Meet Acala: Polkadot DeFi Hub and Karura Parachain Auction Slot Winner

Development on top of the scalable, interoperable, and secure Polkadot protocol is accelerating.

Development on top of the scalable, interoperable, and secure Polkadot protocol is accelerating. In a spate of innovation, over 400 projects are already building out smart contracts, oracles, bridges, NFTs, DAOs, DEXs, and more, bringing defi solutions multi-chain on a network that only went live in May 2020.

Built using the Substrate framework, Polkadot’s sharded blockchain connects various Parachains into a single network, allowing them to exchange data securely and process transactions in parallel. Coordinated by a central Relay Chain, it utilizes a Nominated Proof-of-Stake (NPoS) consensus mechanism secured by native DOT tokens.

Parachains derive their security from that of the Relay Chain, significantly improving scalability, interoperability, and upgradability without forks, eliminating the bottlenecks of legacy blockchains, and connecting with external networks via bridges.

One of the projects at the forefront of this development boom is Acala Network, an Ethereum-compatible platform powering cross-blockchain liquidity and defi applications. The project is doing something right as they have already managed to get investment from a hue range of VCs and funds including Pantera, Digital Currency Group, Coin Fund and many more.

Although Acala is a Parachain providing Layer-1 infrastructure, the Acala team has also built out an entire application layer on top of the Parachain for developers to build their own dApps. Acala’s applications are built around a decentralized stable asset, offering end-user applications such as borrowing, lending, synthetic asset trading, and interest-earning, all executed extremely fast with inexpensive micro-gas fees.

It is fast becoming a financial hub for the rapidly expanding Polkadot ecosystem, leveraging its multi-chain network to provide key financial primitives including a multi-collateralized stablecoin (aUSD), which is pegged against the US dollar and backed by cross-chain assets like bitcoin, liquid staking, and a DEX.

With Accala, users can:

  • Borrow aUSD, by locking up any assets compatible across the Polkadot Network 
  • Manage self services loans on the platform
  • Earn interest on their aUSD holdings,  by placing it in liquidity pools and liquidity mining
  • Use the Acala digital exchange for assets compatible across the Polkadot network
  • Have the ability to self govern if they are ACA holders

aUSD Multi-Collateralized Stablecoin

aUSD is the Acala Dollar, a multi-collateral-backed stablecoin redeemable for 1 USD. aUSD is decentralized, created using any assets from blockchains connected to the Polkadot network including bitcoin (BTC) and ether (ETH). It can be used by any blockchain on the Polkadot network as well as applications on those chains. These Acala Network-supported digital assets can be leveraged to generate aUSD tokens by creating a Collateralized Debt Position (CDP) through the Honzon protocol. Alternatively, aUSD can be acquired from brokers or exchanges.

The Honzon Stablecoin Protocol

Every aUSD is overcollateralized by a crypto asset and is stabilized against the US Dollar through the Honzon Protocol, a dynamic system of Collateralized Debt Positions (CDPs), on-chain governance, and incentivized key actors.

The Honzon stablecoin protocol uses a CDP mechanism design inspired by the first decentralized stablecoin project MakerDAO, which became the defi building block in the Ethereum ecosystem. Combining a set of incentives, supply and demand balancing, automatic risk management algorithms, aggregated oracle price feeds, and community governance, the value of an aUSD token is pegged to the value of a US Dollar, with relative stability.

Polkadot tokens like DOT can be used as collateral, or assets like BTC and ETH can be bridged into the Polkadot network and used to achieve a higher supply ceiling. Only one single type of asset is collateralized in the creation of a particular CDP, however. Stablecoins powered by the Acala Network can, therefore, be transferred to all chains in the Polkadot network, boosting liquidity and adoption to a degree that a single-chain asset would not be able to achieve.

Each type of collateral has a liquidation ratio – the minimum collateral-to-debt ratio required to avoid liquidation of an open CDP, a stability fee representing the accumulated cost of borrowing, overall debt ceilings for each collateralized asset, and a liquidation penalty to disincentivize dangerous positions – the risk parameters of which are voted for via on-chain governance. Once the collateral-to-debt ratio has fallen below the liquidation ratio, the CDP will be taken over and automatically liquidated by the system Liquidator in a Collateral Auction mechanism managed by the on-chain Treasury where a liquidation penalty paid in aUSD is deducted from the collateral sales.

Each CDP holds the collateral asset deposited by the user who opened it and created the aUSD tokens, together with its associated aUSD debt position. The deposited collateral assets inside the CDP are locked and cannot be withdrawn by the user until the outstanding aUSD debt is repaid along with a stability fee. Active CDPs are always overcollateralized, with a collateral value that exceeds the value of the debt. Once the outstanding aUSD and stability fee is settled, the CDP becomes debt-free, the holder can retrieve their collateral, and the CDP is closed by the protocol.

