Whitepapers can sometimes be intimidating. However, going through a whitepaper is important to fully understand the core principles and mechanics of a blockchain project. Here I (Red_Eyed_Bear) attempt to provide a concise approachable breakdown of the Shade Protocol whitepaper, including its underlying principles, mechanics, and applications.
I am by no means an expert, and my understanding of this protocol is limited based on the information provided in the Shade Protocol whitepaper.
Shade Protocol is an array of interconnected privacy-preserving DeFi products built on Secret Network. The Secret Network is the first privacy preserving smart contracts platform that provides programmable privacy to all applications built on the network. $SHD is the governance token that will be integrated in all products on the product roadmap, whose holders are responsible for enforcing and evolving the rules and principles the protocol is based on. The initial supply of Shade governance tokens will be distributed through an airdrop. Approximately 1,450,000 $SHD will be airdropped, out of a total supply of 10,000,000. Silk, the network’s first privacy-preserving stablecoin, made possible by the SNIP-20 token standard, is the first application integrated into the Shade Protocol. Silk will support and secure all the other Shade Protocol applications that are created.
Without privacy, DeFi applications cannot access their true potential. Publicly visible holdings, especially leveraged positions, can be easily tracked and exploited in various ways, such as manipulating the market with the intent of causing investors to liquidate positions and having trades being front-run. The products integrated with Shade Protocol improve on existing versions of DeFi applications, providing more stable, attack resistant, value driving, and privacy preserving DeFi products. All transactions involving $SHD and $SILK have transactional privacy by default.
Staking has inherent risk; however, delegators will benefit from rewards and help secure protocol.
An integrated application must:
Currently, there are 3 applications integrated with Shade Protocol. These include Silk, the world's first privacy preserving stable coin, Shade Treasury (Synthesis balance sheet), and Shade Synthetics. A detailed explanation of these applications, and the value they bring $SHD, are listed below. There are current plans to include a Global Yield Derivation (GYD) mechanism to complement the Synthesis Protocol. This GYD integration would allow users to collateralize their $SILK in order to gain exposure to multiple FIAT pegged stablecoins, while simultaneously stabilizing $SILK's value much more than a simple USD peg could achieve.
This is the world's first privacy-preserving and smart contract interoperable stablecoin. $SILK is algorithmically stabilized by Shade, and is able to replace the entire TradFi payment chain with a single application layer protocol. Shade and Silk are both credibly neutral, which essentially means that the protocol and application have no discriminatory mechanisms that would promote success to particular groups or individuals. Shade and Silk are both fully decentralized, due to initial airdrop distribution and lack of block based inflationary rewards, which increases viability and decentralization of the stablecoin.
$SILK has the 4 key fundamental properties of money:
There are 4 ways to mint Shade or Silk, through 2 different processes known as dual burn entry mechanisms. The dual burn entry mechanism architecture empowers users to directly transfer value into the Silk and Shade ecosystem by giving them multiple pathways into the ecosystem, and also backs the value of Shade and Silk.
The first process is called “DAO entry” minting. This utilizes the Synthesis protocol, a DAO controlled asset management protocol. The DAO entry method allows users to burn sSCRT, sETH, and other crypto assets, to mint an amount of $SHD or $SILK of equal value, effectively using privacy preserving crypto assets as collateral to mint $SHD and $SILK.
The second process is called “Conversion” minting. This process burns $SHD for $SILK and vice versa. “Conversion” minting helps maintain Silk’s peg value during periods of expansion and contraction (where peg disparities are likely) by giving users the opportunity to take advantage of arbitrage opportunities. An explanation of expansion and contraction can be found under the breakdown of Shade Synthetics.
The total supply of Silk and Shade are bounded using the following equations, where the only variable that remains unchanged is the initial shade distribution:
Shade Protocol caps daily “DAO entry” minting for Silk and Shade to a fixed amount of Shade on a daily basis, which is dictated by the Shade governance. This daily cap on “entry” conversion is to prevent an “Entry Dilution Attack”, or EDA, which is the primary attack vector for the Shade Protocol. An EDA is basically selling a large portion of shade in a short period of time to drive down the price of Shade. The attacker could then use an entry-burn mechanism to burn tokens such as sSCRT and sATOM for Shade at a significantly depreciated price than currently valued. There is still one potential attack vector to be noted that is unavoidable, which is the “Entry Minting Discount Attack”, or EDMA. This is the same style of attack as EDA, however its damage is limited to the hard-capped daily entry minting value for $SHD. This attack is risky for the attacker, though, as they incur high risks trying to move the price of $SHD on the open market. It can be stated though that The more liquidity provided on pairs that involve Shade, the more difficult it will be to execute an EDMA.
As with any token, the more decentralized its supply is, the harder it is to attack the underlying protocol or blockchain. Therefore, it can be assumed that as the supply of $SHD becomes more decentralized, it will become more expensive and difficult to acquire large amounts of $SHD to be used for an EDA.
Synthesis is a privacy-preserving decentralized asset management protocol. It creates a balance sheet of crypto-assets controlled by Shade governance which can be used for “buy-backs, hedged positions, leveraged positions, collateralization, liquidity provision, batched Shade burns, user incentivization, and dividend generation”. The balance sheet of crypto assets controlled by Shade governance is also known as the Shade Treasury.
