It’s hard to follow a lot of discussions on Discord these days, so I thought I’d try to bring this up here and hopefully we can stick with the topic at hand in this thread.
I’ve been thinking about coupon redemptions discussion that @lesh kicked off with this slide.
I’m a big supporter of the pro-rata approach.
The push back on this has been that any form of coupon pooling mechanism would be really hard to build:
I’d like us to consider removing the connection between coupons and epochs. Instead I propose that newly issued coupons expire 90 epochs after a debt reset i.e. when the debt is set to zero following the return to peg. In this way, all coupons that are issued during the same debt cycle would be associated with a single Coupon Cohort. And we would create a pro-rata pool for each cohort, so that as new supply is minted all coupon holders in the pool get their pro rata share of the new supply. Every time the debt resets there would be a new Coupon Cohort Pool (CCP) created i.e. one new pool for each coupon cohort.
But this is still a little messy to implement! We could potentially have multiple Coupon Cohort Pools (CCP) active at any time e.g. if the price hits peg and then falls down below peg multiple times before the first CCP expires. So to simplify it again I propose a LIFO ordering for CCP redemptions. We clear all of the coupons in the newest cohort first, then the one before that, etc. etc.
Example: debt accumulates and we sell coupons. Coupons are not tied to an epoch. Once we hit peg the outstanding debt is cleared. We create pool 1 which holds all the coupons sold. The clock starts ticking - there are 90 days before the Pool 1 coupons expire. At epoch 3 we have an expansion and 30% of pool tokens are redeemed on a pro-rata basis. But we drop below peg before they all can be redeemed. Another batch of coupons are sold. Epoch 10 we hit peg, debt is reset and these new coupons are added to Pool 2. Pool 2 now has 90 epochs before expiry. But now Pool 1 only has 80 epochs left. Now, if we have a supply expansion, then Pool 2 is redeemed first. So let’s say at epoch 20 40% of Pool 2 gets redeemed. But Pool 1 does not get any share of these redemptions - so it stays at 30% redeemed. Now let’s say we have no new expansion until epoch 90. Then Pool 1 expires and the coupon holders have taken a 70% haircut. Pool 2 has 10 epochs left before it will expire at epoch 100. Epoch 95 we hit peg. Pool 3 is created. We get 5 epochs of expansion but it all goes to Pool 3. It’s too late for Pool 2: we’ve hit epoch 100 and they take a 60% haircut. The expansion continues and Pool 3 gets 100% redeemed.
So this is Pro-rata combined with LIFO.
Why Is This Better?
Firstly, it stops people waiting to buy coupons. As all coupons in a cohort expire together, we don’t have this weird incentive to delay buying coupons. If we combine this approach with a more aggressive discount curve for pricing coupons, then we can really speed up the sale of coupons, which could restore the peg faster.
The LIFO part ensures that we can sell new coupons when there are a large amount of outstanding coupons. It allows us to prioritize new coupon buyers. Otherwise the rational choice is not to buy them because the probability of a significant haircut would be very high.
The LIFO part also makes the implementation a little simpler, as we’re not trying to redeem across multiple pools every epoch. But it also increases the risk of buying coupons. This is a conscious design choice. It reinforces the idea that you only buy coupons if you have the resources required to restore the peg. We can think of George Soros vs The Bank of England. Soros took on the battle because he knew he could hold out longer than the the BoE. A coupon purchaser needs to be sure they can finance a return to peg, otherwise the risk that they lose out is very high. This is a job for professional investors who have access to financial analysts, models, bots etc. that are required to to be effective in the coupon games.
This design also makes coupon markets more effective. Right now the coupons for each epoch are non-fungible. They will trade at a different price because coupons for each epoch have a unique risk. The CCP approach means we still have non-fungibility across pools but the number of pools should be much less than the number of epochs. So it’s easier for investors to model the risks per pool when they are trading coupons on a secondary market.
I’d love to get your feedback on this.
Please keep this thread for discussions on this idea. But please do start a new thread if this idea sparks off any tangential discussions. It would be great to make this a more vibrant forum!