Detailed Explanation of the ALEX Economic Model in the Stacks Ecosystem: Introducing Quantitative Risk Analysis to Eliminate Liquidation Risk

Author: alexGo.btc
Original Title: 《ALEXnomics》

Compiled by: Creed, Chain Catcher

ALEX economics points the way for the decentralization and community autonomy of the ALEX protocol. Token economics is not a series of binary "do or do not" gates, but rather a guiding mechanism based on incentives and autonomy that directs the community to maximize its utility.

In this article, we outline a framework for progressive governance and liquidity decentralization, with the vision of establishing a long-term public community. ALEX balances the "ceilings" and "gates" of traditional finance to incentivize our liquidity providers in the early stages while aligning their long-term interests with the platform.

We also introduce quantitative risk analysis into token economics, utilizing value-at-risk models and statistical simulations in our risk management framework. By simulating the most severe black swan events, we ensure that ALEX remains robust in any market environment and that our defenses are effective in the event of loss occurrences.

1. What is ALEX?

ALEX is an open-source DeFi protocol that utilizes Stacks smart contracts and is based on Bitcoin. The vision of ALEX is to contribute to the financial infrastructure required for Web3. We achieve this by providing the essential elements of a mature financial system:

Market:

• The Launchpad provides an interface for launching new projects.
• Both AMM and off-chain order books facilitate decentralized trading to promote liquidity for projects built on Stacks.

Financial Tools:

• We introduce fixed-rate and fixed-term lending markets, effectively creating the first zero-interest bond service functionality in the DeFi space.

Leverage:

• We offer leverage services for those seeking higher returns, targeting margin trading and liquidity mining.

Notably, by using dynamic collateral rebalancing pools, we eliminate the risk of forced liquidation.

By establishing these financial primitives, which are the building blocks of the financial ecosystem, more advanced financial tools can subsequently be recreated in the DeFi space.

2. ALEX Token

Tokens are an effective mechanism for a project to allocate its fundamental value. The ALEX token ($ALEX) serves as a medium for exchanging time value and risk/return preferences. $ALEX is the participation token for its platform and protocol, providing governance benefits for participants holding $ALEX. $ALEX also serves as a medium to incentivize platform activity participants, specifically those providing liquidity and staking on our DEX. $ALEX can be obtained through our DEX, LP participation, and staking, and has three main functions:

Incentives

The primary use of $ALEX is as a medium to incentivize platform activity participants, specifically providing liquidity on our DEX and staking. The issuance of $ALEX will continuously drive adoption and sustained participation, attracting community users and strategic partners.

Staking

Users can freely choose to lock up $ALEX for a period to earn $ALEX as a reward. 50% of the initial token supply is allocated for staking, where $ALEX or liquidity tokens can be voluntarily locked by users for a period to earn $ALEX as a reward.

Voting Governance

$ALEX serves as the mechanism for entering and exiting the ALEX community, as well as for voting and platform governance.

$ALEX holders have voting rights, including but not limited to:

• Future platform development
• Trading fee rebates to liquidity providers
• Staking policies
• Reserve fund allocation policies
• $ALEX token supply policies (including buybacks and increases)

Figure 1 provides an overview of the ALEX ecosystem, illustrating that $ALEX holders are at the core of the entire ecosystem. All governance processes rely on $ALEX, which has the function of storing value within its ecosystem.

Figure 1

3. Decentralization of Progressive Governance

ALEX achieves the decentralization of governance through a gradual relinquishment of control by the founding team. This allows the team to focus on and catalyze the network's development in the initial stages. For example, the network can distribute tokens. Token distribution decentralizes control, operation, and management of the network itself. Meanwhile, the decentralization of progressive governance creates a pathway toward regulatory compliance.

The framework set up by our legal entity is managed by the ALEX Laboratory Foundation, which currently consists of the ALEX team. The goal of the foundation is to gradually transition to a complete DAO, where each $ALEX holder is a qualified member of the foundation.

