USTC Repeg and Revitalisation of the Terra Classic Ecosystem through the Implementation of an Algorithmic Peg Divergence Fee & Buyback Protocol, Unidirectional Swaps and USTC Staking
We approach the anniversary of the major depeg event of last May and while we as a community have made great progress in the maintenance and upgrades on our blockchain we have yet to make any progress into repegging USTC and addressing the issues with the AMM algorithm and Terra<>Luna/ Terra<>Terra swaps. The growing tension and agitation in the LUNC community at the lack of progress on this front has been growing increasingly evident and the price of both LUNC and USTC reflects this. While there have been a number of proposals discussed and/or put forward for governance vote, all have so far been deemed too risky, have followed paths the community has disagreed with, or haven’t really addressed the underlying flaws.
As CZ has mentioned multiple times, DK had the right idea, I think most of us believe in the vision that a decentralised economy needs decentralised money and wish to continue down this path but, if we are to attempt a repeg we need to understand that there are some serious issues that need to be addressed. While on-chain transactions and swaps can be maintained algorithmically in depeg scenario, without off-chain implementation the mechanism fails as capital controls are no longer effective. To combat this previously we had publicly LFG (Luna Foundation Guard) and not so public Jump Crypto, and we relied on them having enough assets in reserve to defend the peg on the off-chain markets. When these two mechanisms failed, the price of USTC crashed, causing LUNA(LUNC) to mint into oblivion and sending both tokens into a death spiral.
This leaves us in the situation we are today with a massively overinflated LUNC supply and a completely uncollateralised USTC which is down approximately 98% from its pegged price. So, we need to not only reduce the circulating supply of our tokens and recapitalise USTC, we also need to fix the algorithm and find new mechanism for defending the peg BOTH on and off chain. A mechanism that is strong enough to be able to combat both death spirals and market manipulation. The following proposal I believe addresses all of the above issues and does so in a fair and equitable manner for all holders through the implementation of Peg Divergence Fee and Buyback Protocol. This protocol needs to be implemented across all markets where USTC is traded both on and off chain.
The Divergence Protocol
The Divergence Protocol works by charging an algorithmic/dynamic fee equal to the difference in price between the peg and market price. The fee can range anywhere from 0% at peg to 100% fee at a 50% deviation from peg. Basically the greater the difference in price from peg and market price, the more you will be punished and the higher the fee you will pay. In the beginning the fee will be only charged on the seller side not only to disincentivise selling below peg but also to incentivise buying and ensure we always accrue the more desirable asset at the time. The fees then retained by the protocol are used to buyback USTC and maintain the peg. The protocol would be implemented across all USTC trading pairs both on and off chain but NOT on regular blockchain transactions. This means that regular blockchain transactions such as purchasing products or services or sending money between wallets is unaffected. It is important to note that capital controls are only effective if they are applied to all markets. As the majority of our tokens are traded off-chain, it’s imperative that this protocol is also applied to all markets; this includes CEXs and DEXs both on and off chain.
Mathematically how the algorithm works:
For simplicity of the worked examples we will use the USTC/USD trading pair and have a peg of $1 USTC: $1 USD
X = Target Peg Price
Y = Market Price
T = Divergence Fee
Scenario 1: Price is below Peg of $1USD (X>Y)
In this scenario the Seller creates a sell order of $1USTC for $0.95USD, the Buyer pays $0.95USD for the $1USTC, the Seller receives $0.90USD and the protocol receives $0.05USD in divergence fees.
X(Target Peg Price) – Y(Market Price) = T(Divergence Fee)
$1.00 - $0.95 = $0.05
Scenario 2: Price is above Peg of $1USD (X<Y)
(We will not see this activated in the protocol until we are actually at $1USD if at all, this will not feature in the initial stages of the incremental repeg plan)
In this scenario the Seller creates a sell order of $1USTC for $1.10USD, the Buyer pays $1.10USD for the $1UST, the Seller receives $1.00USD and the protocol receives $0.10USD in divergence fees.
Y(Market Price) – X(Target Peg Price) = T(Divergence Fee)
Scenario 3: Price is at Peg of $1USD (X=Y)
In this scenario there is no fee or fee = 0
This is how the protocol will apply the fee in very basic terms. It can be applied to any trading pair in reality whether it be USDT, BTC, PAXOS, ATOM…etc So for the mathematicians among you what will happen in these instances is the oracle will reference the price of the non USTC asset against all markets, then calculate the price of $1USTC worth of these assets and apply the deviation fee accordingly.
For simplicity of this worked example we let USTC have a peg of $1 and BTC has a current market price of $25,000. This means 1USTC = 0.000040BTC or our target peg price is equal to 0.000040BTC at this time.
Scenario 1: Price is below Peg of $1USD(X>Y)
In this scenario the Seller creates a sell order of $1USTC for 0.000036BTC, the Buyer pays 0.000036BTC for the $1USTC, the Seller receives 0.000032BTC and the protocol receives 0.000004BTC in divergence fees.
