SILK price depeg/overpeg module

Shade's Products
1

Abstract:
Currently the SILK peg is approximately 3% below the target price, so I think it is important to consider measures and create safe but at least somewhat effective mechanisms to flatten the SILK peg to its target.

This thread serves primarily as a reference to Bounded Liquidity Mi…

Depeg:

  1. SILK buybacks
    The first solution may be to buyback SILK instead of SHD if it falls below its peg ( say by more than 1% )
    The current problem is that the Shade team is selling ( if I am not mistaken ) SILK which they get from the swap fee to SHD, which may partially distort the SILK price.
    Introducing SILK buybacks could also incentivise SHD stakers to use SILK/ or send SILK to the community threasury and sell it in an eventual overpeg.

  2. SILK LSD ( dSILK? ) / SILK earn remake
    I have already suggested SILK LSD several times here, it would be a token that would deposit SILK into “Earn” and automatically swap all liquidations into SILK, such a token would not need liquidity on the main DEX ( (un)bond can be instant ), this:
    -Can increase the attractiveness of SILK due to possible expansion outside of Secret
    -Can stabilize the price of SILK by increasing the demand for SILK at the time of liquidations

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    Another possible option could be to introduce automatic collect to SILK directly in “Earn”
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  3. Incentivizing orderbook SILK liquidity
    Personally I am not going to discuss this path, I know that Carter and Shade team are doing research/working on this area, I will comment on it once I see the result

Overpeg:

  1. Vault taxes
    Now, I’m going to primarily refer to: Bounded Liquidity Mi…
    Carter suggested to “print” the uncovered SILK and buy, for example, USDC against it and work with it further, this does not seem to me to be an ideal solution, mainly because of the potential problem with the potential growth of SILK and the potential uncovered SILK by the Shade team.
    As an alternative, I propose to introduce a tax on USDT and USDC vaults in the form: % overpeg /2 = % tax
    The tax would be applied to SILK ( i.e. the lender would be raising debt ) which would automatically add to Shade’s coffers, so Shade could sell the covered SILK to bring the price back to target without compromising his collateral in any way.

  2. Selling already accumulated SILK ( as I mentioned in "depeg 1. )

If there are any questions I will be happy to answer them, now we can move on and start discussion :slight_smile:

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2

what about simply using bonds for what they’re meant to be like explained in this video?

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Yes, that would be one way, but in any case it is a way that will create inflation, which should not be our goal.

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Let’s think about what does an under-peg means.
It just means people who have minted SILK against their volatile collateral, have now sold that SILK on the open market - usually for stables. That marks ultra-bearish conditions where people are willing to potentially give up their collateral in order to hold “hard stables”. It is both a short on SILK and a short on their collateral. I am assuming people who have minted SILK against stables are not part of that cohort and would NOT sell their SILK for stables as they would rather repay their SILK to get back larger % of their stables.

So given that people have shorted the entire market through minting SILK and then selling it, it makes sense to incentivize people to take the opposite side of that trade.

Thankfully the design of the protocol provides the basis for such a mechanic, but those mechanics can be further improved.

Let’s start from the basics:

One obvious way for each individual volatile minter to benefit from the under-peg is to sell part of their volatile collateral (that now has an increased effective health because of SILK being cheap on the market) and repay their position. They effectively sell their collateral for a 3% (when depeg is 3%) premium above the market price. They are effectively repaying their loan when SILK is being the cheapest - increasing their health in peak bearish times = good for them.

