UXD Protocol is a stablecoin that is backed by a delta-neutral position. In this post we explain what a delta-neutral position is and how it leads to stability in the stablecoin. We also explain why interest can be distributed to UXD holders.
What is it
The definition of a delta-neutral position from investopedia: Delta neutral is a portfolio strategy utilizing multiple positions with balancing positive and negative deltas so that the overall delta of the assets in question totals zero. A delta-neutral portfolio evens out the response to market movements for a certain range to bring the net change of the position to zero.
When you have zero delta, the price of BTC or any other crypto asset fluctuating has zero effect on your PnL. You don't make or lose any money.
Now let's think of a position where you are long 1 spot BTC and short 1 BTC perpetual swap. The position has 1 - 1 = 0 delta and hence the position is a delta-neutral position. The price of BTC fluctuating has no effect on your PnL.
A stablecoin (UXD) that is backed by a delta-neutral position will be pegged to the USD since anyone can mint/redeem 1 UXD for 1 USD. Otherwise traders can arbitrage and make a risk free profit, which is not possible in financial markets.
The delta-neutral position generates/pays interest depending on the market condition. This is possible because of the funding rate. Longs pay shorts when the funding rate is positive and shorts pay longs when negative.
When the funding rate is positive, the interest will be distributed to UXD holders and the insurance fund. When the funding rate is negative, the insurance fund will pay out the negative rate so that UXD holders do not have to pay any interest.