The world’s first public blockchain, Bitcoin, disrupted monetary transactions by removing third-party processes. The second blockchain, Ethereum, set the stage for disrupting the overall financial system. Ethereum enabled an open financial system that is available to everyone regardless of its geographic location.
The name given to this revolutionary financial system is decentralized Finance (DeFi). Ethereum remained the superpower of DeFi until recently. But as the DeFi activity grew rapidly on Ethereum, the problems with scalability and high gas fees provided other blockchains the opportunity to share their part in this exponentially growing market of DeFi.
Furthermore, the lack of cross-chain communication capabilities of Ethereum has taken down its position as a go-to platform for new DeFi teams. This allowed other next-generation blockchains platforms like Solana, Tezos, Algorand, and Polkadot to come head-to-head with Ethereum in the DeFi revolution.
Among these new blockchains, Polkadot is considered the true rival to Ethereum because of its unique architecture that offers high scalability and cross-chain communication capabilities.
USD-pegged stablecoins are also a new sensation of the crypto industry. So, a team comprised of the best minds from Polkawallet, a mobile wallet for the Polkadot ecosystem, and Laminar Protocol decided the grab the land of DeFi and stablecoins by using Polkadot.
The result of their work is Acala Network, a cross-chain DeFi hub and stablecoin based on Substrate for Polkadot and Kusama. Let’s take a look at this much-talked DeFi project in the Polkadot ecosystem.
What is Acala Network?
The whitepaper describes Acala as decentralized finance (DeFi) network for stablecoin and staking liquidity. Founding members from two Polkadot ecosystem teams, Laminar and Polkawallet, started development in 2019, and the project is currently available on Polkadot parachain testnet Rococo.
Acala is an all-in-one defi hub of Polkadot that will enable users to stake, swap, borrow, lend, earn, and more with micro gas fees. Acala brings a slew of defi services to Polkadot, including an automated market maker (AMM) decentralized exchange (DEX), staking liquidity (Liquid DOT (LDOT)), and even an algorithmic stablecoin, aUSD. Acala is both a parachain platform on which other teams can build, as well as an application layer providing a suite of applications offering the aforementioned financial products.
Cross-chain communication is now the undeniable necessity of the blockchain industry and therefore, Acala is an Ethereum-compatible platform for financial applications to use smart contracts or built-in protocols with out-of-the-box cross-chain capabilities and robust security.
Unlike Ethereum, which requires gas fees to be denominated in ETH, Acala allows any blockchain platform to participate and pay for computation in any currency in what the team calls “bring your own gas.”
Acala is built on Substrate, an SDK to built Polkadot interoperable blockchain called parachains. Furthermore, the Acala engineering team has also deployed a custom-built Acala EVM, a novel contribution to the Polkadot ecosystem that gives a seamless, full-stack experience for Solidity, Substrate, and Web3 developers. The main purpose of Acala Network is not to redeploy Ethereum on Polkadot but create an environment that supports cross-chain innovation and interactions between distributed applications on top of interoperable blockchains.
As we know that Acala is a DeFi network for stablecoin and staking liquidity. So, there are two protocols in Acala to provide these services: Honzon – The Stablecoin Protocol, and HOMA – The Tokenized Staking Liquidity Protocol.
Honzon-The Stablecoin Protocol
As the name suggests, Honzon Protocol manages activities involving its stablecoin decentralized Acala Dollar (aUSD). The Acala Dollar stablecoin is a multi-collateral-backed cryptocurrency, with value stable relative to the US Dollar (1 aUSD ≈ 1 $US). As Acala Dollar is multi-collateral, can be created using assets from blockchains connected to the Polkadot network including Bitcoin (BTC) and Ether (ETH) as collaterals. It can be used by any blockchains on the Polkadot network as well as applications on those chains.
Honzon manages all these activites. Anyone who owns the type of crypto assets supported by the Acala network can leverage them to generate aUSD tokens by creating a Collateralized Debt Position (CDP) through the Honzon protocol. It is a cross-chain stablecoin system where each aUSD is backed in excess by a cryptocurrency asset and stabilized against the US Dollar.
In other words, Honzon Protocol is a dynamic system of Collateralized Debt Positions (CDPs), on-chain governance, and incentivized key actors. The protocol is available on Acala’s main DApp, Acala Mandala, and Polkadot UI.
Every CDP holds the collateral assets deposited by the user who opened the CDP that created the aUSD tokens, together with its associated aUSD debt position. Active CDPs are always over collateralized with the collateral with value that exceeds the value of the debt.
