA must make up 30% or less of deployed liquidity
• Non-fiat backed Cardano native stablecoins must make up 10% or less of deployed liquidity
• Remainder of holdings must be in fiat backed Cardano native stablecoins

Example: Each month ~4.2 million ADA will be deployed. If some of this liquidity will be deployed to a DEX for an ADA/Stablecoin pool, then at most ~1.3 million ADA (30% of 4.2 million) can be paired with a fiat backed stablecoin for the month. If paired with another stablecoin such as iUSD or DJED, then at most 420,000 ADA (10% of 4.2 million) worth of iUSD or DJED may be paired with a fiat backed stablecoin for the month.

DeFi Protocol Applications

Protocols must apply to the committee to receive liquidity distributions. The committee will ensure a maximum of 2-3 protocols per protocol types will receive liquidity distributions to help prevent significant fragmentation. Protocol types may include decentralized exchange (DEX) and lending protocols, but the committee will be responsible for creating categories.

Protocol applications must make a strong case for why their protocol should be chosen to receive distribution. A demonstrated history of success will help establish a strong application, but newer protocols should also be considered provided they can demonstrate a strong community and efforts to perform due diligence for the safety and security of their protocol. Strong applications will highlight features of the protocol that will maximimize revenue for supplied liquidity, allowing the best returns back to the Cardano treasury.

For protocols applying to pair their stablecoin (algorithmic or synthetic) with a fiat backed stablecoin, the protocol must detail the relevant mechanisms for maintaining peg, potential risks, and potential risk mitigations (if any).

Third Party Providers

There are two necessary third party providers needed to execute the development of the Cardano stablecoin reserve. They may all be 1 entity or multiple entities. The committee is responsible for performing proper due diligence for all counterparties.

The committee will both accept applications from for 3rd party providers and/or pursue 3rd party providers for each role. Each third party must clearly define any fees (or none) they might charge for their services. These can be flat fees or percentage of assets managed fees. The Stablecoin Market Maker may not charge a fee at all if it is the protocol that does the USD custody and minting of stablecoins. Many times, these protocols earn fees by investing the USD in yield bearing assets (like money market funds, treasury bills, etc.). The ADA Market Marker should earn a flat fee as well, paid monthly from the execution of ADA to USD.

ADA Market Maker

A third party market maker will need to be hired to facilitate the swapping of ADA for USD. This market maker will have guidelines, similar to an investment management agreement/guidelines, which dictate the allowable terms of swapping from ADA to USD. This could be on centralized exchanges, decentralized exchanges, or OTC deals. The ADA Market Maker is responsible for executing the purchase of USD at the best possible prices, with a concern for how the approach will impact the ADA price. This means the market maker will request for quote (RFQ) multiple counterparties (could be individuals, hedge funds, private equity funds, liquid token funds, etc.) with the terms of the deal. Then they will pick the best quotes (lowest discount from spot / highest ADA price in USD) conditional to the terms specified by the Cardano treasury. OTC deals tend to occur at a discount from spot. The Cardano Treasury should consider terms for these deals such as: what discount from spot is allowable, is there a lock associated with the deal (vesting, cliff etc.), can 1 counterparty take 100% of the deal or multiple counterparties, etc. A legal agreement must be put in place to hold the ADA Market Maker accountable and liable for proper custody and best execution practices.

A potential concern for large scale selling of ADA for fiat is ADA price impact, and we present a brief analysis under the ADA price impact section.

Stablecoin Market Maker

A third party market maker will facilitate the swap/minting of USD for the stablecoin (assuming all fiat backed stablecoins at first). Likely this will be facilitated by the protocol itself (i.e. Mehen for USDM and/or Anzens for USDA). This step requires the ADA Market Maker to coordinate with the Stablecoin Market Maker to transfer USD for minting, with appropriate reporting back to the committee transaction details. The stablecoin protocol will then have custody of the USD and mint the stablecoin on chain, depositing it into the committee multisignature account. Research on the backing of each stablecoin is necessary. Ideally the fiat back stablecoins are backed by US Dollars held in backs, treasury bills, or low risk money market funds that only invest in government issued short term paper like treasury bills.

Consideration of ADA Price Impact

A potential concern with this proposal is the conversion of ADA to USD having a major price impact, which is a valid concern. One duty of the ADA Market Maker is to ensure that ADA price is not significantly impacted by conversion to USD. While OTC deals can and should play a part in this, it is helpful to look at the ADA budget allocated to the stablecoin reserve with respect to CEX volume. This proposal requests 3.33% of the 1.5 billion ADA treasury (50 million ADA), dispersed evenly on a monthly basis for 12 months. This means that 4.17 million ADA will be converted per month. Looking at CEX volume, for the last 3 months Coinbase has had an average daily volume of 60 million ADA, with 1.25 million ADA representing ~6.94% of the daily volume. Spreading out sales of ADA combined with use of other CEXs (such as Binance, which has even higher daily volumes) would further reduce price impact. Thus, even not accounting for OTC deals, the amounts of ADA being converted to USD make up a small fraction of daily CEX volume and thus should not have a major impact on ADA price.

Strategy

The primary goal of this proposal is to increase the on-chain liquidity of stablecoins in the Cardano ecosystem. So the first and primary goal should be to create stablecoin liquidity pools on multiple DEXs, which may involve use of a portion of the funds to supply tokens that are not fiat backed stablecoins. There are three critically important types of liquidity provisions.

1. A stablecoin to stablecoin pool – ideally using the stablecoin invariant (like Curve’s). These invariants allow for imbalanced pools but keep the price between 2 or more assets relatively steady even with imbalanced pools.

