Bounded Liquidity Minting Proposal
Currently, SILK is overpeg by ~2.37%. This premium significantly impacts the trading experience of ShadeSwap due to SILK being the de facto routing pair. Additionally, this makes lending a less lucrative product because if I sell SILK (borrowed from ShadeLend) for another asset, when I return to pay back my SILK loan there may even be a larger premium.
I would propose that we engage in bounded liquidity minting which is the process of programmatically minting SILK, selling it into LP pools to bring SILK back to peg, and then solidifying liquidity at the correct peg price point.
Example:
SILK target peg is $1.05 with the open market trading at $1.075. To resolve this, the protocol could mint out 274,500 SILK and sell this for USDC on the SILK/USDC pool. This sale of SILK would result in 288,278 USDC received by the ShadeDAO. Next, the protocol would mint out 274,550 SILK which is paired with the 288,278 USDC as SILK/USDC liquidity at the correct peg price point.
Net result:
(1) USDC/SILK pool at $1.05
(2) An additional $576k in TVL at the correct target peg
It would be advisable to also do this for the SILK/USDT pool. To resolve this pool’s imbalance, the protocol could mint out 232,000 SILK and sell this for USDT on the SILK/USDT pool. This sale of SILK would result in 243,806 USDT received by the ShadeDAO. Next, the protocol would mint out 232,196 SILK which is paired with the 243,806 USDT as SILK/USDT liquidity at the correct peg price point.
Net result:
(1) USDT/SILK pool at $1.05
(2) An additional $487,611 in TVL at the correct target peg.
From here, arbers would be able to arb between the primary SILK StableSwap pools and the rest of ShadeSwap - bringing the peg back into alignment across all pools.
Collateralization
| Total Collateral | Total Silk | LTV | |
|---|---|---|---|
| $5.97M | 2.8M | 201.69% | Current collateralization |
| $5.97M - IL | 3.8M | 148.37% | Assumes 1M SILK minted has 0 backing. |
| $6.5M - IL | 3.8M | 161.59% | Assume collateralization from stables purchased with bounded mint |
| $6.98M - IL | 3.8M | 173.55% | Assume 100% collateralization due to SILK only existing when being purchased with USDC from the LP pools. |
There is 3 different ways to view SILK minted through bounded minting:
- No backing
- Partial backing (from stables purchased with the minted SILK)
- 100% backing - IL (acknowledges all SILK going into circulation has at least 100% backing at inception minus impermanence loss experienced overtime with SILK volatility).
You can see here that even if you assume every bounded minted SILK has 0 collateral backing, SILK remains overcollateralized at 148% via Shade Lend - maintaining the ability of SILK to maintain its promise of stability. However, the final option (173.55% LTV - IL) is the most accurate representation of what is happening with assets & liabilities. This model is used by FRAX with their AMOs and is a tried and trued model. Let me describe this below:
| Assets | Liabilities |
|---|---|
| USDC received from selling initial SILK mint | Minted SILK sold into LP pool for USDC |
| USDC received every time a SILK is purchased from an LP pool with bounded liquidity minting | SILK pulled out of LP pool anytime USDC is deposited |
The primary problem with this model is that SILK & USD stablecoins are tracking different pegs. This means that impermanence loss accrued results in either a larger “asset” position or a larger “liability” position. However, when looking at the numbers the potential IL is quite bounded.
With ~1M in SILK minted, sold, and converted into LP these are the types of bad debt risks we are looking at:
In effect, the ShadeDAO would be short USD against the assets in the basket. SILK was designed to have volatility that is +/- ~$0.02 annually. Even with a black swan global event that makes the dollar significantly less valuable, even a $0.04 - $0.06 swing upwards in SILK vs USD remains reasonable to manage. In the event of global crisis where the USD vastly depreciates against the SILK basket, the ShadeDAO Will have incurred somewhere between -$20k to -$30k of bad debt. This can be readily handled via Shade Protocol fee streams + use of SHD to cover this shortfall. In the event that USD appreciates against the basket, Shade Protocol could be profitable with $20k - $30k with excess USDC/USDT accrued in the LP pool.
In summary, for the potential IL cost of $5k - $30k over the course of 2-3 years we can safely return SILK back to peg in the present moment which vastly improves the ShadeSwap, ShadeLend, & SILK adoption/experience. Ironically, in the event of this IL SILK will be doing its job and probably be even more popular due to its hedging properties against the dollar.
Going to be continually adding edits as thoughts come up, would love to get everyone’s thoughts on this.