X(Target Peg Price) – Y(Market Price) = T(Divergence Fee)
0.000040BTC - 0.000036BTC = 0.00004BTC
Scenario 2: Price is above Peg of $1USD(X<Y)
In this scenario the Seller creates a sell order of $1USTC for 0.000044BTC, the Buyer pays 0.000044BTC for the $1USTC, the Seller receives $0.000040BTC and the protocol receives 0.000004BTC in divergence fees.
Y(Market Price) – X(Target Peg Price) = T(Divergence Fee)
0.000044BTC – 0.000040BTC = 0.000004BTC
The above examples demonstrate how the Divergence fee aspect of the protocol works and we can see how we always accumulate the more desirable asset at the time. So we would be building a basket of different currencies as collateral to back USTC. For example if we open a trading pair against BTC and Paxos for instance we will be partially backing USTC with BTC and gold. Having a basket of currencies which consist of both fiat backed stables and crypto tokens is a much better strategy for us in terms of risk management.
Now that we’ve began to accumulate assets we need to use those assets to defend the peg by buying back USTC. The buybacks will be completely automatic. For me to design a buyback strategy I would need access to spot orderbook data, failing this we will need to hire a quant to assist us in creating one. The great thing about us coupling the tax with the divergence fee is that it means we as a community are buying back assets at a fraction of the cost. For example, a severe depeg event where USTC was pegged to one dollar but traded at $0.60. In this scenario the Seller would only receive $0.20 and the protocol would receive $0.40 in taxes. The real cost to the protocol is what the Seller receives which is $0.20. The reason for this is the divergence fees are accrued by the protocol anyway when it’s the buyer so when we buy, the fees return immediately. This means that for every one external buy of 1USTC on the market, the protocol accrues enough in taxes to buyback 2USTC. This is a much stronger defence mechanism than we had before and is buying back USTC for the community at a fraction of market price.
Following buy backs we will start to accumulate USTC, this is essentially profit held by the protocol. The community owns these assets. Rather than just burn it to reduce supply, I suggest using it a bit more effectively. The USTC accumulated by the protocol will be distributed for the following purposes in the following percentages to both rejuvenate the ecosystem and lock more tokens out of circulating supply.
Unidirectional Limited LUNC>>USTC Swap Pool – 47.5%
45% of USTC funds will be sent to a new liquidity pool. This pool will open above peg and allow one-way LUNC to USTC swaps for a profit. Swaps will be limited to the supply of protocol owned USTC, if the supply runs out – the pool shuts. When the price falls below peg again the pool will shut. This allows a limited arbitrage opportunity to occur where the community can profit from maintaining peg. The LUNC acquired through the swaps could be either burnt or staked by the protocol to take it out of circulation. This arbitrage opportunity will also greatly increase transactions on our network which helps fund the Oracle Pool and Community Pool.
USTC Staking/Saving Vault – 47.5%
We are in a unique situation with USTC in that it is currently viewed less as a store of value and more a speculative asset. The potential to near 50x with a repeg is one of the few drivers of trading as there’s currently no utility. To bring some utility to USTC and take it out of circulating supply in the process, I propose that we create a new savings/staking module for USTC with 1month, 6month and 12month lockup periods with increasing reward rates for longer lockup. 47.5% of the USTC acquired by the Divergence protocol will be sent to the savings module. This module is purely about taking USTC out of circulating supply to accelerate the incremental repeg efforts and put increased positive pressure on USTC price.
Oracle Pool -2.5%/Community Pool -2.5%
The remaining 5% will be evenly split between the Oracle Pool and the Community Pool to increase our network security and encourage building and the onboarding of dApps to our chain.
The community can decide in the future to split assets differently if they wish, as the protocol would be completely controlled via governance.
Should this proposal be accepted by both the community and the majority of CEXs an accurate dated timeline will be determined with the L1 team. It will be a phased development as follows:
Phase 1: The Oracle would need to be examined and fixed first and foremost. Terra<>Terra swaps via the AMM would be disabled for the short term until the Oracle fix is in place. Work would take place developing the Divergence Protocol, Limited Swap Pool and USTC Savings Module. Pending a successful Protocol code audit, a deadline for Divergence Protocol implementation and launch date would be set. The minority of opposing CEXs and DEXs would be informed of the deadline and that failure to comply by the set deadline would result in a wallet blacklist. The wallet blacklist not only protects us, it protects the CEXs that got behind our repeg initiative.
Phase 2: The Divergence protocol would be launched across all markets at the same time. Peg would be set to approximately market price at the time e.g. $0.025 and would only be applied below peg. This means at or above peg there would be no fee. This is to disincentives selling below peg but also to put no restrictions on buying. The price would be incrementally raised as we built collateral in the system. However, if the price never goes below peg, we never build collateral. To combat this if there is high demand for USTC and trades
above a certain cent value for 48hrs the protocol will automatically raise peg to that value. For example if peg is at $0.025 and USTC trades at $0.055 for 48hrs the protocol will automatically set the peg level to $0.050.