2. ADA to stablecoin pool – given the current developments in the Cardano ecosystem, this will likely need to be a 50/50 Constant Product AMM pool.

3. Stablecoin lending protocols - Easy and low cost access to stablecoins are a critical component to a vibrant DeFi ecosystem. Supplying more stablecoin assets to these protocols lowers the lending rates, and decreases the barrier to accessing stablecoins.

Up to 3 protocols can be seeded for each of the above pool types. It will be the responsibility of the committee to research and understand the risks and benefits of each protocol’s implementations of these different types of pools. However, it makes sense to specificy that at least 2 protocols should be used to limit closure risk.

Note that use of AMMs inherently require a second token. Refer back to the Stablecoin Reserve Composition section for details on the maximum allowances for non-fiat backed tokens and types that are permitted.

Oversight

The committee that operates outside of the third parties will be responsible for selecting 3rd parties, reviewing protocol applications for liquidity provision, managing liquidity, and delivering reports to the community. The oversight committee will have the following responsibilities:

• 3rd Party Selection: The committee will be responsible for the underwriting of all three third party managers. The committee is responsible for the initial search or application review, due diligence review, and recommendation. The committee is also responsible for the continual underwriting of third party managers. The role is similar to a manager research role in traditional finance. There should be a cadence to the reviews, quarterly or semiannually. The committee will ensure that the third party managers are operating within their guidelines and pursuing best practices in operations/custody and best execution.
• Protocol Selection: The committee is responsible for reviewing applications for liquidity disbursement. They should select at least 2 but no more than 3 DeFi protocols for DeFi type. Considerations for protocol selection should include security, history of success, revenue generation, and commitment to prompt support if there is a need for the committee to resolve any issues.
• Liquidity Management: Most protocols collect fees passively, so active management should not be required. However, liquidity will need to be disbursed to protocols, and 15% of fees should be removed from protocols and sent back to the Cardano treasury. Actions should be minimized to reduce number of fees generated, and it is recommended to only perform these actions once per month.
• Quarterly Report: Once per quarter the committee should generate a report to deliver to the Cardano community to provide an update on the status of the treasury. The report should include active protocols who have received liquidity, amount of ADA currently held by the committee address, amount disbursed to each protocol, fees generated, and amount of fees returned to the Cardano treasury. To assist in this process, the committee may desire to build a dashboard to keep the community up to date on the current status of the treasury.

Stablecoin Selection

The ultimate selection of the stablecoins in the reserve is a key consideration. As stated above, there is a balance between stability, capital efficiency, and resilience/decentralization that needs to occur. The primary recommendation is to focus on fiat backed stablecoins initially, willingly allowing for some centralization in order to promote the nest peg protection and capital efficiency.

Ideally the committee is responsible for the initial selection and continued re-underwriting of stablecoins to choose from.

Preference should be given to native Cardano stablecoins in order to avoid unnecessary bridge risk.

Understanding the arbitrage mechanism to protect a stablecoins peg is key. If the arbitrage mechanism for fiat backed stablecoins requires native minting/burning, it's highly possible that there is a time delay in arbitraging a stablecoins on chain price back to the peg. This time delay may cause on-chain depegs for a period of time as on-chain users have differing liquidity preferences. These liquidity preferences could show that on-chain users are willing to buy a stablecoin slightly above peg in order to move out of risky token exposures/repay debt/leverage, or sell stablecoins below peg in order to access debt/leverage/ risky token exposure. If the arbitrage mechanism requires a time delay, we could see price depegs from parity and that may affect high Amplification factor stableswap pools.

Risks

1. Stablecoin peg risk
2. DeFi protocol smart contract risk
3. Custodial risks from protocols and the DeFi Custodian
4. Execution risks from the ADA Market Maker
5. Custodial risks of the stablecoin protocols reserve assets (USDC depeg event as an example)
6. Impermanent loss/LVR on stableswaps and ADA/stablecoin pools
7. Solvency/bad debt of other DeFi protocols like money markets

Historical View:

Avalanche's Rush Program (2021)

Strategy:

The Avalanche Foundation launched "Avalanche Rush," a $180 million liquidity mining incentive program aimed at attracting DeFi applications and assets to the Avalanche ecosystem.

Key Actions:

• Partnerships - Collaborated with leading DeFi protocols like Aave and Curve to enhance lending services and stablecoin liquidity on Avalanche.
• Incentives - Encouraged users to provide liquidity and engage in borrowing activities, leading to a rapid increase in Total Value Locked (TVL).

Outcome:

• TVL Growth - The program significantly boosted Avalanche's TVL, reflecting increased user engagement and capital inflow.
• Stablecoin Adoption - Established stablecoins such as USDC, USDT, and DAI as prominent assets within the Avalanche network.
• DEX Liquidity - Enhanced liquidity on decentralized exchanges like Trader Joe, resulting in improved trade execution and reduced slippage.

Optimism's Liquidity Mining & Grants (2022)

Strategy:

Optimism, a Layer 2 scaling solution for Ethereum, implemented a liquidity mining program using OP tokens to incentivize DeFi activity on its platform.

Key Actions:

• Incentivization - Allocated OP tokens to liquidity providers on platforms like Uniswap to encourage liquidity provision.
• Governance-Funded Programs - Supported liquidity mining initiatives through governance proposals, aiming for sustainable growth.

Outcome:

• Sustained TVL Growth - The incentives led to increased Total Value Locked on Optimism, attracting more users and capital.
• Treasury Management - Enabled governance to reinvest yields into treasury reserves, promoting long-term sustainability.