I can argue that the elasticity of the peg can actually be beneficial for the protocol as it provides an opportunity to develop a secondary market for volatility / range trading. In essence an over-peg means that the market incentivizes minting while a de-peg incentivizes the repaying of loans.
Whether any mint is done via stables or volatiles at any point of the depeg or overpeg is in itself an issue for market participants to decide and that is where the secondary market can be constructed.
A fairly straight-forward vault design that comes to mind goes as follows:
A = asset - volatile or stable underlying collateral
- Xd/Xo% = SILK de-peg/over-peg targets
- Rd/Ro% = max % exposure of SILK / A during de-peg / over-peg scenarios
These form the range trading parameters ^
- LP parameter - use the collateral held to LP into any LP pool
This increases potential rewards at the risk of incurring Impermanent loss ^
Steps in action
- Deposit A = volatiles or stables → Sell 1/2 Volatile for stables OR Buy 1/2 Volatile using stables → Both scenarios end up with 1/2 Volatile and 1/2 Stables → Mint SILK at some safe ratio from both piles and LP (as discussed different options for LP might be presented - SILK-SHD / SILK-stables / SILK-volatiles, etc.) So far this strategy reward will equal the following:
(chosen LP reward %) * [ 1/2 * (volatile asset LTV%) + 1/2 * (stable asset LTV%) ]
> example: we deploy into stkdSCRT vVault (volatility vault) to farm stkdSCRT/SILK at 40% / 70% initial LTV's during perfect peg.
3% peg range.
Vault would use 1/2 USDC to buy stkdSCRT to mint SILK at 40% LTV and will use 1/2 USDC to mint SILK at 70% LTV.
Vault would LP all SILK into the 28% APY stkdSCRT/SILK.
The total APY would be (1/2 * 0.4 + 0.7 * 1/2) * 28% = 15.4%.
We incur no borrow fee by minting as the peg is perfect.
- De-peg target reached → Vault pulls out LP funds, buys SILK at a premium → Repays SILK = Exponentially converts LP rewards at an exponential premium to a reduced risk of volatile liquidation (because of likely collateral de-valution associated with a depeg) and reduces the borrow fee on the stable vault mint (*)
> example: during a 3% de-peg vault will pull out all LP funds into SILK with a premium.
Repay SILK in the stable mint and reduce the stable borrow position to target exposure - reduces the incurred borrow fee.
Use the freed up stable collateral to buy the suspected devalued volatile and bring the volatile LTV to a safe ratio.
Essentially at this point part of our stable position is converted to volatile during suspected peak bearish conditions depending on the Rd%.
Finally, mint SILK (at a possibly lower rate) since more of our position is in volatiles that we expect to rise in value.
Since 55% of our initial capital was used to LP, we only capture 3% * 0.55 in premiums = 1.65%
As per the vault parameters we also use the de-peg conditions as an indicator for going into volatiles (100% target exposure at 3% de-peg).
We have 100% stkdSCRT which we use to mint SILK at 0.4% rate and deploy it in LP
Our APY is now 0.4 * 28% = 11.2% during the de-peg conditions with an additional 1.65% in the bag from premiums and we are also 100% exposed to the devalued stkdSCRT.
- Over-peg scenario → pull out LP into
X% stables (ranged target) and mint SILK → Sell that SILK at a premium and LP back = We essentially convert LP rewards during over-peg conditions into a premium and going into higher stables exposure
Similar to the under-peg scenario but instead we go X% into stables at a premium.
Note: If you deposit into vault during over-peg or under-peg the deposit step will convert to a different ratio of stables/volatiles.
The vault would have to manage the borrow / selling of assets in order to maintain a target ranged ratio for each peg step. As such the vault also provides a strategy for ranged trading on a volatile pair with the added benefit of stabilizing the SILK peg and bagging some extra SILK peg premiums.
The strategy basically trades on the assumption that an underpeg means peak bearish conditions and starvation for collateral to bid up SILK, while an overpeg means peak bullish conditions, excess of collateral which bids up SILK and provides a market for range trading that also stabilizes the SILK peg.
As such the elasticity of the peg is used to fund range trading incentives and provide opportunity for traders.
The borrow fee on stables / volatiles can become the reward function during under-peg / over-peg conditions so users are incentivized to deploy capital to bring back the peg. As such the borrow fee matches acts as a kind of funding-rate on holding a short on SILK and is distributed in ranges depending on the size of the user short. The tighter your range matches the actual range of the de-peg the less borrow fee you would incur and the more profitable that strategy would be.
The extra step of using volatiles to fund such vault position is just a consideration by the respective bullishness of each market participant to that volatile.
The final parameter of where to deploy LP is also a market participant consideration and would further optimize the strategy based on user preferences.
- The safest SILK peg vault (volatility vault) is providing and lp-ing stables into high peg ranges and thus be exposed to SILK and stables only and only be exposed to SILK volatility and peg elasticity risk in a high-range.
- the most risky SILK peg vault would be providing the most volatile asset and lp-ing into the most high APY range with a tight SILK peg range. You would be highly exposed to SILK peg volatility and highly exposed to the intrinsic volatile asset volatility that might be associated with it.
This is just some quick thoughts and there was no in-depth analysis on the mechanics and/or implementation. The main point is to give people the opportunity to benefit from SILK peg fluctuations and thus strengthen the peg in a marketable way instead of fixing the market either by treasury intervention. Obviously one of the main drivers for this strategy is a borrow fee that the strategy avoids. This DOES position the borrow fee as a main mechanic which CAN be difficult to explain and market but the theory stands.