Arrington Capital: Detailed Explanation of Acala's Product Architecture and Features

Author: Ninos Mansor, Partner at Arrington Capital

Original Title: 《Composability Squared: The Acala Thesis》

Compiled by: Li Zeyi, Chain Catcher

Acala is the first layer one blockchain tailored for DeFi, deployed as a parachain on Polkadot. It is the first blockchain to reconstruct the entire DeFi stack utilizing a native multi-chain environment. The project secured its first parachain slot in December 2021, with the community contributing over 32 million DOT tokens, equivalent to approximately $130 million.

We met this team in early 2020. The most remarkable aspect of this team is that they have always been ahead of their time. Ethereum DeFi exploded in 2020 and evolved into the L1 battle in 2021. In both cases, DeFi was conservative. Whether it was Ethereum or L1, composability adapted to the limitations of general-purpose computing platforms.

Early on, the Acala team tried to envision the "ultimate state" of DeFi. Now, market developments are merging the concepts that Acala has been building for years—DeFi should be multi-chain, application clear, and highly customizable. DeFi should be inherently intertwined with the protocol layer.

Now there are chains focused on DeFi—like Vega's L1 derivatives. There are projects like C3 that assumed from the start that they would build a project with the advantages of composability and cross-market margining. DeFi protocols that are chain-agnostic and centered around cross-chain interoperability are emerging.

Acala had these ideas early on. They had the advantage of starting to build while the dust had not yet settled, staying ahead of the times. They could learn from DeFi experiments and integrate them into a single blockchain.

What is Composability Squared?

Acala poses the following question:

What does it mean to reconstruct the DeFi stack within a single customizable blockchain and then integrate it with the existing multi-chain ecosystem?

Acala has three foundational concepts:

(1) Acala reconstructs the DeFi stack on the protocol layer of a customizable blockchain.

(2) These primitives enjoy Acala's native composability.

(3) Based on Acala's composability, they inherit Polkadot's multi-chain composability.

We summarize Acala's argument as "Composability Squared" (Composability²). DeFi primitives not only enjoy the benefits of a native single blockchain (Acala Hub), but they also communicate using the same language with every parachain and dApp on Polkadot. Acala is the combination of native composability for DeFi applications and native multi-chain composability for Polkadot.

Developers typically build new primitives brick by brick. They try to figure out how their primitives communicate with other applications on the same chain. Then, they piece together a way for protocols to communicate with applications on other chains. Acala starts from this end state.

It enhances DeFi's composability by combining singularity and customizability with native interoperability. This unlocks applications that would be impossible to achieve in a fragmented environment. Ken Seiff from Blockchange Ventures summarized this positioning at a recent panel:

"The question Acala poses is: Is this a product or a feature? For previous DeFi protocols, it was a feature rather than a product, and when you put them together, those are the products. This is a very clever team that has built a single product that can do many things that don't need to be done across different products, so I guess this will become the model of the future. Other DeFi projects may have to catch up because if you are not designed from the ground up, it is harder to catch up."**

So far, we have described Acala's overall vision. The remainder of this article will delve deeper into the project's three main focuses.

1. Polkadot's DeFi Hub

Polkadot is built on the idea of a heterogeneous multi-chain world, a consensus mechanism that connects all blockchains. Parachains and dApps inherit seamless cross-communication through the XCM format. This eliminates the need for trusted bridges. Each parachain is "application-specific," acting as its own L1 within the Polkadot network.

Acala is trying to become the DeFi hub of Polkadot. They provide a coalition of financial primitives that are natively integrated with the broader ecosystem. These primitives not only enjoy the advantages of the entire stack on Acala, but they also inherently possess the ability to communicate with all other parachains and applications on Polkadot.

The Acala DeFi hub has three main units:

Stablecoin Network—Acala's foundational product is a centralized stablecoin. The Acala Dollar stablecoin (aUSD) is backed by multiple collateral types and pegged to the US dollar. It is produced or minted through the Honzon protocol, a dynamic CDP mechanism inspired by MakerDAO, where users deposit assets as collateral for on-chain governance.

Collateral can be native Polkadot assets like DOT or assets like BTC and ETH that can be bridged to Polkadot.

Liquid Staking—As projects successfully bid for parachain slots, they lock up DOT. This supports Polkadot's security model but also creates opportunity costs. It introduces the risk that if DeFi yields exceed staking yields, DOT may migrate from the parachain, ultimately reducing network security.

One of Acala's products is a primitive for collateralized derivatives. The HOMA protocol addresses the liquidity shortage of staked assets by introducing L-DOT. L-DOT unlocks locked DOT collateral and allows users to participate in DeFi and parachain auctions. For example, L-DOT can be used as collateral for aUSD.

Native DEX—Acala DEX is a fixed product AMM capable of swapping between any Polkadot native or bridged assets while providing more yield opportunities.

2. Application-Specific Customizability

DeFi appears within the realm of general-purpose computing. On Ethereum, developers can only customize applications at the smart contract level (i.e., application layer).

On Acala, developers can optimize the core blockchain logic of DeFi. Primitives can be adjusted and customized in ways that cannot be accomplished within a general framework. For example, any token such as ACA, DOT, aUSD, or WETH and WBTC (often referred to as economic abstraction/economic extraction) can be used to pay gas fees. This enhances user onboarding and liquidity.

Acala's long-term vision is for any developer to leverage this native customizability. Their EVM+ environment optimizes the EVM compatibility of Substrate. Ethereum dApps can deploy on Acala using EVM+. These applications, constrained by Ethereum, can leverage Acala's customizations to innovate beyond the limitations of EVM.

Unique features of Acala DeFi include:

Native Automated UX: Acala supports native automated trading and smart contract calls

--- An on-chain scheduler that supports use cases like recurring payments and subscriptions.

--- During liquidity crises, protocols can automatically liquidate without requiring administrator guarantees of solvency, either at a single asset or global level.

Transaction Hierarchy: Acala prioritizes different types of transactions to enforce orders

--- Different transaction types can be whitelisted and prioritized, such as oracle price feeds. Thus, price updates can occur quickly, preventing liquidation cascades.

--- Liquidation transactions are prioritized over other types of transactions. Liquidation transactions are considered "first priority." They are always favored over general transactions to ensure timely liquidation.

Built-in Upgradability: Acala supports non-fork upgrades

--- Developers can add chain-level upgrades required for their dApps by leveraging Acala's non-fork upgrades with Substrate. This means Acala can be seamlessly updated simply by pushing code on-chain, without the threat of consensus forks.

3. Hybrid Finance

DeFi has developed rapidly over the past few years but has yet to penetrate the mainstream market. As part of its market entry, Acala aims to become the DeFi backend for existing fintech companies. Acala calls this hybrid finance: any Neobank should be able to connect to the network and offer DeFi products to its customers.

An example of this strategy is Acala's integration with the fintech savings app Current. They are a neobank aiming to bring DeFi to 3 million users in the United States. The Current integration could serve as a testing ground for the future: users interact with high-yield APYs, self-service loans, and liquidity provision—without the complexities of the DeFi user experience.

Investing in "Composability Squared"

As the "Summer of DeFi" and the "L1 Wars" are in full swing, Acala is considering the next phase of composability. It is very interesting that now Acala is live, and we hope to see a vibrant dApp ecosystem launched on top of the blockchain.