The YAM Rebase: Mechanism and Game Theory
This post is a deep dive into the logic and game theory of the YAM rebase mechanism.
From our launch post:
At its core, YAM is an elastic supply cryptocurrency, which expands and contracts supply in response to market conditions, initially targeting 1 USD per YAM. This stability mechanism is supplemented by one key addition to existing elastic supply models such as Ampleforth: a portion of each supply expansion is used to buy yUSD (a yield bearing basket of stablecoins) and add it to the Yam treasury, which is controlled via Yam community governance.
The YAM treasury can be deployed as token holders see fit via the governance process. It also serves as an effective lower bound on the market capitalization of YAM, because holders can vote to distribute the treasury amongst themselves.
Dilution and Price Impact
When YAM experiences a positive rebase, the sync() function is also called on supported Uniswap pools. This means that the adjustment in supply is instantly accounted for.
Next, the treasury mints YAM and purchases yUSD. In doing so, the overall supply is diluted in proportion to the amount of YAM sold to the Uniswap yUSD/YAM pool.
At the time of this post, about 30% of YAM is in the Uniswap pool, and the price impact is capped at 10%.
Key takeaways:
- YAM holders who are not in the Uniswap pool get diluted
- The price impact of a positive rebase is significantly higher than the amount of dilution would imply
- This creates an irrational, instantaneous drop in valuation, which creates a buying opportunity for efficient market participants.
Game Theory for LPs
YAM holders are incentivized to provide liquidity to the YAM/yUSD pool, and can stake their LP tokens to earn rewards. This is done because a larger liquidity pool allows the treasury to grow more quickly, and to compensate LPs for taking on divergence loss risk.
There are some interesting implications for LPs who are in the pool during a positive rebase. They:
- Avoid dilution and increase their ownership of the YAM system
- Earn trading fees from the treasury sale and resulting arbitrage
- Can attempt to make additional profits by exiting the liquidity pool immediately after rebase
Game Theory for YAM holders
YAM holders who are not providing liquidity get their share of the network diluted, but benefit from a growing treasury. They can also attempt to profit from the irrational price drop that a positive rebase will create.
Some YAM holders may attempt to sell YAM before the rebase and repurchase afterward. Others may be aware of this strategy, and attempt to position themselves to exploit those who attempt it.