The assets locked in a CDP are locked and cannot be withdrawn by the user until the associated aUSD debt is paid back.
Unlike Ethereum-based protocols that use external liquidators to liquidate under-collateralized positions, Honzon uses off-chain workers, an automatic scheduler service, to automate this process and inherently increase the security and stability of the stablecoin.
Homa- The Tokenized Staking Liquidity Protocol
Homa is the second innovative DeFi protocol of Acala Network and it focused on liquid staking. According to Acala, Homa Protocol is the answer to the following question for Proof-of-Stake (POS) chains.
“Can we have both security and liquidity at the same time?”
POS blockchain uses staking for securing its network. But there is always a competition between staking and liquidity. The problem is that “if DeFi lending applications provide a better yield than staking, it could motivate the collective movement of funds from staking to lending, causing a ‘bank run’ and risking the security of the entire network.”
So, the Homa protocol solves the illiquidity challenge of staked assets. According to the whitepaper, the Polkadot network targets 50% DOTs staked, the rest in circulation would be used for bonding, paying transaction fees, and others.
Users can stake DOT, the native token of Polkadot network, trustlessly with the Homa staking pool, and in return you receive Liquid DOT (L-DOT) accounting for both the DOT amount and ongoing staking reward earned. These L-DOT tokens are fungible, can be traded, used for payment, and in DeFi e.g. as collateral to generate aUSD stablecoin. It can also be used in other blockchain-based applications.
Once DOTs are staked, there is a 28-day unbonding period which in principle reduces liquidity and improves security and stability of assets at stake. But Homa also allows users to withdraw their DOT assets from the Homa Staking pool at any time. For this, users are required to pay a higher premium for a shorter wait time to compensate for the loss reward of free liquidity. Fees paid for immediate or shorter withdrawal are paid in L-DOT and managed by the Homa Treasury.
L-DOT holders also have the right to vote for favorite validators using a selection mechanism similar to the Phragmen election to choose a maximum of 16 validators. L-DOTs are required to lock their L-DOTs in Homa Council for voting rights and power.
Apart from two foundational protocols, Acala also offers a Uniswap inspired automated market maker (AMM) decentralized exchange (DEX) which is implemented as runtime modules hence better integrated with other protocols. Acala DEX is accesbile thorugh its testnet dapp Acala Mandala.
Users can provide liquidity in two tokens in liquidity pools. On Acala DEX, there are markets for bridged in assets like BTC and ETH, as well as DOT, ACA, and aUSD.
Traders can swap tokens instantly without the need for an order book, whereas liquidity providers can earn a fee for their liquidity.
They earn an exchange fee and an additional reward from stability fee profit share, as liquidity on Acala DEX not only serves users for the token swap but also serves the Honzon stablecoin protocol for liquidation.
Acala (ACA) Token
ACA is the native token of ACALA Network’s Substrate chain. ACAs serve two key functions in Acala Network: Network utility token and Governance of the network.
As a utility token, it is used native fee token native transactions and smart contracts, and also utilized in staking for collator, staking for oracle and other network activities.
According to Acala Token Economy Working Paper:
“As a governance token, ACA tokens provide their holders voting right in Treasury governance, Council member election, referendum, network upgrade, risk management and more, e.g. adjustment of key risk parameters, such as Stability fee, Liquidation Ratio, and Collateral Type.”
According to the paper, the total supply of A unit of ACA Tokens will be minted at the launch of the mainnet and stored in the ACA Reserve Pool. In the pool, 20.25% will be reserved for the Acala team, 5% for Ecosystem development, and 11.62% for Acala Foundation Treasury.
29.13% will be distributed to the strategic investors. 18.33% and 10.8% will go to seed investors and ventures respectively. 34% will be distributed as rewards to IPO participants and network contributors including liquidity providers, early participants, oracle operators, and collators.
Acala is also building a canary network of Acala, Karura Network, on Kusama, a canary network of Polkadot. Karura will run on the Kusama Relay chain and it has virtually the same codebase as Acala.
Karura provides its own algorithm stablecoin kUSD. Besides kUSD, it will enable liquidity staking for KSM by the liquid token L-KSM, which will have the same qualities as Acala’s L-DOT.
- Website: https://acala.network/
- Acala Mandala: https://apps.acala.network/
- Documentation: https://wiki.acala.network/learn/acala-introduction
- Twitter: https://twitter.com/AcalaNetwork