There has been discussions about the contract locking mechanism, and wheter it could be improved. Here is my review of the proposals that I have come across so far.
The current use of the sigmaUSD v1 and v2 contracts have been useful for ironing out bugs, and understanding the dynamics of the protocol. I will focus on the next phase by assessing how the protocol behaves, when the secondary markets are added. For this review, I assume that there will be sigUSD/ERG and sigRSV/ERG pairs in Ergodex, further use cases for sigUSD and possibly some yield generating mechanisms.
#1 Keep the protocol as it is.
Lets first consider what happens in case of a high demand for sigUSD. It might be used for example in multiple pairs in Ergodex, external exchanges, or means of payment in shops. High demand would drive the reserve ratio (RR) to 400%, which in turn would prevent purchasing more sigUSD in the contract. The pressure is alleviated if people purchase more sigRSV. However, they will do that only if the financial incentives are higher than in other market alternatives. If investors expect the future value of sigRSV to be low, then there might be shortage of sigUSD. That would drive sigUSD/USD and sigUSD/ERG exchange rates out of balance. After 1 sigUSD is worth >1.02 dollars on external markets, then an opportunity for arbitrage opens in the contract. At RR 400%, purchasing sigRSV before sigUSD would be the only option to carry out the arbitrage. This might not be lucrative for small arbitrage of 1.025 dollars, but most likely soon thereafter. The only problem would be a situation where RR is below 400% due to reduction in ERG price. For example at 350% it would take large amount of money to bring RR above 400% and benefit from the arbitrage. This is inefficient, and may be improved.
The second consideration is an event where ERG price drops significantly. AgeUSD is marketed as “no liquidations” protocol, but that is misleading, because someone always carries a risk. The question is how well such events are dealt with. In the worst case, the price drop would be large enough (e.g. 90%) to drop RR under 100%. The oracle price smoothing mechanism gives time for people to react, but if they would not be fast enough, then sigUSD would be redeemed for less than 1$ each. SigRSV holders would lose everything. In reality, sigUSD would probably start exiting the contract when RR approaches 100%, because of that risk. It would be a more controlled deflation of the contract than a forced collateral liquidation. This is the advantage that ageUSD has in the bad scenarios.
Even though cryptos tend to be volatile, the likelihood of these scenarios can be reduced by the ageUSD protocol. Money tied in the contract and secondary market liquidity pools increase the usage of the contract, and consequently the price of ERG. As the usage increases, people can be more confident that there is no sudden price drop. All monetary systems are based on trust after all. That trust is fostered by security, transparency and stability through usage in ageUSD.
#2 Varying fees
Increasing fees close to 400% and 800% RR could be an alternative to locking the redeem/purchase options. This could be done for example with an exponentially increasing function or threshold steps. For example, fee could be usual 2% at RR 450%, 10% at RR 425% and 99% at RR 401%.
The advantage would be that people are never locked out of the contract. The downside would be that sigUSD would lose the peg of 1$ within the contract. Therefore, it is a trade-off between locking options and fixed peg. It is not clear which option is preferable, and alternative protocol implementations might also find different sets of demand in markets.
The excess demand and ERG price drop events would run smoother with the varying fees, because everyone could exit at all times. However, they would complicate the contract, and reduce the trust of getting out 1$ worth of ERG for each sigUSD. Therefore, it might be better to keep the contract as simple as possible, and rely on the external market mechanism to value the ageUSD assets in bad scenarios.
#3 Option of purchasing and redeeming assets simultaneously
This solution addresses the problem in #1, where arbitrage is inefficient at RR < 400%. In such situation, it would be good to allow purchasing sigUSD and sigRSV simultaneously in such ratio, that it does not impact the RR. Also, those looking to exit their sigRSV position could buy a matching amount of sigUSD on secondary markets and combine them in one redeem transaction in the protocol. This possibility would also make it smoother for all to find the way out in case of a ERG price drop scenario.
Altogether, I believe that the simple, transparent and secure ageUSD design is the best foundation for a stable coin. Too complicated design as the base layer of a decentralized finance platform might lead to further unpredictable dynamics. The market mechanism provided by the external markets will be more efficient in setting the incentives than an arbitrary fee mechanism within the contract. The only change that I would recommend, is to add the option for redeeming and purchasing assets simultaneously. It allows the market mechanism to function even when the RR is not within the 400% – 800% range.
Everything above is highly speculative, and there may be many factors that I have missed. Therefore, I welcome all criticism and feedback.