Things to note:

  1. While those secondary sellers of volatiles are effectively contributing to the short market conditions introduced by the de-peggers, they are ALSO recovering the peg and as such are disincentivizing the de-peggers to continue shorting SILK against stables. The primary shorters see the depeg conditions recover AND their volatile mint positions get in poorer health and see that they will need to get back into SILK at higher prices to avoid liquidations.
  2. The secondary shorters who sold part of their volatile collateral during peak bearish conditions can encounter 2 scenarios - either the price of their volatile begins to recover BACK in which case they would need to mint SILK back and use it to buy back and recover their volatile exposure. Thus they contribute back to the depeg (losing on some swapping fees). The other option is for the price of their volatiles to go back more - this is the best scenario and they have hedged against it with a good premium.
  3. So, now the game becomes an economic battle between the primary shorters who are ready to be liquidated by the short market conditions and the secondary shorters who maintain healthy mint positions with a 3% premium. One more thing to note is that the primary shorters are always ready to deploy their stables to mint SILK. Another analysis is needed for bringing a higher tax for minting SILK using stables in depeg conditions this thread. Long story short - such bearish conditions would usually correspond to stables being a big part of the backing of SILK - low volatile assets price vs stables - and thus SILK having an increased centralized risk.

Now back to disincentivizing minting and selling of SILK is a borrow fee. This way those who lack SILK will faster reach a point of liquidation, while those who reduce their position will pay less in terms of fees because of the premium they receive for reducing their exposure. So the borrow fee would essentially need to increase with the furthering of depeg conditions. It will act as a catallizer for faster liquidations during depeg periods. It will also punish minters in general which has to be evaluated.
One thing to note is that the borrow fee should be such that it slowly liquidates a position back into SILK and thus brings the peg up.
This process in turn will also reduce the borrow fee back to a 0 peg.
Having such dynamic borrow fee is extremely important for a monetary protocol to be healthy – the borrow fee should INCREASE when market conditions are tough in order for borrowers to reduce their risk

In summary - a combination of a dynamic borrow fee which increases with a SILK de-peg AND a dynamic minting fee via stables in peak bearish conditions would reduce both the depeg conditions and the risk of SILK being backed primarily by stables.

However let’s do the due diligence and analyze the counterpoint. What if market conditions deteriorate further - volatile assets drop further, SILK continues to lose peg and borrow fee increases. What would that mean for SILK? Let’s analyze each one by one:

  1. Volatile assets dropping further means that the secondary shorters and the primary shorters are both winning. What the protocol needs to ensure is that the primary shorters are paying a premium for being out of SILK in a depeg conditions. This is where the borrowing fee would come into play. It would slowly increase the SILK being owed by the primary shorters who lack SILK to repay their positions. Furthermore, in such conditions the stable part of the backing of SILK would increase in proportion to the volatile one. This would entail a bigger tax to be incurred (or even entirely blocking) a stable minting of SILK. This way the primary shorters can only buy SILK via their stables and not mint it.
  2. The borrowing fee would increase. That means that everyone on the platform is incentivized to reduce their exposure to SILK. Those who should be the most incentivized are those who have minted SILK using volatiles as their positions are becoming the most at risk. They can afford selling some portion of their volatiles and reduce their risk by a larger margin because SILK is trading below peg. They would incur less penalty from the borrowing fee increase because they have decreased their mint position.

The question in such a mechanic is how to design the borrowing fee mechanism, i.e how do you fairly put a fee on holding a SILK mint position in de-peg conditions?
The second question is of course - how much do you want to punish SILK minters via borrow fee in order to incentivize healthy behavior during depeg and disincentivize shorting during depeg. How much do minters want to pay for the disincentive mechanism for punishing depeggers (bad minters)?

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Thanks for the summary, anyway I guess I don’t see the only way to achieve punishing “bad minters”, anyway the way definitely seems to be the introduction of the Tax on stablecoin vaults which solves both problems.

Overpeg → SILK collected from fees can be sold on the open market and converted to another asset which will stabilize the SILK price and create more money in the treasury

Depeg → Leaving SILK in the treasury will increase the debt/liquid SILK ratio (more SILK will need to be bought than was deposited when the loan is repaid), SILK left in the treasury can be sold in a possible overpeg in the future.

Alternatively, SILK earned at Depeg can be used for Earn incentives, reducing the SHD emission to Earn, i.e. “good minters” remain protected because they can put their SILK into Earn and get tax back

Tax can be calculated, for example, based on data from Shade Swap pools

  • you can add Tax limits and divide by two, so that the tax really only solves problems and not minor spikes.

