How to Burn 1.5 Billion USTC in 200 Days
A floating peg for USTC has certain advantages such as allowing partial collateralization and a much more flexible monetary supply allowing for greater scaling. My recent Floating Peg Proposal discussed how to achieve this. I believe it makes sense to utilize a fixed peg initially however, and burn on the order of 1.5 billion USTC in about 200 days as I will discuss below.
Since the working reserve is low, a fixed exchange rate can be instituted. This can be implemented quickly and will generate fees that can be used to fund the reserve. The goal of this fixed peg system is to reduce TerraSDR (USTC) supply by buying back TerraSDR while its value is low.
Going back to Mundell-Fleming Trilemma discussed in my Floating Peg Proposal, if exchange rate is fixed we must give up either free flow of capital or an independent monetary policy. In this proposal we give up free flow of capital and “swap options” are used to allow only the highest bidder access to the swap mechanism. A dApp interface that would be a cross between an orderbook and smart contract to pay interest on TerraSDR (USTC) and LUNC deposits, would be built.
Swap Options
Like USTCBONDs and Call Options (CO) described in my previous Floating Peg Proposal, Swap Options exist completely on-chain. This allows for automatic liquidation when conditions are met.
Swap Options can be used to restrict the free flow of capital when needed, and only allow the highest bidders access. Swap Options can be used to create a simple decentralized order book. This allows the algorithm to have strict control over the flow of capital between USTC and LUNC. A dApp interface can be constructed to make the UI much like an order book at an exchange.
Swap Options exist in two variations:
- USTC2LUNC: User purchases with USTC in effort to trade to LUNC
- LUNC2USTC: User purchases with LUNC in effort to trade to USTC
These coins allow users to bid for a swap fee they would be willing to pay to swap from USTC to LUNC or vice versa. The amount of the fee is added to the end of the coin. For example:
- USTC2LUNC05 would indicate 0.5% swap fee paid in USTC
- USTC2LUNC25 would indicate 2.5% swap fee paid in USTC
- LUNC2USTC30 would indicate 3.0% swap fee paid in LUNC
- LUNC2USTC00 would indicate 0.0% swap fee paid in LUNC
An algorithm would determine when to liquidate holders starting at the highest fee and working down to the lowest fee. Liquidations would be proportional among all holders at a given fee. For example:
- User 1 holds (2000) USTC2LUNC35
- User 2 holds (3000) USTC2LUNC25
- User 3 holds (5000) USTC2LUNC25
- No other users exist and the algorithm determines that it needs to burn 6,000 USTC and provide the corresponding amount of LUNC.
- The system liquidates all 2000 USTC2LUNC35 coins and provides the corresponding amount of LUNC to User 1 at the current exchange rate.
- 4000 USTC is still needed out of the 8000 USTC2LUNC25 coins available. User 2 holds ⅜ of the total USTC2LUNC25 supply and User 3 holds ⅝ of the total USTC2LUNC25 supply.
- User 2 : ⅜ * 4,000 = 1500 USTC, therefore User 2 has 1500 of their 3000 USTC2LUNC coins converted to LUNC
- User 3: ⅝ * 4000 = 2500 USTC, therefore User 3 has 2500 of their 5000 USTC2LUNC coins converted to LUNC
In exchange for users bidding and providing liquidity to the system, they can be compensated with X% APY. The return can be paid in any combination of coins as follows:
The rewards can be:
- X% minting of USTC
- X% USTCBONDs
- X% ReserveCoins
- X% Call Option Strike $0.25 (CO25)
- X% Call Option Strike $0.50 (CO50)
- X% Call Option Strike $0.75 (CO75)
- X% Call Option Strike $1.00 (CO100)
Users can trade their USTC2LUNC coins back for USTC at any time. Likewise, LUNC2USTC coins can be traded back for LUNC. For example, one USTC2LUNC30 coin can be traded for 1.03 USTC at any time. The user would just lose transaction fees from entering and exiting the position.
How the Fixed Peg Would Operate
The peg between market cap of LUNC (MKTCAPLUNC) and market cap of TerraSDR (MKTCAPTerraSDR) can initially be set to a ratio (PEG) of approximately 2:1. The quantity of LUNC in circulation (NBC) and quantity of TerraSDR (NSC) will be known and updated on a regular basis as mint/burn activity occurs.
The target price of TerraSDR (PTSC) will be:
PTSC = MKTCAPLUNC / (PEG * NSC)
Example A:
PEG=2
MKTCAPLUNC = $650,000,000
NSC = 9,820,000,000
PTSC = MKTCAPLUNC / (PEG * NSC) = $0.0330 USTC
The price of TerraSDR will rise as Market Cap of LUNC rises due to LUNC burn activity and other market forces, and as TerraSDR total supply is reduced.
