Peg Stability Module
Last updated
Last updated
The most important component of Cork Protocol is the Peg Stability Module, which is the core mechanism around which our markets are built. It works as follows.
Each Peg Stability Module is built around an asset pair:
Redemption Asset or RA is the base asset from which redemptions can be made. This could for example be Ether/USDC/DAI or even assets such as pDAI or stEth.
Pegged Asset or PA is an asset that should track the price of the Redemption Asset. This could for example be ezeth, USDe or stEth.
The Peg Stability Module or PSM can receive deposits of Redemption Asset where it is locked and mint two tokens that are returned to the depositor:
Cover Token or CT which is a claim on receiving back the assets in the Peg Stability Module at expiry.
Depeg Swap or DS which is a swap token that allow a user to before it’s expiry make the following exchange:
Furthermore, the Cover Token + Depeg Swap can before the expiry always be converted back to the Redemption Asset 1:1.
Peg Stability Module Deposit: The Redemption Asset is deposited and used to mint the Cover Token and Depeg Swap that is returned to depositor. In the below diagram the flow can be seen with Eth as the Redemption Asset.
Dealing with non-rebasing Pegged Assets
Most yield bearing Pegged Assets accrue yield into the token value, for example Lido steth is a rebasing token but most of the liquidity and DeFi integrations for steth are in wsteth which trades at 1.17 eth per wsteth. To address this, there is an Exchange Rate or ER in the Peg Stability Module that is fixed for each expiry between the Redemption Asset and Pegged Asset. The Exchange Rate determines how many Redemption Assets you need to deposit to receive 1 Cover Token + 1 Depeg Swap and how many Redemption Assets you receive when redeeming 1 Pegged Asset + 1 Depeg Swap.
For example in the above wsteth example it would compute as follows:
A Redeemer can deposit 1 Pegged Asset + 1 Depeg Swap to receive 1 Redemption Asset from the Peg Stability Module. This means holding a Depeg Swap enables you to redeem the Redemption Asset at a 1:1 relationship with the Pegged Asset.
In the presence of a Depeg Swap the Pegged Asset inherits the liquidity of the Redemption Asset, since they can always be swapped 1:1. This has huge implications for the risk profile of the Pegged Asset as collateral (eg in lending markets) since the Redemption Asset often has orders of magnitude more liquidity than the Pegged Asset. Take for example a LRT lending market looping trade, where a user takes for example ezEth as collateral to borrow Eth, trade this Eth for more ezEth and repeat lever up further. If there is a minor depeg of ezEth, the lending market has to liquidate its position to repay the Eth loan. With a Depeg Swap involved, this position would be liquidation risk free, because you could always swap ezEth for Eth through the Peg Stability Module to repay the loan. This means the lending market could offer these trades at a higher Loan To Value ratio, allowing better use of ezEth as collateral. Furthermore, it changes the liquidity risk profile for larger investors since with the available liquidity on many pegged assets it is difficult to immediately liquidate big positions. For such users, the immediate liquidity guarantee from Depeg Swaps is another use case and form of utility for the token.
If the Pegged Asset depegs from the Redemption Asset, the holders of the Depeg Swap can profit by redeeming the Redemption Asset from the Peg Stability Module. The value of the Depeg Swap will therefore be related to the Redemption Asset:Pegged Asset relative price and implied depegging risk of the Pegged Asset. The Depeg Swap becomes a market to price the risk of the Pegged Asset depegging.
For example in an LRT-ETH pair, if the Pegged Asset would depeg such that it is worth 0.8Eth, the DS will then be worth at least 0.2Eth. If an investor bought the Depeg Swap for 0.01Eth, they 20x their investment from the depeg event. This is an example of the leveraged upside inherent in the Depeg Swap token, similar to how investors betting on Credit Default Swap make significant upside if there is loan defaults (eg like Michael Burry famously did in 2008). There is a significant speculative use case enabled by Depeg Swaps for betting on depegging event. For example if you think the market is underpricing the risk of depegs, you can take a long position on Depeg Swaps and make a potential profit if your thesis turns out to be correct. The net effect of placing such bets, becomes increasing the liquidity of the Pegged Asset peg, because buying Depeg Swaps will increase revenues to the Liquidity Vault and increase assets in the Peg Stability Module which can serve as exit liquidity in a depegging scenario. Therefore, even the use case of betting on a depegging event, is synergistic for the issuer of the Pegged Asset. Equally, there is a speculative use case of buying the Cover Token if you believe the market is over-pricing the risk of a depeg. Furthermore, if there is a depeg occuring where the Cover Token is trading at a discount to the Pegged Asset, investors who wish to speculate on the repeg of the Pegged Asset have higher potential upside in buying the Cover Token than the Pegged Asset itself. Again by speculating, volume to the system increases the available liquidity that will deepen the peg liquidity.The speculative use cases will be an important driver in growing volume and liquidity for the system, something which is uniquely enabled in the current design as opposed to for example traditional insurance mechanisms.
When the Peg Stability Module receives Pegged Asset + Depeg Swap tokens during periods of redemptions, these assets can be repurchased to facilitate potential arbitrage. The Pegged Asset Repurchase Mechanism allows you to repurchase the Pegged Asset + Depeg Swap. The exchange is as follows:
There are two scenarios where one would do this: 1. If the price of Cover Token < Pegged Asset, then both the Pegged Asset and Depeg Swap can be sold to Redemption Asset for a profit. 2. Alternatively, if the price of Depeg Swap + Pegged Asset > Redemption Asset, then these are sold to Redemption Asset for a profit. We intend to run a bot to execute this arbitrage within the Liquidity Vault. Since the Liquidity Vault receives the fees and holds the AMM LP, it has a slight edge compared to other market participants in performing this arbitrage which will increase the yields to the vault.
How to treat the Pegged Asset in the Peg Stability Module
When redemptions occur, some Redemption Asset is replaced by Depeg Swap + Pegged Asset. The goal is to convert these Depeg Swaps + Pegged Assets back to Redemption Asset without any loss for the Cover Token holders. The following logic will be applied to deal with the Pegged Asset:
The Depeg Swap + Pegged Asset can be repurchased as described above, which replaces them back to Redemption Asset.
If the above is not possible, Pegged Asset is held in the Peg Stability Module until the above are possible or held to be redeemed at expiry by Cover Token holders.
Take a scenario where the Pegged Asset temporarily depegs, the system would generate meaningful profit. To explain this, take the example of a LRT:Eth pair. Prior to the depeg, the pair trades 1:1 with the Depeg Swap being priced at 0.02 Eth. A depeg occurs and the LRT is trading at 0.9 Eth. In this instance the DS might be trading at 0.13 Eth as the market anticipates a further depeg. At this point spending 1 Eth to repurchase and then sell the DS+LRT (even with a fee of up to 3%) is profitable.
If however, the DS price doesn’t increase as much and no arbitrage profit can be made, if the peg is restored, and the DS returns to 0.02 eth, at that point a profitable arbitrage exists to redeem the LRT+DS for 1 Eth. This should lead to profits for the vault, from fees and trading volume, regardless of what actor executes the arb. If the vault is able to execute the arbitrage it has even more profit.