Exemple:

tax = depeg / 2 

if tax > 0,25%:
      tax = 0%

elif tax > 2%:
      tax = 2%
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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:

Parameters:
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

  1. 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.
  1. 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.
  1. 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.

Some examples:

  1. 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.
  2. 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.

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To resolve a peg disparity there are two options:

Reduce circulating supply of SILK OR increase demand for SILK. The problem with any option that is tied to increasing demand for SILK is that someone can come in and mint more SILK to then chase this opportunity. They end up expanding supply instead of transforming the demand into buy pressure on SILK.

As such, I would propose the following potential experiments:

Supply Freeze, Demand Stimulation
Increase the borrow fee on all vaults to 100%. This means, no new SILK can be minted. Next, we increase the rewards on the SILK earn vault and/or the SILK/USDC pool. What this ends up stimulating in that the only way to chase the opportunity is to buy SILK - thus shifting SILK back to peg.

Supply Discouragement, Payback Encouragement
Add a borrow fee & add an interest fee on all vaults.

Supply Discouragement, Payback Encourage, Demand Stimulation
Add a borrow fee & add an interest fee on all vaults. Additionally, add additional incentives to stableswap pool.

Payback Encourage
Add in just an interest fee and see how market reacts.

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1. Supply freeze, demand stimulation
NO, by restricting minting you would cut a main feature of ShadeSwap without changing mint situation that brought the short on the peg. I can go into more details if needed but I think it would do more damage.

2. Borrow fee / interest fee on all vaults
see point 1. Borrow fee is bad.

3. Supply Discouragement, Payback Encourage, Demand Stimulation.

a) Add a borrow fee & add an interest fee on all vaults - see point 2
b) Additionally, add additional incentives to stableswap pool - that makes sense for attracting USDC but we have to think about the composition of the minting. Also we have to see how an increase of rewards would offset some of the borrow fee introduced in the stable vault and that contradicts my point that stable minting should have higher interest during depeg times.

4. Payback Encourage
add an interest fee, with the caveat that during underpeg a borrow fee should be introduced predominantly on “stable” minting . My argument is that during underpeg you want to add a borrow fee only on stable vaults (in an overpeg scenario you want to attract more stable minting and reduce volatile minting). The reason is it would essentially be adding a funding rate to people who are shorting SILK using stables. A liquidation on a stable pool would be basically swapping USDC for SILK. The reason why you do not want to add as high a borrow fee on volatiles as on stables is nuanced and deserves attention. I would argue that adding borrow fee on volatiles would bring sell pressure on volatiles to USDC rather than directly to SILK and that wouldn’t arb the price of SILK. In case an argument is made that shorters would just move from stale to volatile minting, the truth is that shifting that ratio would ultimately reduce the supply of SILK because of volatiles having much lower LTV. If stables ratio shrinks and the borrow fee doesn’t have that much effect we can bring it to volatiles.

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My goal was rather to find a solution that will not negatively affect the price of SHD.

So for example not printing, limiting supply by stopping the mint is just one way, personally I see it as a short term solution that only delays the problem.

What I am proposing now is the introduction of taxes on USDC and USDT.
SILK paid on tax will be transferred to the Shade coffers.

In the future, it might also be interesting to introduce a tax on loans nearing liquidation ( i.e. the higher the LTV ratio you have, the higher the tax will be )

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I’m reopening this thread:

Currently SILK is around 6% below the peg, this threshold is already starting to create not only an unhealthy environment for Silk holders and makes ShadeSwap inefficient where Silk is one of the main liquidity assets ( using stablecoins like USDC/USDT/IST/USK becomes fundamentally less efficient )
But at the same time it can undermine confidence in the Shade Protocol and SHD itself.

For this reason, I suggest:

  1. Temporarily raise taxes in all vaults ( except SCRT and stkd-SCRT ) to 1% until a better plan or automatic tax is created

  2. Raise taxes in USDT and USDC vault to 2%

  3. Redemption of “Minting Closed” vaults

  4. Use POL funds received in exchange for SHD buybacks to convert to SILK and pair with SHD in to LP

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