The algorithm will attempt to burn USTC and mint LUNC up to 0.1% (MAXBURN) of the Market Cap of LUNC per rolling 24 hour period.
On a periodic basis of minutes or hours an algorithm will determine how much TerraSDR/LUNC to burn/mint from the available Swap Options. Only the option to burn TerraSDR and mint LUNC will be available initially. No minting of TerraSDR will occur. The goal of this fixed peg system is to reduce USTC supply.
The algorithm will have the option to match LUNC sellers with USTC sellers as needed, but will only perform matches in this way once the maximum USTC burn for the day has been met.
If an inadequate number of TerraSDR (USTC) sellers come to market within any given 24 hour (14,400 Blocks) time period, the PEG will be lowered so that the target price of USTC increases by $0.0015 (Δ). This is done by lowering the PEG value.
The new PEG will be:
PEG = MKTCAPLUNC / (PTSC * NSC)
Starting at $0.033 per USTC, it would take 644 days for USTC to reach $1 with this method if the peg increased every day. I envision only operating with this fixed peg system for the first 200 days or so.
In a way this fixed peg system would function like a very slow auction, allowing USTC holders to exit each day at a slightly higher level.
The amount of each USTC price increase (Δ) and (MAXBURN) percentage can be parameters that change as needed.
From May 30, 2022 to August 6, 2022 LUNC has increased 18.63% over 68 days. Which averages to 0.27% per day as can be seen in the chart below:
If we assume:
MAXBURN = 0.001 (0.1%)
Δ = $0.0015
Assumed LUNC Daily Market Cap Increase = 0.002 (0.2%)
The following results occur:
Notes:
- Assumes a steady and constant LUNC Market Cap Growth
- Assumes just short of the maximum allowable amount of USTC is burned per day (If max is reached, peg stays at same level for an additional day. If max is not reached, less total burn than what is shown will be achieved)
- Assumes Market Price of USTC does not outpace PEG value. (Possibility #1)
- Assumes LUNC Market Cap does not decrease below target (ex. $600M) (Possibility #2)
- Assumes USTC price increases are not paused by governance periodically.
As you can see, 600 Million USTC tokens could be burned in the first 90 days, but this assumes the pegged value of USTC increases everyday. It will likely remain at a lower value for some of these days and burn less. Which would result in some number above or below this level.
It may be better to set Δ value lower than $0.0015 per day to start. As an example, if we assume:
MAXBURN = 0.001 (0.1%)
Δ = $0.0010
Assumed LUNC Daily Market Cap Increase = 0.002 (0.2%)
The following results are obtained:
Likely something close to 1 Billion USTC could be burned in the first 100 days or so, if USTC price is held to these levels. Possibly as much as 1.5 billion burned in 200 days.
For the first two weeks or so it is would be best to hold the peg at the initial value to build interest in the swap options/orderbook system.
Possibility #1:
In anticipation of a rising USTC price, the market price of USTC could outpace the PEG. This would be bad for the collection of swap fees but overall a good sign showing confidence in the system. When Market Price of USTC exceeds Peg Price of USTC, governance would have the option to either increase the daily peg increase to catch up to the market price or pause the increase to bring the market price back to peg.
Possibility #2:
LUNC Market Cap decreases over time. A safety valve could be instituted so that if LUNC Market CAP decreases below a set value (ex. $600M), decreases in the PEG could be halted, until Market Cap rises above the target (ex. $600M).
Possibility #3:
Governance could vote to pause the increase in pegged value of USTC at certain key points such as $0.05, $0.075, and $0.10 USD to increase the amount of time USTC can be bought back and burned at a lower value.
Possibility #4:
The increase at each step could be stopped until a minimum amount of USTC is burned, before continuing the PEG adjustments.
Conclusion
This system allows for possibly 1.5 Billion USTC to be burned within the first ~200 days. It does this by adjusting two parameters:
- MAXBURN: Maximum amount of USTC that can be burned in a rolling 24 hr period, expressed as a percentage of LUNC Market Cap (ex: 0.1% of LUNC Market Cap)
- Δ: Change in pegged value of USTC in USD per peg increase event
Unlike the original swap mechanism that allowed a free flow of capital through the system at all times, this system strictly controls the flow of capital, preventing another death spiral. The icing on the cake is the collection of swap fees to add to the working reserve to back USTC going forward once a floating peg is instituted.
Feel free to test these calculations yourself using this spreadsheet.
