Pika Protocol is a stablecoin protocol backed by decentralized derivatives. It consists of two components: Pika Exchange and PIKA Stablecoin.
Pika Exchange is a perpetual swap exchange that supports leverage trading. It supports token based inverse perpetual swaps. The underlying of the exchange is a virtual automated market maker(vAMM).
PIKA Stablecoin is a stable currency backed by Pika Exchange with these features:
- Stable: it uses perpetual swap positions to back its price stability around a 1 dollar target. PIKA is minted by opening a 1x short position of an inverse perpetual swap.
- Capital Efficient: a PIKA is minted by depositing one dollar value of supported tokens(e.g., ETH, WBTC), achieving better capital efficiency than overcollateralized stablecoins.
- Yield-bearing: yields are generated from trading fees of perpetual contract exchange.
Stablecoin: DeFi’s Missing Lego
Stablecoin market is huge. As of Feburary 2021, total market capitalization of stablecoins surpassed $50 billion.
However, the currently market are dominated by fiat backed stablecoins such as USDT and USDC. Dai, the most adopted decentralized stablecoin, accounts for less than 5% of the market share after so many years, and its share is not growing.
With the DeFi market’s exponential growth, we cannot rely primarily on fiat based stablecoin, because of its censorship, seizure and counterparty risks. If any of these risks happens, it could liquidate large portion of DeFi protocols. It is clear that market needs better and more DeFi native stablecoins, and that’s why we are witnessing waves of stablecoin experiments.
Derivatives Backed Stablecoin: A Proven Concept
While the waves of stablecoin experiments are taking place with many uncertainties, let’s look back and pick up a concept that have been proven for years.
One of the easiest ways to transform any token into dollar exposure is perpetual swap contracts. For example, Bitmex offers a BTC/USD contract that is margined in BTC. This contract is structured like non-linear inverse future contracts, meaning the contract value is measured in one currency, USD, but the position is margined and settled in a different currency, BTC. If a user opens a 1x short position, this gives the user a dollar exposure with the ability to earn yields from funding payments. This way of hedging is in fact widely adopted by traders to get exposed to dollar exposure.
PIKA achieves its stability in a similar way. To mint a PIKA, a user can simply open a 1 dollar value of short position in any supported token swap markets.
Pika Exchange: An Inverse Perpetual Swap Exchange
To better understand PIKA stablecoin, it is important to understand Pika Exchange. Pika Exchange is a decentralized non-linear inverse perpetual swap exchange.
Perpetual swap is the most popular way to trade cryptocurrencies with leverage in centralized exchanges like Binance and Bitmex. There are two popular types of perpetual contracts: linear and inverse.
While linear contracts have the benefit of low exposure to the volatility of the underlying assets, it is unfavorable to those long term holders of the underlying assets, especially in the bull market. Almost all the current decentralized perpetual exchanges are only supporting linear contracts. Pika Exchange is the one that supports inverse contracts.
Pika Exchange is also providing these features:
- Funding rate baked into price: funding payments are taken care of by the open and close price of perpetual contracts, so no explicit funding payments need to be made by longs and shorts, making it more friendly for DeFi folks.
- Tokenized leveraged positions: leveraged positions are tokenized into NFTs via ERC1155 standards, which allows traders to transfer or use tokens in the whole DeFi system.
- Virtual AMM with dynamic k adjustments: the “x * y = k” formula is used to determine the price of the perpetual contract, with k being dynamically adjusted based on open interest. This allows the exchange to achieve low slippage with small liquidity.
We want to give credits to Alpha Finance and Perpetual Protocol for some of these ideas. Our major difference is that they are providing USDT based linear contracts while Pika Exchange’s contracts are token based inverse contracts. Also, a key purpose of the Pika Exchange is used to back the PIKA stablecoins.
How PIKA Stablecoin Maintains its Peg
Essentially, PIKA stablecoins are backed by long positions’ loss at the time of the underlying token depreciation. At the time of the underlying token appreciation, the long positions’ profit are generated from both short positions’ loss and PIKA stablecoins’ collateral token appreciation.
Let’s assume the current price of ETH is $2000 and Bob deposits 1ETH to Pika Protocol to mint 2000 PIKA stablecoins. This effectively opens a 1x short position of ETHUSD in the inverse perpetual swap margined in ETH.
Assume the total value of all the long and short positions in the exchange are both $10000 (5 ETH), meaning there are $10000(5 ETH) values of long position and other $8000(4 ETH) of short position in the exchange. When Bob uses the 2000 PIKA to claim back their ETH at a later point, there could be three scenarios:
ETH price remains the same:
Since both the longs and shorts positions of the exchange have 0 profit or loss, Bob can deposit 2000 PIKA to claim back their 1 ETH, with $2000 worth.
ETH price goes up:
- Assume the price goes up to $4000.
- Net profit of longs: 10000 * (1/2000–1/4000) = 2.5 ETH
- Net loss of shorts: 2.5 ETH
- Net loss of Bob’s position: 0.5 ETH
- As a result, Bob’s current collateral is 0.5 ETH(1–0.5). If Bob burns the 2000 PIKA stablecoins to claim back ETH now, it is still worth $2000.
ETH price goes down:
- Assume the price goes down to $1600.
- Net loss of longs: 10000 * (1/1600–1/2000) = 1.25 ETH
- Net profit of shorts: 1.25 ETH
- Net profit of Bob’s position: 0.25 ETH
- As a result, Bob’s current collateral is 1.25 ETH(1 + 0.25). If Bob burns the 2000 PIKA stablecoins to claim back ETH now, it is still worth $2000.
How PIKA Stablecoin Compares with Other Stablecoins
We can write an entire blog about this but in short, PIKA’s unique derivatives backed design makes it a stablecoin that avoids the shortcomings of other protocol designs. PIKA avoids the centralized risk of USDT and USDC, requires less collateral compared to DAI, achieving a stronger peg than ESD and Basis Cash, has a more battle tested model than Frax and Fei.
Among all the current stablecoins, fractional collateralized algorithmic stablecoins are the most interesting ones to compare and we believe it will have a promising future, but it needs time to iterate and to be proven. In comparison, the advantage of PIKA is that its design has been battle tested in crypto perpetual exchanges for many years. The opportunity for DeFi native stablecoins is huge, and won’t be a zero-sum game. We look forward to a future where multiple DeFi native stablecoins take off.
How to Benefit from Pika Portocol
Why should you care about Pika Protocol? Because there are various ways you can benefit from it.
Take leverage positions
Any trader who likes to take leveraged positions can long or short with Pika Exchange. Since Pika Exchange is settled in the underlying tokens, it is favourable to traders who are long term holdes of the tokens.
Earn fees from holding PIKA
Any person who likes to earn interests without exposing to the volatility can benefit from holding PIKA tokens to earn trading fees.
Use PIKA as a stablecoin
PIKA can also be minted to use as a stablecoin to transact in the entire DeFi space or hedge the volatility.
Arbitrageurs can profit from:
- arbitraging price difference among Pika Exchange and other exchanges.
- arbitraging across different markets within Pika Exchange. For example, the price of PIKA from ETHUSD market and BTCUSD market could be different, and people can profit from minting PIKA from one market and burning in another market.
Earn fees from staking
More details will be shared in a later post.
This post shares the basic idea of how Pika Protocol works. More articles will be published on the development updates and the governance plans. Welcome to the new world of derivatives backed stablecoin!
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