Establishment of the Corporation

The ALEX Laboratory Foundation will implement the long-term development and continuity of ALEX. The foundation aims to gradually become a mature DAO.

The foundation has two affiliated entities:

• ALEX Issuer Inc. ("Issuer Co") is established solely for the purpose of issuing ALEX governance tokens.
• ALEX Operations Inc. ("Operation Co") is responsible for the daily operations of the protocol.

Token Distribution

Issuer Co issues an initial total supply of $ALEX of 1 billion. The distribution is as follows:

• 20% allocated to the foundation for community reserve pools to support the ecosystem, early adopters, and future development of ALEX
• 50% allocated to the community for staking $ALEX or as liquidity tokens to earn $ALEX
• 30% allocated to employees, advisors, early investors, and the founding team

Community Token Distribution Plan

Different staking pools may have different token distribution timelines, reflecting the various risks associated with the underlying pools/assets.

The launch of a staking pool will require 20 unique wallets to issue an activation signal, as a feature in the smart contract, after which a countdown will begin, and anyone will be eligible to stake within a specific block.

In all staking pools, the maximum distribution of $ALEX is capped at:

4. Governance

ALEX is committed not only to establishing decentralized finance but also to gradually decentralizing the entire project. The goal of the ALEX Laboratory Foundation is to become a mature DAO, allowing the ALEX community to have complete control over on-chain and off-chain governance decisions. However, this is a complex process that must be approached gradually and cautiously when necessary.

ALEX Genesis DAO

The first step toward decentralized progressive governance is the creation of the ALEX Genesis DAO. Approximately 60 days after the mainnet launch, the foundation will announce a Genesis team and a formal ALEX Growth Proposal (AGP) framework, through which any ALEX holder can submit proposals for community consideration.

The Genesis team will consist of ALEX team members, serving as intermediaries between the community and the foundation. AGPs may range from slight adjustments to transaction fees to complex proposals for adding new features or cross-chain assets. The Genesis team will review community-approved AGPs and provide an execution proposal regarding the feasibility and timing required to execute the AGP. The execution proposal will be publicly voted on by $ALEX holders.

The Genesis DAO will be in place within 6-18 months after the mainnet launch, working with the community to determine the best governance practices based on experience. While we will make every effort to respect the final results of governance votes, as a safeguard, the foundation will retain the ability to veto and suspend the governance system.

Once the governance system operates reliably in a decentralized manner, it will begin the transition to the formal ALEX DAO. The Genesis team will remove the fail-safe mechanisms, and the community will vote on whether to transfer all governance to the ALEX DAO.

5. Gradual Liquidity Decentralization

DeFi protocols must balance initial liquidity while maintaining long-term usage. Incentives for providing short-term liquidity are likened to "leasing" liquidity. Short-term incentives attract profit-driven capital, which captures a significant portion of initial returns and then quickly exits to pursue the next highest-yielding project. Users of smaller protocols may feel disappointed as rewards are exploited.

ALEX creates a liquidity commitment mechanism by borrowing from traditional fund managers' liquidity management through a series of thresholds. As we achieve progressive liquidity decentralization (PLD), this will filter out LPs committed to ALEX's long-term growth.

Progressive liquidity decentralization manages the transition from a concentrated liquidity state characterized by platform launches to a decentralized liquidity state, meaning no individual or small group controls the majority of the platform's liquidity.

ALEX will set "ceilings" on the amounts that individual liquidity providers can offer and "gates" to manage the orderly exit of capital, ensuring that no single LP can exceed a certain percentage of total liquidity to gain returns from long-term liquidity commitments.

This helps align the interests of our liquidity providers with those of the ALEX community and protocol, thereby best ensuring the long-term growth, prosperity, and appreciation of the ALEX token.

6. Risk Management of the ALEX Reserve Pool

How will black swan events affect the ALEX platform? How should risks be "quantified"? What measures have been taken to ensure ALEX's solvency?