Phase 3: As the protocol builds collateral from buybacks we will launch the Unidirectional Swap Pool and the USTC Savings Module. This should rapidly accelerate our repeg efforts. We should long have achieved parity at this stage so we should see d’Apps come on board and drive USTC utility and adoption further. With the modified AMM algo in place and Oracle fixed we should see the gradual introduction of Terra<>Terra swaps.
Phase 4: If we reach this phase we will have been successful in bringing USTC back to 1USD. We will have built sufficient collateral in protocol reserves to maintain that peg and can start to relax the divergence protocol fees. We have now a fully functioning Forex system with our 20+ stables and should be well positioned to broaden into payment and merchant service solutions/partnerships.
This all sounds great but the CEXs didn’t even want to implement the Burn Tax what makes you think they will implement a dynamic fee?
I personally believe its our money so we should be able to implement the controls we want, but that doesn’t necessarily mean the CEX’s think that way. At the end of the day CEX’s are businesses, they are about making money. Most CEX’s charge a flat transaction fee of between 0.1%-0.3% of each trade. When trades are off peg the divergence protocol can pull in many multiples of this. So I’d propose we share some of the profits with the CEXs, it incentivises them to implement the protocol but also strengthens our business relationship with them. To prove the protocols feasibility and to prove that it would be beneficial to both CEXs and the LUNC ecosystem I modelled it against the USTC/BUSD trading pair on Binance for the last 6months. Fees charged by Binance are at a rate of 0.2% and I’ve modelled the protocol based on peg targets of $0.020, $0.0225 and $0.025.
Case Study: Binance USTC/BUSD Trading Pair Q1/Q2
|Month||Binance Fees below $0.02||Protocol Fees Below $0.020 Peg||Binance Fees below $0.0225||Protocol Fees Below $0.0225 Peg||Binance Fees below $0.025||Protocol Fees Below $0.025 Peg|
If we look at the totals in the table above we can see that Binance has taken in $23,906, $567,674 and $1,276,558 in regular trading fees over the last 6months, below the respective peg levels. If we look at the protocol fees, it would show to take $476,314, $22,134,705 and $91,925,372. These values as great as they sound are unrealistic. We must assume that there will be a drastic reduction in trading volumes below peg. As such, I’m assuming a 90% reduction in trading volume, which would give us figures of $47,631, $2,213,470 and $9,192,537. Even with the 90% reduction in trading volume this proves we would always be able to compensate the CEX’s more than they would take in from regular trading fees. It also proves that it will be much more effective at reducing circulating supply than the current flat burn tax and that the burden of this fee will only be carried by those who sell below peg rather than by the whole community.
I believe this proposal outlines an approach to revitalising our ecosystem in an equitable manner that will appeal to both USTC and LUNC holders. The Divergence protocol allows us to slowly but safely recapitalise USTC with a basket/index of tokens and replaces the manual buybacks of the last system with a much stronger automatic buyback protocol. The Unidirectional Swaps and USTC Staking/Savings Module will both serve to not only increase network traffic but more importantly reduce the circulating supply of both tokens. Most important of all though we are taking control back over our money and building a defence mechanism which prevents the possibility of future death spirals and punishes market manipulation. If successful it will also build and strengthen our relationships with CEXs. The protocol will be controlled via governance so the fee and distribution parameters can be changed by the community if they wish in the future.
- Relies heavily on CEXs agreeing to this. Without it the protocol would not be effective and I would not recommend implementing it. Will most likely have a dramatic reduction in trading volumes below set peg level. The majority of trading will most likely resume above or at the peg but this is not guaranteed.
- Will have to be a soft peg to begin. Due to the lack of initial capital to defend the peg, there is going to be numerous depeg events until the divergence fee builds collateral in the system.
- If there isn’t sufficient liquidity at peg levels or the price has already depegged and you need/decide to sell. You could be taxed quite aggressively by the protocol depending on the how far from peg the price has deviated.
- Recapitalises and incrementally repegs USTC back to $1USD over time without the need for minting, forking, reverse splits or external capital.
- Reduces LUNC supply through the introduction of unidirectional swaps.
- Reduces circulating supply of USTC through the introduction of USTC Staking/Savings Vault
- Funds both the Oracle Pool and Community Pool
- Targeted approach so only those that are selling below peg pay the fees
I will leave this up for discussion for 1 week on Agora. I will then submit a signalling prop to contact the CEXs. Should we convince the top 3 CEXs, I will proceed with a governance vote and spend proposal. While this may be an innovative approach and nothing like this has ever been attempted in the crypto space there is no guarantees. I urge you to read this proposal numerous times. This is your money and you need to understand how the mechanics of this may affect you. Don’t vote yes just because there’s repeg written in the title, vote yes if you understand and believe what we are trying to achieve here and how we are attempting to do so. I will endeavour to make myself available for any questions/AMAs about the proposal over the coming week. Should this proposal pass I will only be able to take a part time role as I run my own business and wouldn’t be in a position to leave that, this shouldn’t be an issue as most of the work will lie with L1 team and I wouldn’t be needed all the time but I thought it should be mentioned so you are fully informed.