How arbitrage keeps DUSD price-stable
DUSD can always be minted and redeemed from the system for $1 of value. This allows arbitragers to balance the demand and supply of DUSD in the open market. If the market price of DUSD is above the price target of $1, then there is an arbitrage opportunity to mint DUSD tokens by placing $1 of value into the system per DUSD and sell the minted DUSD for over $1 in the open market. At all times in order to mint new DUSD a user must place $1 worth of value into the system. The difference is simply what proportion of collateral and DARK + NESS makes up that $1 of value. When DUSD is in the 100% collateral phase, 100% of the value that is put into the system to mint DUSD is collateral. As the protocol moves into the fractional phase, part of the value that enters into the system during minting becomes DARK and NESS. For example, in a 98% collateral ratio, every DUSD minted requires $0.98 of collateral and $0.02 of DARK and NESS. In a 97% collateral ratio, every DUSD minted requires $0.97 of collateral and $0.03 of DARK and NESS, and so on.
If the market price of DUSD is below the price range of $1, then there is an arbitrage opportunity to redeem DUSD tokens by purchasing cheaply on the open market and redeeming DUSD for $1 of value from the system. At all times, a user is able to redeem DUSD for $1 worth of value from the system. The difference is simply what proportion of the collateral and DARK + NESS is returned to the redeemer. When DUSD is in the 100% collateral phase, 100% of the value returned from redeeming DUSD is collateral. As the protocol moves into the fractional phase, part of the value that leaves the system during redemption becomes DARK and NESS (which is minted to give to the redeeming user). For example, in a 98% collateral ratio, every DUSD can be redeemed for $0.98 of collateral and $0.02 of minted DARK and NESS. In a 97% collateral ratio, every DUSD can be redeemed for $0.97 of collateral and $0.03 of minted DARK and NESS.
The DUSD redemption process is seamless, easy to understand, and economically sound. During the 100% phase, it is trivially simple. During the fractional-algorithmic phase, as DUSD is minted, NESS is burned. As DUSD is redeemed, NESS is minted. As long as there is demand for DUSD, redeeming it for collateral plus DARK and NESS simply initiates minting of a similar amount of NESS into circulation on the other end (which burns a similar amount of NESS). Thus, the NESS token’s value is determined by the demand for DUSD. The value that accrues to the NESS market cap is the summation of the non-collateralized value of DUSD’s market cap.
Lastly, it’s important to note that DarkNess Dollar is an agnostic protocol. It makes no assumptions about what collateral ratio the market will settle on in the long-term. The protocol does not make any assumptions about what that ratio is and instead keeps the ratio at what the market demands for pricing DUSD at $1. It could be the case that the protocol only ever reaches, for example, a 70% collateral ratio and only 30% of the DUSD supply is algorithmically stabilized while over half of it is backed by collateral. The protocol only adjusts the collateral ratio as a result of demand for more DUSD and changes in DUSD price. When the price of DUSD falls below $1, the protocol recollateralizes and increases the ratio until confidence is restored and the price recovers. It will not decollateralize the ratio unless demand for DUSD increases again. We believe this deterministic and reflexive protocol is the most elegant way to measure the market’s confidence in a non-backed stablecoin. Previous algorithmic stablecoin attempts had no collateral within the system on day 1 (and never used collateral in any way). Such previous attempts did not address the lack of market confidence in an algorithmic stablecoin on day 1. It should be noted that even USD, which DarkNess Dollar is pegged to, was not a fiat currency until it had global prominence.
The protocol adjusts the collateral ratio during times of DUSD expansion and retraction. During times of expansion, the protocol decollateralizes (lowers the ratio) the system so that less collateral and more DARK and NESS must be deposited to mint DUSD. This lowers the amount of collateral backing all DUSD. During times of retraction, the protocol recollateralizes (increases the ratio). This increases the ratio of collateral in the system as a proportion of DUSD supply, increasing market confidence in DUSD as its backing increases.
At genesis, the protocol adjusts the collateral ratio once every hour by a step of 0.25%. When DUSD is at or above $1, the function lowers the collateral ratio by one step per hour, minimum to 5%. When the price of DUSD is below $1, the function increases the collateral ratio by one step per hour, maximum to 30%. This means that if DUSD price is at or over $1 a majority of the time through some time frame, then the net movement of the collateral ratio is decreasing. If DUSD price is under $1 a majority of the time, then the collateral ratio is increasing toward 30% on average.