Due to limitations in the Ethereum ecosystem, an external liquidator would be required to monitor and close CDPs. In contrast, the Honzon protocol can use Off-chain Workers, a scheduler service unique to Substrate, to automate this process, increasing the security and stability of the stablecoin.

Liquid Staking

The Polkadot network targets 50% active DOT staking with a 20% annual return, creating an opportunity cost for using DOT in other applications versus staking. On the other hand, if defi lending applications provide a better yield than staking, it could motivate a collective movement of funds from staking to lending, risking the security of the network.

The Homa Protocol

The Homa protocol is a tokenized staking liquidity protocol that solves the illiquidity challenge of staked assets, allowing liquid staking by tokenizing staked assets to use elsewhere while the underlying asset still remains staked.

It works by establishing a staking pool, tokenizing users’ staked assets as an L-asset, such as L-DOT for locked DOT, which users can invest or use in other applications. For example, to lend L-DOT to earn interest or use L-DOT as collateral for stablecoin aUSD.

The Homa Protocol resides on the Acala Network and leverages Polkadot’s shared security mechanism to establish a decentralized staking pool. Users lock their DOTs to gain staking rewards while receiving L-DOTs as fungible and liquid asset receipts, tradable across all chains on the Polkadot network.

The protocol manages the issuance of L-DOTs and redemption of underlying assets. Underlying assets are redeemable at any time for a customizable redemption fee, with a higher premium for immediate redemption. The protocol manages the aggregated locked assets and rewards, participates in collective staking, and executes algorithmic staking strategies like validator selection to optimize returns – the parameters of which are again voted for via on-chain governance.

DOTs supplied to the staking pool are represented as an L-DOT account balance, entitling the owner to a likely increasing quantity of underlying assets as staking rewards are generated. Therefore, earning staking rewards is as simple as holding an L-DOT token, while L-DOT cross-chain capabilities can be used to participate in other defi activities.

ACA Token Utility and Governance

ACA is the native token of the Acala Network, the initial supply of which is set to be minted and distributed to reserve pools and investors, with the remainder sold to the public upon mainnet launch. ACA will serve three key functions in the network:

Network Utility

ACA tokens will be used for paying network transaction fees, liquidity staking redemption fees, stability fees (the interest rate of aUSD loans), and penalty fees in case of liquidation. When ACA is received, it is burned and removed from the supply permanently, so as market demand for aUSDs and CDPs increases, so does the demand for ACA.

Network Security

Polkadot Parachains rely on Collators to provide recent state transitions to Validators on the Polkadot Relay Chain, operating under NPoS to maximize chain security. Collators would maintain a full node for Acala, producing Parachain blocks and proving bad behaviors in return for ACA token rewards.

Network Contingency

In urgent situations such as a sudden price collapse of a collateral asset resulting in under-collateralized CDPs, ACA tokens will be automatically diluted and sold on the market for system recapitalization.

Network Governance

ACA token holders also have rights to propose network upgrades, and risk parameter adjustments, such as stability fees, staking strategies, debt ceilings, liquidation ratios, and liquidation penalties, which will be approved or declined by the elected on-chain General Council and specialized councils. For example, the Financial Council governs the financial and risk management of the network, and the Homa Council governs the Homa protocol and includes L-DOT holders as well as ACA holders.

The Acala EVM

Just as Ethereum can do things Bitcoin cannot, which subsequently inspired many innovations, Substrate and Polkadot will empower many more innovations outside of the Ethereum sandbox.

The Acala EVM leverages the best of Ethereum, and is of course now interoperable with the Binance Smart Chain, enabling users to work between these separate blockchains seamlessly. while unlocking Substrate’s full potential, providing Solidity, Substrate, and Web3 developers a complete full-stack experience seamlessly with a single wallet. Acala EVM also brings protocol composability for Ethereum and Substrate and enables developers to build and deploy dApps on Acala with tooling support.

In this composable defi environment, smart contract dApps deployed in Acala EVM can directly use native and cross-chain assets such as DOT, ACA, aUSD, renBTC, and XBTC. ERC20 tokens deployed in the EVM can also be made available to be listed in the DEX or, following governance approval, used as gas fee tokens. This means that, for example, Ampleforth could deploy AMPL contracts on Acala EVM to be made available as a native token, so it can be used to pay transaction fees and listed directly on the Acala DEX.

Acala App and DEX

The Acala App brings it all together, providing a platform that leverages the Honzon and Homa protocol features, ACA token utility, Acala EVM composability, and a decentralized exchange to deliver lending, borrowing, earning, liquid staking, liquidity mining, yield farming, trading, and governance participation in an all-in-one user-friendly defi service center.

