Composability Squared: The Acala Thesis

January 27, 2022 Ninor Mansor

Acala is a layer one blockchain customized for DeFi, deployed as a Parachain on the Polkadot network. It is the first blockchain to reimagine the entire DeFi stack with a natively multi-chain environment. The project secured the first Parachain slot in December 2021, with the community contributing over 32 million DOT tokens, then equivalent to ~$1.3b USD.

We met the team in early 2020. One thing that stands out is how consistently they have been ahead of their time. Ethereum DeFi exploded in 2020. It evolved into the L1 wars in 2021. In both cases, DeFi was reactionary. Whether it was Ethereum or the L1s, composability adapted to the constraints of generalized computing platforms.

Early on, the Acala team tried to imagine DeFi’s “end-state”. As it happens, the market is now converging on concepts Acala has been building on for years. DeFi should be multi-chain, application-specific and highly customizable. DeFi should be natively intertwined with the protocol layer.

There are now DeFi-specific chains — like Vega’s L1 for derivatives. There are projects like C3 which start with the assumption that building a single hub has unique benefits for composability and cross-margining. There is an ongoing rush of chain-agnostic DeFi protocols centered on cross-chain interoperability.

Acala was early to these ideas. They had the advantage of building while the dust around them was still settling. They were able to take lessons from DeFi experimentation and consolidate these into a single blockchain.

What Is Composability Squared?

Acala asks the following question:

What would it mean to rebuild the DeFi stack within a single customizable blockchain, and to then marry this hub with a natively multi-chain ecosystem? 

There are three ideas underpinning Acala:

(1) Acala rebuilds the DeFi stack on the protocol layer on a customizable blockchain
(2) These primitives enjoy Acala’s native composability
(3) On top of Acala composability, they inherit Polkadot’s multi-chain composability.  

We summarize our Acala thesis as “composability squared”. Not only do DeFi primitives enjoy the benefit of living on a single blockchain (the Acala Hub), they are born speaking the same language as every Parachains and dApp on Polkadot. Acala is the marriage of a DeFi app-chain’s native composability and Polkadot’s native multi-chain composability.

Developers usually build a new primitive brick-by-brick. They try to figure out how their primitive can talk to other applications on the same chain. They then patch together a way for their protocol to talk to applications on other chains. Acala starts with this end-state. It compounds DeFi composability by merging a single, customizable hub with native interoperability. This unlocks applications that are impossible in a fragmented environment. Ken Seiff from Blockchange Ventures summarized this positioning on a recent panel:

“The question that Acala asked that nobody has asked up until now was ‘is this a product or a feature?’. For the prior DeFi protocols, they were features not the product, and when you put them all together, that’s the product. It’s a really smart team that built a single product that can do an awful lot of things that don’t need to be done in disparate products, so my guess is that this is going to become the model for the future. And other DeFi projects may have to play catch up and if you’re not designed from the ground up it may be hard to play catch up.”

We have so far described the big picture vision for Acala. The rest of this article will go into greater detail and describe three major focuses for the project.

1. The DeFi Hub Of Polkadot

Polkadot is built on the idea of a heterogeneous multi-chain world with 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’, functioning as its own L1 within the Polkadot network.

Acala is trying to be Polkadot’s DeFi hub. They offer a consortium of financial primitives that natively integrate with the wider ecosystem. Not only will these primitives enjoy the advantage of the entire stack living on Acala, they are born with an innate ability to speak to every other Parachain and application on Polkadot.

There are three major building blocks to the Acala DeFi hub:

Stablecoin Network — Acala’s foundational product is a decentralized stablecoin. The Acala Dollar stablecoin (aUSD) is multi-collateral-backed and pegged to the USD. It is produced or minted via the Honzon Protocol, a MakerDAO inspired dynamic CDP mechanism where users deposit assets as collateral with on-chain governance.

Collateral can be native Polkadot assets such as DOT, but also assets like BTC and ETH that can be bridged into Polkadot.

Liquid Staking — As projects successfully bid for Parachains slots, they lock up DOT. This underpins Polkadot’s security model, but it also creates opportunity cost. It introduces the following risk: if DeFi yields outpace staking yields, DOT could migrate away from Parachains and ultimately reduce network security.

One of Acala’s products is a primitive for staking derivatives. The HOMA Protocol addresses the  illiquidity of staked assets by introducing L-DOT. L-DOT unlocks locked DOT collateral and allows users to participate in DeFi and Parachain auctions. L-DOT could (for instance) be used as collateral for aUSD.

Native DEX — The Acala DEX is a constant product AMM that enables swaps between any Polkadot native or bridged asset whilst providing further opportunities for yield.

2. Application Specific Customizability

DeFi emerged in the confines of generalized computing. On Ethereum, developers can only customize applications at the smart contract level — the application layer. 

On Acala, developers can optimize core blockchain logic for DeFi. Primitives can be tweaked and tailored in a way that can’t be done in a generalized framework. For instance, gas fees can be paid with any token such as ACA, DOT, aUSD or WETH and WBTC (often referred to as economic abstraction). This improves user onboarding and liquidity. 

Acala’s long term vision is that any developer could leverage this native customizability. Their EVM+ environment optimizes EVM-compatibility for Substrate. Ethereum dApps can use EVM+ to deploy on Acala. Constrained on Ethereum, these applications can leverage Acala’s customizations to innovate beyond the constraints of the EVM.

Distinct features of Acala DeFi include:

Native automated UX: Acala enables native automated transactions and smart contract calls

— An on-chain automatic scheduler that enables use-cases like recurring payments and subscriptions.

— Automatic liquidations at a single asset or global level without the need for keepers to guarantee protocol solvency during liquidity crises.

Transaction hierarchy: Acala prioritizes different types of transactions to enforce order

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

— Prioritizing liquidation transactions over other types of transactions. Liquidation transactions are treated as first class citizens. They are always favored over generic transactions to ensure timely liquidation.

Built-in upgradability: Acala enables forkless upgrades

— Chain-level upgrades that developers need for their dApps that can be added with Substrate by leveraging Acala’s forkless upgrades. This means that updates to Acala can occur seamlessly just by pushing code on-chain, with no threat of consensus forks.

3. Hybrid Finance

DeFi has grown tremendously in the past few years but is still yet to penetrate the mainstream market. As part of its go-to-market, Acala wants to become the DeFi backend for existing fintechs. Acala calls this Hybrid Finance: any Neobank should be able to plug into the network and offer DeFi products to their customers.

One example of this strategy is Acala’s integration with Current, a FinTech savings app. They are a Neobank that intends to bring DeFi to 3 million US-based users. The Current integration could be a testing ground for what is to come: users interfacing with high interest APY, self-serviced loans and liquidity provision — without the complexities of DeFi’s UX.

Investing In Composability Squared

While DeFi summer and the L1 wars raged on, Acala was thinking through the next phase of composability. Now for the fun part: now that Acala is live, we expect to see a vibrant ecosystem of dApps launched on top of the blockchain.

We are excited to invest in these new projects. We have already committed to one, and are excited to see how developers take advantage of Acala’s customizability to create new dApps and DeFi use cases. If you are a developer building an application on Acala, we want to meet you.