Out with the old, in with the new
Algorithmic stablecoins started with the revolutionary idea of rebasing, allowing for dynamic contraction and expansion of the total supply of coins, also called elastic supply. For the first time, rebases enabled viable non-collateral backed stablecoin designs. Direct rebasing has two main problems: it’s not composable and it’s confusing to see your wallet balance increase or decrease. The debt-coupon system employed by the most successful next generation of algorithmic stable coins improved upon the rebase mechanic by making rebases driven by market participants. The debt-coupon mechanic created voluntary elastic supply, where market participants were incentivized to contract the token supply. This worked wonderfully for a while, helping many coins to achieve large market caps.
Unfortunately, in mature algorithmic stable coins it has become clear that the coupon-debt mechanic has problems, such as degraded incentives. It is more optimal to buy the token above the peg to participate in supply expansions, then dump all coins immediately after supply expansion rewards while the price is still above the peg. It is suboptimal to buy the token once the price has fallen below the peg. Coupons fail to create upward pressure since it is more optimal to buy coupons once the price re-approaches the peg and not when it deviates away, which is when contraction is most needed.
CDSD is the keystone in DSD V2’s new set of contraction incentives.
CDSD, the next evolution in Algorithmic Stablecoins
DSD V2 eliminates the debt-coupon mechanic. Expansion and contraction cycles remain, but those cycles are now achieved through CDSD. CDSD is an ERC20-compatible token that will be obtainable by burning free-floating DSD for CDSD 1:1. Unlike coupons, CDSD will be freely tradable and transferable without expiry. Users can lock their CDSD into the DAO to receive contraction rewards. Contraction rewards are the replacement for debt and come in the form of newly minted CDSD. CDSD can be redeemed during expansion cycles 1:1 for DSD. Only bonded CDSD can be redeemed. To encourage participants to bond DSD even during contractions, there is a capped 25% APY incentive that pays out in CDSD. This is a 40,000ft overview of CDSD, for all of the details of how CDSD works, see this DIP-10 article.
CDSD encourages a healthy balance of expansion and contraction cycles. Let’s look at how it solves some of the incentive problems mentioned above. Buying DSD above the peg for the expansion benefit is now nonsensical since contraction rewards are given to CDSD staked holders during contraction. Simply put, staked CDSD holders will overwhelmingly benefit from expansion cycles. It is optimal to buy the token below the peg, burn it for CDSD (thus contracting the supply and increasing the price), stake the CDSD, and redeem contraction rewards during the next expansion. Unlike coupons, CDSD creates upward pressure since it is optimal to buy DSD cheaply, burn it 1:1 for CDSD, stake it, collect contraction rewards, and redeem CDSD 1:1 for DSD above the peg. You can then create sell pressure by selling your newly redeemed DSD, starting the cycle anew.