How the peg works
how the USDP secures its peg
Concept
Every USDP issued is over-collateralized. It's backed by collateral in the Unit Protocol. This means that the value of the provided collateral is higher than the value of USDP in circulation at any given point of time. This principle is based on ICR (Initial collateral ratio).
USDP attempts to maintain a value of $1.00 US. There is a free-floating peg, considering that the value of USDP may still experience slight fluctuations explained by the economics of supply and demand. USDP sustains its stability through a combination of external (market) and internal forces, and incentives used by DUCK token holders and the Unit Protocol team.
The moment a user pays off their loan, the deposited collateral is unblocked and the returned USDP tokens are burned. If the user has been liquidated, the collateral is up for auction and paid out by the auction participants with USDP tokens, which are burned in the same way.
The amount of USDP tokens circulating on the market depends on the amount of collateral that is currently deposited.
Self-regulated market
Unit Protocol operates on the understanding that the market is self-regulated and this can ensure that the price of stablecoin reaches its peg.
CDP owners have a natural incentive to mint USDP when there is a price premium and repay the debt when there is a discount. The same is true for USDP holders, they have an incentive to sell when price is above the peg and buy when price is below.
The mechanics used is based on arbitrage and can be applied in the following scenarios:
Scenario 1: If users carrying a debt in USDP, detect that the USDP is trading on some market below US$1 they might wish to buy USDP at this discounted price to pay back their debt, partially of fully. Thus, the amount of USDP would be drained from the market and this will result in USDP price rising in relation to its volume.
Scenario 2: If users having assets that can be used as potential collateral for the debt position, detect that the USDP is trading on some market above US$1 they might decide to open the position within the protocol and sell minted USDP to use the profit somewhere else. In this case, the greater amount of USDP would be released to the market, therefore, this transaction will have a USDP price lowering effect in relation to USDP volume.
Scenario 3: Crypto holders may find that USDP trades differently in two or more markets and decide to buy USDP on a certain market where the price is below US$1 and sell on another market where the price is US$1 or higher. Subsequently, this can also affect the value of the token.
Internal tools to affect the peg
Right now, the mechanism of keeping the USDP at the peg is the Stability fee regulation. This is the primary peg control technique we have.
When there is a peg premium, the stability fee tends to become lower to increase supply of USDP via minting. Meaning, if USDP is trading above US$1, stability fees are cut across all new CDP openings to make it cheaper to take out loans. There would be greater USDP supply on the market and hence the price would come down.
The opposite happens if USDP is below the peg, then the stability fee is increased which lowers the supply as it makes borrowing more expensive. Thus, in case USDP is trading below US$1, stability fees would be increased to limit the number of new CDP openings. The current CDP owners would be incentivized to repay their debt positions at lower price. Altogether, it will shrink USDP supply, thereby taking the USDP out of circulation and driving the price up.
The above is a long-time solution as it takes some days for this effect to become operative. The short-term peg stabilization comes from another response: USDP borrowing limit restriction.
When there is an exceeding number of USDP on the market the USDP borrowable amount would be limited to reduce the USDP turnover, therefore, to keep the peg parity.
What if the value of a collateral drops?
If we rule out a recovery, there are only three possible outcomes:
Users deposit more collateral and restore the peg
Users repay USDP loan fully or partially and restore the peg
Users take no action and let the liquidation ratio be reached, which eventually restores the peg
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