The core mechanics of DSD to maintain the 1$ peg consist of supply expansion during a positive price deviation, and supply contraction during negative price deviation. Similar dynamics are implemented among nearly all algo stable coin designs, yet none of them has demonstrated a sustainable method of maintaining the peg.
This is mainly due to incentives being overly powerful to buy in above the peg to participate in supply expansions, but fairly weak to re-approach the peg once the asset price has fallen below.
Coupons have been proven to be a failed approach to recover the 1$ peg. This is mostly caused by the pricing of the coupon being too static due to the fact that the duration they are held is completely neglected. This incentivises buying coupons once the price re-approaches peg and not when it deviates away, which is when contraction is most needed.
The outcome is that contraction cycles are numerous and protracted. By contrast, expansion cycles are rare and brief. The majority of users are scared away by the complexity of coupon mechanics, so they avoid participation in the debt market. Speculators exert an increasingly strong sell pressure as the price of DSD approaches the peg, making further expansion cycles extremely hard to achieve.
With DIP-10, we introduce a complete revamp of the debt-cycle mechanics and eliminate the current coupon approach
Inspired by perpetual futures funding rates — the mechanism currently proven to work best for pegging one asset to another — we want to take a big leap forward and achieve (near) mechanism symmetry between expansions and contractions.
To this end, we propose to discontinue the current debt and coupon system and replace it with a surrogate set of contraction incentives in the form of DIP-10.
DIP-10 introduces a brand-new ERC20-compatible token to the protocol. This token — which we will name CDSD — will be obtainable by burning free floating DSD. Unlike coupons, CDSD will be freely tradable and transferable without expiry. Most importantly, however, users will be able to lock their CDSD into the DAO to receive contraction rewards.
During contractions, rewards will be capped on a per-account basis at 100% of the DSD amount burned by that account. Buying CDSD from the secondary market will thus not increase the size of contraction rewards but instead help participants to earn their rewards faster. Consequently, in order to maximize contraction rewards, participants will be incentivised to continuously buy and burn more DSD.
When the protocol enters expansions, CDSD are partially redeemable 1:1 for DSD for all CDSD bonders pro-rata to their holdings. This means that when 10% of the “debt” becomes redeemable, all participants will be able redeem 10% of their staked CDSD (instead of 10% of holders redeeming 100% of their earnings).
Additionally, this DIP makes a first step at introducing incentives for bonded DSD, even during contractions. This incentive, which is capped at 20% APY, is intended to encourage participants to stay bonded and engage in governance even during contraction cycles.
In any state:
- As a user who holds free float DSD, I am able to burn DSD for CDSD 1:1
- As a user who holds coupons, I am able to migrate coupons (principal+premium) to CDSD
- As a user who holds CDSD, I am able to bond CDSD to the DAO
When the protocol is in contraction:
- As a user who holds CDSD bonded to the DAO, I receive 95% of contraction rewards (former debt) per epoch
- As a user who holds DSD bonded to the DAO, I receive 5% of contraction rewards per epoch (capped at 0.006% > 20% APY)
- As a user, I am not able to buy coupons anymore (as there is no debt anymore)
- As a user who holds free float or bonded CDSD, I am NOT able to redeem CDSD for DSD
When the protocol is in expansion:
- As a user who holds CDSD bonded to the DAO, I am able to redeem a partial amount of my bonded CDSD for DSD 1:1 per epoch.
- While there are unredeemed CDSD, 50% of expansion rewards get distributed to CDSD stakers, pro-rata, to their holdings, making them redeemable 1:1 to DSD
- As a user who holds free float CDSD, I am NOT able to redeem my CDSD for DSD.
Timeline and progress
The team has already started working on the full technical specifications and implementation. Some implementation details are still being worked out, and we will share the progress and current developments in the #changelog channel in Discord.
The new debt cycle mechanics introduced by DIP-10 are mandatory steps to make DSD the first uncollateralized algo stable coin that is able to sustainably maintain its peg, which is crucial to our mission of becoming a trusted and adopted reserve asset for DeFi.