[Proposal] Have the protocol adjust supply automatically

New Asset / Mechanism
#1

What would happen if a feature was added to the protocol that:

  • if swap price > oracle price, automatically mints m-assets and distributes them to liquidity providers, proportionally to their stake

  • if swap price < oracle price, automatically burns a fraction of the m-assets of the liquidity providers

(by mint and burn, I create tokens out of thin air and burning them for nothing)

So all current features would remain same, but the protocol would have also the role of a central bank, aiming at aligning oracle and swap prices.

It seems to me that this could give an essentially exact peg, but there might be side effects (transfer of wealth for example) depending on the precise implementation of the idea.

#2

This system you propose is essentially similar to the expansion/contraction mechanism for the Terra network.

I haven’t given it a ton of thought, but at first glance it seems to be weak in the sense that all mAssets are currently collateralized by the minter’s UST whereas it would not be here. Perhaps fees can be gathered into some sort of treasury to be used in the way as you mentioned.

Also, I am pretty sure that the burning mAssets of the liquidity providers is not possible at the current moment due to the Uniswap-type mechanism (although I am not 100% certain).

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#3

I am not sure collateralization is a problem, in Uniswap there’s no collateralization other than the UST (transposing to our case) that’s in the pool.

In Uniswap imbalance is created temporarily when swapping. Here the idea would be to have the protocol trigger an imbalance automatically (not even through arbitrage like for the Terra network but by outright expansion/contraction of pool supply) to bring price back to the peg.

At this point I’m not understanding what would go wrong if we did that.

#4

Again, it is possible to potentially implement something like this. However, we would need to figure the process for a contractionary process.

Also depending on implementation, if I know there’s a specific parameter that controls when the protocol will mint&sell to lower the price, I can take a short position and vice versa.

#5

I think it should be feasible to implement yes, it’s more a matter of code/system than market dynamics a priori. The interesting question is what would this imply in terms of wealth transfer between liquidity providers and traders, what are the strategies/equilibrium etc… There’s room for possibly tweaking the idea there to perhaps match what we’d like to have

#6

Yes, I understand your last point now, implementing such a mechanism with some tolerance on the peg, say, 5%, might be enough to make minters arbitrage the usual way without using the mechanism much in practice (depending on precise implementation/incentive choices) maybe?

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