The balance sheet uses a controllable dual-variable system, “Synthesize” and “Burn” to manage assets. Crypto-assets such as sSCRT, sETH, and SILK are added to the Synthesis balance sheet via a “synthesis” mechanism introduced into all of the Shade Protocol products. The synthesis mechanism effectively allows for the minting of $SHD or $SILK by providing collateral in the form of other crypto assets. “Burn” is used to destroy a portion of the $SHD as a result of the executed contract.
This destroyed $SHD is then sent to the Synthesis balance sheet. The amount of token burned (x) is a variable percentage decided by the Shade Governance. This means that every time the synthesis mechanism is used to mint Silk or Shade, the Shade Treasury grows as does the value of the governance token, $SHD. When Shade or Silk are minted via synthesis, the crypto-assets used to mint Shade and Silk are considered “locked”, and are under control of Shade Treasury, and by default Shade governance.
The underlying smart contracts for the Synthesis protocol includes a variety of whitelisted contract addresses that can be interacted with. These interactions can include, but are not limited to minting Silk with Shade, providing liquidity to pools, synthesizing real world assets, and staking tokens. Whitelist addresses can be added to the synthesis secret contract via a Shade governance vote, after the new contracts have been tested for execution and functionality.
While Shade governance can approve various changes in capital conservation, it is hardcoded into the synthesis protocol that no more than 20% of a particular pool can be sent in a single transaction. This is intentional, as it ensures due diligence from Shade governance members.
Shade governance token holders can stake their tokens to the Shade dividend contract. The dividends from the contracts will be paid in the SILK. Dividend payment associated data is kept encrypted and private. Users who stake their Shade will benefit from growth of the Synthesis balance sheet which includes all cash flow generating activities such as LP swap fees and burned SHD or SILK from synthesis mechanism.
The value of Shade Protocol, and by default the Shade governance token, is the sum of all of its parts. Therefore, the total value burned into the Shade Product ecosystem, including value collateralized in Shade Protocol, value of governance, value of assets on the Synthesis balance sheet, value of utility across all Shade Products, and the value of the dividend distributed on a quarterly basis represents the total value of $SHD. At a bare minimum, the value of Shade can be determined by the value in the Shade treasury.
Shade Synthetics is the first privacy-preserving synthetic assets protocol ever created. This protocol allows anyone to mint and trade privacy-preserving synthetic assets that reflexively track the price of real world assets using Band Protocol - a decentralized cross-chain oracle solution. Band Protocol will initially support reflexive data for BTC, ETH, USDT, USDC, DAI, and SCRT, with plans on supporting more APIs for asset prices in the future, increasing the number of synthetic asset pairs. These future assets include S&P 500, NASDAQ, gold and silver.
There are 2 main types of synthetic assets issued by the Shade protocol, outside of Silk. They are S-tokens, which are synthetic tokens that represent real world assets, and s-tokens, which are the stabilizer tokens. These types of tokens mirror the peg mechanisms that Silk and Shade utilize to stabilize the value of the Silk. This means s-tokens help continually peg the value of the synthetic asset to its real world counterpart by providing arbitrage opportunities if there is a disparity between peg values. Each synthetic token has its own stabilizer token to help increase stability of the total synthetic asset pool, and allows for users to determine what synthetic pairs are worth maintaining.
As a result of the peg mechanisms, there are 2 main scenarios where arbitrage profits can be taken, Expansion and Contraction of the synthetic token supply. An example of expansion and contraction follow:
Expansion: If a particular synthetic asset had a higher value than its real world counterpart (not optimal) due to a peg disparity, S-token holders would be incentivized to convert their stabilizer token to the appreciated synthetic token, where the swap rate would respect the real world price, not elevated synthetic price, and then can then be immediately sold for an arbitrage profit on the open market. The conversion of the stabilizer token to the synthetic token would increase the synthetic tokens total supply and reduce the supply of stabilizer tokens. This ultimately would push the synthetic token price back down towards the value of the real world asset.
Contraction: If a synthetic asset price is listed below that of its real world counterpart, holders would be incentivized to convert their synthetic tokens to their respective stabilizer token. This conversion mechanism uses oracle data that accurately reflects the assets higher real world value, not the synthetic price on the open market, therefore the holder would get an increased amount of stabilizer tokens. This could then be sold on the open market for arbitrage profit. The conversion of the synthetic token to the stabilizer token decreases synthetic supply, increases stabilizer supply and thus pushes synthetic asset price upwards to the accurate price.
In order to access any synthetic pair, one will need to collateralize Silk to mint a s-token or S-token. Silk will be the only entry-minting token allowable for any synthetic pair. This is to help promote the use of Silk as a gateway to the synthetics market, and to take advantage of the entry-minting cap mechanism that Silk and Shade minting utilizes to prevent dramatic amounts of dilution, in which case an “Entry Dilution Attack” could occur. Also, by only allowing Silk for entry-minting of a synthetic pair, it also increases the value of Shade. This is due to the burn mechanism within entry-minting of both SILK and synthetic assets, that increases the holdings within the Shade Treasury.