Recent news of Tornado Cash being sanctioned by the U.S. Treasury and Circle freezing USDC in addresses belonging to Tornado Cash users has been the talk of the town. And this event has underscored the censorship risk associated with centralized stablecoins as well as the inevitability of stricter regulation. This development reinforces the thesis for decentralized stablecoins — a need that is more pressing than ever.

In a recent stablecoin piece, we wrote that some of the most prominent “decentralized” stables are in fact masking a large centralized stable collateral backing, causing them to inherit the risk of the centralized collateral. In this report, we explore an alternative form of crypto native money: RAI, a non-pegged stablecoin by Reflexer Finance that is backed purely by ETH.

Reflexer can be difficult to wrap your head around at first due to the sheer number of market driven, second-order effects that offset each other. So bear with us as we dig through the mechanics.

How RAI Works

A simplistic way to think about RAI is to see it as similar to Single Collateral DAI (SAI), where users deposit ETH as collateral and mint the corresponding stablecoin. A key difference is that while SAI was pegged to $1, RAI’s target price (or redemption price) is not bound to an external reference price like the US dollar. In short, RAI doesn’t perpetually target an explicit price.

Instead, it has a floating peg that changes according to market forces. When the price on secondary markets (i.e. market price) is the same as the redemption price, the system is in equilibrium. Otherwise, the protocol sets a redemption rate to counter price moves and incentivize market participants to return RAI’s market price to the redemption price. In the scenarios below, we describe how the protocol responds to a state of “disequilibrium.”

To really understand this, we need to consider