[Proposal] Fix the spread between Oracle price and Terraswap price

This is my proposal to fix current difference between oracle price and terraswap price. I just thought of this and seems like a good idea in my head, please stress test if this has any unintended consequences

the problem – currently there is a large difference between terraswap price and oracle price, because there isn’t enough incentive to mint, and no pure way to arbitrage the price difference

solution
When Terraswap Price > Oracle Price, you can mint at oracle price, and burn at terraswap price
When Terraswap Price < Oracle Price, you can mint at terraswap price, and burn at oracle price

simplified solution
actually you never need to mint at terraswap price, since you can always buy at terraswap price, so you can just do:

you can always mint at oracle price, and you can burn at the higher of oracle price and terraswap price

This provides a quick and direct way to arbitrage any difference in price immediately, providing an incentive for people to make sure that the oracle price and terraswap price is always similar.

There could be some cushion like terraswap > oracle price within 1% or something like that.

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I think the first part makes sense, though I dont know all the practical implications.

yea maybe in the second part your don’t need to be able to mint at terraswap price, since you can always buy at that price

I do think that one risk is that it makes the platform vulnerable to an attack where the attacker jacks up the price of an asset, and then burn at the terraswap price to cash out.

These statements as they are not explicitly clear, so could you clarify a bit more?

Let’s look at your first statement where Oracle Price < Terraswap Price. In this case, the flow would be:

  1. Mint an asset at the oracle price by locking up sufficient UST.
  2. Then I immediately close this position by burning at the Terraswap price (as a consequence of the protocol allowing me to do so).

Given that this is a completely isolated process how does this arb away the price differential between the Terraswap and oracle price? In addition, where is this differential in UST coming from?

ok I see. since the supply doesn’t get changed, it does not change the terraswap price, which is determined by supply and demand. – it doesn’t work then, sorry!

I would just like to end by saying that I do think the problem is in fact that there is no risk-free way to arb between the terraswap price and oracle price. You can bet on mean reversion but there is uncertainty involved – you don’t know when it will play out and meanwhile you are getting 300%+ yield instead for liquidity mining. So we need to either 1) create a risk-free way to arb terraswap/oracle prices, 2) incentivize minting and burning more, or 3) (unpopular) decrease incentive for liquidity mining.

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Or 4. Attract more liquidity, thus bringing down rewards per LP autimatically.

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sure, I kinda see that as one way of decreasing the yield for LPs (so a way of doing 3))