Exploring Shadows Network’s Unique Debt Pooling Mechanism for Synth Trading

Built on both Binance Smart Chain and Polkadot’s multi-chain ecosystem, Shadows Network provides an alternative to traditional derivatives exchanges, removing the need for counterparties by allowing participants to issue synthesized asset tokens on a blockchain. Users can then enter into smart contracts to long or short underlying assets without owning them.

Synthetic assets on the Shadows Network are underwritten by the native DOWS token, providing the collateral required to mint the synths, later destroyed to settle the debt. Users can first stake DOWS and mint the xUSD stablecoin, backed by a minimum 800% collateralization ratio to secure enough liquidity against price volatility. Those xUSDs can then trade for a range of synthetic derivative assets including cryptocurrencies, indices, commodities, and stocks, powered by a unique debt pooling mechanism. But what is this debt pool and how does it work?

The Shadows Network Debt Pool

In contrast to traditional exchanges, Shadows Network doesn’t have counterparties as it operates a decentralized system of minting and burning tokens. Shadows smart contracts automatically and safely execute the conversion of one synthetic asset to another without an order book, liquidity, or slippage issues, in what is simply a transfer between debts.

To facilitate this, traders assume debt and become responsible for a proportion of the total Shadows Network debt pool. Upon minting, a trader’s initial debt balance is equal to the value of those derivative assets. This debt balance is also measured against the network debt pool value to calculate that trader’s Debt Increment Ratio (DIR), representing their share of overall debt they are responsible for in the system.

The DIR for each trader will then constantly adjust as synths in the system are minted and burned and as other traders join or leave the network. Depending on price action, synth portfolios will increase or decrease in value with the Shadows Network debt pool adjusting to the value of all the minted derivative assets in the system.

A trader’s ultimate profit or loss is the value of their portfolio against their debt balance. Therefore, they are effectively trading against the whole debt pool with exposure not just to their own portfolio synths but those of the entire Shadows Network.

How Does It Work?

Let’s imagine there are just two participants who lock up the same DOWS collateral to mint the same amount of xUSD, creating a DIR of 0.5 for each of them.

One trader then burns their xUSD for xAAPL share synths, while the other burns them for xGLD commodity synths. If xAAPL then rises by 50% over a certain period, but xGLD only 25% over that same period, the overall debt pool increases by the average gain of 37.5%.

In this simplified example, no other synths have been minted or burned, nor have any participants joined or left the system. The DIR of these traders has remained at 0.5, each responsible for half of the debt pool.

When a trader wants to exit the Shadows liquidity pool and retrieve the staked DOWS, they will need to burn the minted synths to settle the debt, ensuring the burned assets meet the same minimum 800% collateralization ratio.

Coming back to the example, this demonstrates that while both trader’s synths gained in price, if they destroyed them to repay the debt, the xAAPL trader would gain 12.5% overall (150% synth value minus 137.5% DIR), while the xGLD trader would lose 12.5% (125% synth value minus 137.5% DIR) as they are also trading against the total network debt.

In return for providing this liquidity and sharing the risk of the overall debt pool, however, synth issuing Stakers will earn a share of the 0.3% transaction fees across the Shadows Network that are pooled together and distributed proportionally to each Staker in DOWS according to their DIR. In our example, both participants would therefore also receive half of the transaction fee pool funds generated. Debt collateral lending to earn interest can further offset this risk.

Bringing Real-World Assets to Blockchain

The power of the debt pooling mechanism allows users to access decentralized synthetic exposure to stocks, commodities, forex, and other derivatives that were previously confined to traditional centralized exchanges, trading them alongside crypto on the same platform.

As a bridge to map the value of real-world assets on-chain, Shadows is delivering a new world of opportunities throughout an increasingly interoperable crypto ecosystem that leaves intermediaries behind, helping to disrupt a $1.2 quadrillion global derivatives market as a result.

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