ESD has matured and the protocol needs to adapt to handle new supply and demand requirements. Suggestions are provided to incentivise liquidity to handle supply and demand crises.
A stablecoin should have the ability to be redeemed for $1 worth of USD. Getting an algo stablecoin to work is tough; market dynamics are impossible to predict and change at different scales. To achieve this aim the path is roughly: speculation > liquidity > stability. ESD just underwent a long expansion phase where speculative value pushed fomo valuation on the market price of ESD resulting in reflexive growth of the ESD market cap. With the price now <$1.00, the future speculative value of ESD is greatly discounted.
ESD has undergone several expansion + contraction cycles. The following chart illustrates the price history during this time. There have been protocol changes since the start of that blue line, however note how the current contraction phase (greyed rectangle) is playing out:
During the previous expansion phase, one of the first use-cases for ESD appeared in the form of a farm for a Basis.cash clone - the red circle in the diagram. It can be seen how that reversed the trend and prolonged the expansion. This was a sign of things to come; ESD has been used in many other farms since, and is now included in Cream, has a Curve Metapool and is being actively arbed in things like the Stabilize pool.
This increased supply and new integrations and applications for ESD are welcome, however they incur supply and demand effects that the system isn’t optimised to handle.
The current contraction mechanism dis-favours liquidity provision, both by a lack of incentives and that the less liquidity the less costly it is to move back to the peg (see second chart below). And it does this precisely when a deep liquidity pool is required to handle a scenario of less demand.
The above chart shows liquidity levels in the ESD-USDC Uniswap pool, hi-lighting some tops and lows. The following chart outlines the price effect on buys and sells from the peg for various sizes of the liquidity pool (happy to have someone check my math, just ask for the spreadsheet):
Before looking at solutions, one more chart, a supply schedule with various permutations. A small elephant in the room can be seen in that right hand column.
Various solutions have been presented in this forum and on the Discord and are summarized below. They range from incentivizing a stability pool (the DAO) to more complex lockup and distribution solutions. Bear in mind the supply schedule and other numbers presented above, the code complexity to achieve them, and that an iterative process is generally being followed at ESD.
Before listing off some of the ideas collected from the community, it is worth mentioning the Reserve and EIP-12. The reserve can be used to aid with supply regulation, something that is not actively done by the protocol during contraction in the current implementation.
The following are ideas from around the community:
Incentivize the DAO during contractions: an indirect method whereby the DAO acts as a stability pool, rewarding people for parking unused ESD rather than selling it. This is simple to implement and doesn’t have to have a large effect on the supply.
Flip the reward scheme such that DAO and LP rewards are given out during contraction and then disbursed during expansion to bonded DAO and LP. Unbonders would lose any unredeemed rewards; if rewards go directly to wallets as coupons do, this strategy could mitigate supply crises during expansion.
A person should be indifferent to investing above the peg or below the peg, the potential rewards should be roughly similar. Hence we allocate a half of expansion rewards for “stakers” who stake into a pool when twap is below 0.97, staking is only open below 0.97.
Track DAO and LP bonds during contraction and either reward only those positions during expansion or don’t let people bond at all when the TWAP > $1.00.
Some mix of the above where rewards can be tracked based on when bonded (expansion vs contraction) and how long it has been bonded for.
Some combination of the above - in particular those that encourage liquidity above and below the peg - along with the Reserve should help to keep ESD more tightly bound to the peg*. In addition, depending on the solution it might be worth considering the supply change limit.
*Bear in mind that the Reserve is meant to step in on wider swings from the peg
Most of these aren’t trivial suggestions, and more than anything the goal of this was to paint a state of the current situation, to ask if it is time to reward consistent deep liquidity and to bring together some of the discussion of how to handle this from around the community.
My personal take is:
A stablecoin should have the ability to be redeemed for $1 worth of USD. A person should be indifferent to investing above the peg or below the peg, the potential rewards should be roughly similar. Lower emissions, reward DAO and LP all the time , and have the reserve work to control excess supply through mint-and-burn.