The US dollar used to be backed by gold because gold is a resilient asset. Gold does not devaluate easily. Luna, on the other hand, became a weak asset because there is no limit for its dillution.
When a currency is backed by a weak asset, it has the systemic risk of being devalued along with its backing. This proposal aim at fixing this, by preventing the death spiral from ever happening again to Luna.
The death spiral is when the algorithm drives the price down without ever letting it go back up. In other words, it locks the price trajectory in a single direction. To fix this, we must ensure that the price is allowed to reverse its course. And there is a way to do this.
Luna’s death spiral taught us that when UST depegs by a substantial amount, Luna’s price falls much faster than the UST price because there aren’t enough buyers for the amount of Luna that needs to be minted in order to restore the UST peg. So, we must limit the minting of new Luna to prevent a price crash, but we must limit it in a way that still allows for UST to recover its peg.
The way to do this is by taking the speed of the price movement in consideration. To ensure that Luna is a strong asset, its price must not fall faster than the price of UST.
Let’s say that the price of UST is falling 10%, and the price of Luna is falling 5%. The amount of new Luna minted must not surpass the minimum amount that would make the fall of Luna’s price surpass the fall of UST price.
In this case, let’s say that enough Luna is minted to reduce the fall of UST to 7.5%, while increasing the fall of Luna to 7.5%. At this point, no new Luna should be minted.
Afterwards, if the price of UST keeps recovering while the price of Luna stays at the 7.5% loss, nothing else should be done until UST fully recovers its peg. Luna holders will have to wait until UST become overvalued (above $1) for Luna to be burned.
The core of the idea is that while the interaction between UST and Luna is a closed system, the interactions between UST & USD and Luna & USD are an open system that can’t be fully controlled by the algorithm. It’s inevitable that the US Dollar price of both UST and Luna can fall at the same time. So, what the algorithm can do is to direct the flow of USD between UST and Luna to make UST as stable as possible (which doesn’t mean 100% stable) while never unbalancing the value of Luna.
The more resilient Luna becomes, the better it can back UST. This proposal ensures that Luna will never be weaker than UST on the way down, while UST will always have a stronger price recovery.