Priceless Synthetic Tokens

Basics

• From Bankless (14-5-2020):

"“Priceless” contracts use oracles that can look backwards in time for a price if-and-only-if there is a dispute that’s otherwise unresolvable by contract counterparties. And, for any oracle price that does need to get pushed to the blockchain, provide an economic guarantee about that price’s accuracy."

• From the announcement by UMA (25-3-2020):

"“Priceless” contracts are designed with mechanisms to incentivize counterparties to properly collateralize their positions without requiring any on-chain price feed. These mechanisms include a liquidation and dispute process that allows counterparties to be rewarded for identifying improperly collateralized positions. Unless a position is liquidated, it is assumed to be solvent (properly collateralized). Oracles are only used when a liquidation is disputed — which is designed to be rare.

One analogy for this design pattern is the traditional legal contract. If Alice and Bob write a contract under US law they (hopefully) enter into that contract without any intention to end up in litigation. Provided that Alice and Bob both think the other person followed rules of the contract, they will never use the court system. Priceless contract design applies similar principles by reframing the “oracle” as a type of court system: oracles should only be used as a backstop to resolve disputes that cannot be handled by mechanisms codified in the contracts themselves.

Priceless Synthetic Tokens

Synthetic tokens are collateral-backed tokens whose value fluctuates depending on the tokens’ reference index. They are created by depositing collateral into a smart contract and minting tokens backed by that collateral. One example of a synthetic token is USStocks, an ERC-20 token launched last year to track the value of the S&P500.

Up until now, synthetic token designs have required the smart contract to know the value of the collateral at all times, as reported by an on-chain price feed. “Priceless” synthetic tokens differ because they do not require an on-chain price feed to indicate whether the contract is properly collateralized. Instead, they have a liquidation mechanism that allows anyone to liquidate an undercollateralized position.

In this design, liquidators can choose to liquidate positions based on their own off-chain view of the reference index for the token, which informs their view on whether the position is properly collateralized. Positions that have not been liquidated are assumed to be properly collateralized.

Liquidators are kept honest by disputers who are rewarded for catching invalid liquidations. Only when a liquidation is disputed is an oracle needed. If the price returned by the oracle implies that the disputer was correct, the disputer is rewarded with a penalty charged to the liquidator; conversely if the disputer was incorrect, the disputer forfeits a bond to the liquidator.

This system of incentives functions to minimize oracle usage while keeping the entire system correctly collateralized."