ALEX essentially consists of two parts: a decentralized exchange (DEX) and a platform for lendable funds (PLF). The former facilitates trading activities, while the latter promotes lending. PLFs typically require over-collateralization, meaning the value of loans is usually less than the value of collateral to ensure loans remain floating.

When the market is in distress, the value of collateral is likely to fall below the value of loans, leading to defaults. Most DeFi lending protocols introduce "liquidators" who clear collateral pools by charging high fees, causing significant losses for borrowers.

To ensure a smooth lending experience, ALEX employs a collateral rebalancing feature (whitepaper), which avoids forced liquidation by continuously rebalancing the collateral pool between risk assets and risk-free assets.

Despite all precautions, black swan events may lead to a sharp decline in collateral value, making it impossible to convert risk assets into risk-free assets in a timely manner. When borrowers default, the ALEX platform incurs losses.

How does ALEX ensure the sustainability of its platform? To answer this question, we start with a framework for quantifying market risk. We then design various defenses to protect ALEX's solvency.

Value at Risk (VaR)

VaR is a statistical framework for quantifying risk exposure in risk management. Commonly applied in traditional finance, it is defined as the maximum expected loss over a given time frame. For example, VaR allows financial institutions to say, "We are 99% confident that our losses will not exceed $5 million in a trading day."

ALEX's risk model is conservative:

• We focus on extreme loss events with very low probabilities.
• To amplify market dislocations, we simulate exaggerated "jumps" in cryptocurrency price movements, meaning prices may suddenly drop to unprecedented levels.

For instance, in the past five years, the largest negative hourly jump was 18%. The probability of jump sizes between -10% and -18% is as low as 0.017%. To study the potential impact of black swan events, we randomly added 20% to the negative jump size, amplifying the probability of jumps to 100 times the historical average.

These simulations provide deep insights into the extent of losses the platform may incur. For example, with an initial LTV of 75%, assuming a jump frequency 100 times higher than the historical average, the probability of a 12.5% collateral value default is less than 1%.

Furthermore, under reasonable assumptions regarding the size of the collateral rebalancing pool and ALEX's annual fee income, we can compare losses with the income generated by ALEX through transaction fees. In the case studies listed in the appendix (assuming a collateral pool size of 31.25% and monthly fee income accounting for 1.25% of total TVL), we conclude that the platform's losses are approximately equivalent to three months of fees.

The black swan severe events simulated here will enhance credibility, and the elimination of ALEX's liquidation risk is sustainable in the long term.

Shortage Events

If a shortage event occurs due to any unforeseen reasons, the first line of defense is the ALEX reserve pool. The primary income of the reserve pool comes from transaction fees. Since we return a certain percentage of transaction costs to LPs, the remainder is automatically allocated to the reserve pool. Subject to governance, the size of the reserve pool is related to platform risk and may trigger $ALEX buybacks or new issuances. As long as the reserve pool is solvent, it will compensate for minor shortage event losses without suspending protocol operations.

If the reserve pool becomes insolvent, it may issue more ALEX tokens, subject to community voting approval. This is the second line of defense. All proceeds from the sale will go into the reserve pool until the shortage losses are compensated.

7. Conclusion

ALEX is a protocol built by seasoned quantitative analysts who have constructed quantitative trading and risk management systems for Wall Street banks. We have applied this knowledge and expertise to DeFi and token economics. For our risk management, we do not rely on arbitrary "token reserves" of any size, but rather apply statistical models to infer how ALEX will respond to black swan events.

Decentralization is our greatest advantage, as it allows us to create an open and adaptive protocol that can evolve in new ways. Our pursuit of progressive decentralized governance begins with our Genesis DAO.

We seek gradual liquidity decentralization through the unique commitment mechanisms of DeFi. By introducing "ceilings" on the amounts that individual LPs can contribute and "gates" to manage the orderly exit of capital, we strike a balance between incentivizing early LPs and the long-term interests of the ALEX protocol and community. ALEX has been exploring partnerships and community engagement within our ecosystem to build lasting financial infrastructure.