Users can borrow aUSD by locking up any assets from blockchains connected to the Polkadot network and manage their outstanding self-serviced loans on the platform. They can also put minted aUSD to work, earning interest on the stablecoin by depositing to liquidity pools as well as liquidity mining ACA governance tokens on the decentralized exchange. Stakers can access Acala’s liquid staking feature, taking advantage of staking rewards for Polkadot-compatible assets while gaining liquid fungible tokens to generate additional yield farming opportunities. Tokens can be traded on the Acala DEX, compatible with other networks like Ethereum by utilizing the interoperability and composability of the Polkadot ecosystem. ACA holders can also participate in governance on the app, voting on various strategies and parameters within the feature set.

Introducing Karura: Acala’s Defi Parachain on Kusama

There are different ways to participate in the Polkadot network depending on usage and customization requirements. Projects can be:

  • Deployed as Parachains with permanent (for the auctioned slot period) ongoing security for high usage and fully customized chains, as is the case with Karura, which has just won a parachain lease slot, 
  • Deployed as Parathreads for a fully customized chain with lower usage and pay-as-you-go security renting economic model.
  • Deployed as smart contracts on a Parachain or Parathread to leverage Polkadot security. 

Becoming a Parachain by leasing a slot from Polkadot is an ideal option to bootstrap the Acala Network and maximize its benefits and reach to other chains and applications in the ecosystem.

Karura, is a Kusama Parachain and is the sister network to Acala. Because it is based on Kusama, rather than Polkadot, it has the potential to go further than Acala as a place to launch bold new projects. Kusama has faster governance parameters and higher risk tolerance while still offering interoperability between multiple networks, as it is ultimately bridged to Polkadot.

Kusama is an early, unaudited, and unrefined release of Polkadot, described as a canary network for Polkadot experiments. Kusama serves as a proving ground, allowing teams and developers to build and deploy a Parachain or try out Polkadot’s governance, staking, nomination, and validation functionality in a real environment, making it the perfect stepping stone towards an Acala Polkadot Parachain. Karura uses Kusama’s plug-and-play security while taking advantage of fast  processing speeds, extremely low gas fees, and interoperability.

As Acala’s sister network, Karura is built with nearly the same codebase and feature set, enabling a scalable, user-friendly, and fast cross-chain defi platform. Karura’s Parachain is a fast-moving and powerful platform that enables the development of efficient, inexpensive, and sophisticated financial applications, improving trading effectiveness and saving time. The platform will offer the same suite of financial primitives: a multi-collateralized stablecoin backed by cross-chain assets like KSM and BTC for lending and borrowing, liquid staking within L-KSM, and a decentralized exchange to unleash liquidity and power financial innovations.

Karura successfully won the first-ever parachain slot auction on Kusama with 501,137.66 KSM contributed by the community. In return for locking their KSM for Karura to lease a Parachain slot, Karura’s native token, KAR, was distributed to participants. KSM tokens will then be returned at the end of the lease as part of a fair and ethical token distribution.

Acala and Karura will continue to operate in parallel going forward and serve the users of both the Polkadot and Kusama communities. Once Kusama is bridged to Polkadot, Karura and Acala will also be interoperable with each other.

Where Next?

With much of Acala Network’s feature set already developed, the Parachain launch on the Polkadot Rococo testnet complete, and the Karura Parachain launch on Kusama set for the near future, the roadmap is progressing well.

The aUSD stablecoin, liquid staking derivatives, liquidity mining, and the DEX were enabled in Q1, alongside the Council governance system and Initial Parachain Offering (IPO) to secure a Polkadot Parachain slot with support from DOT holders.

From here, Acala plans to follow the next steps in its launch process:

  • technical verification and a runtime upgrade
  • enable KSM transfer from Kusama to Karura
  • Distribute KAR to the community
  • Remove the sudo key
  • Enable the Karura DEX
  • Enable kUSD borrowing
  • Enable token transfers on Karura
  • Enable the initial version of LKSM staking

Acala also plans a Q3 launch of its on-chain decentralized sovereign wealth fund, dSWF. Acala aims to build the dSWF from income surpluses on the network. It will hold DOT as its foreign cryptocurrency reserve as well as strategic investments in other crypto assets that satisfy the criteria of value, yield, and utility access. The returns will be used to help the Acala Network become self-sustainable, leading to further investments to bring the network to a higher level under its next-generation DAO.

In doing so, the Acala Network promises to deliver a first-of-its-kind defi infrastructure chain, governed by a decentralized consortium and powering financial activities for all chains on the Polkadot network.

On The Flipside

  • Once again, the question remains – “Why do we need so many sister-brother-nephew networks?” Let’s count: Karura, Acala, Kusama, and some others. The project is decent, but the names and their quantity are messy. They should be either clarified better or changed entirely.

This article is for information purposes only and should not be considered trading or investment advice. Nothing herein shall be construed as financial, legal, or tax advice. Trading forex, cryptocurrencies, and CFDs pose a considerable risk of loss.

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