the current dilemma of the dToken system: a conceptual approach to solution AND why the currently favored dUSD proposal is flawed

[LumpiesRevenge]

disclaimer: I will constantly edit this post to improve the conceptual approach via feedback loops. if the ideas are valuable a proposal might follow

The given

We have two completely unconnected and independent markets in the dToken system

1. real world stock market (reflected by the oracle price)
2. dToken market (reflected by the DEX prices)

Every dToken must be collateralized and minted. The higher the demand for dTokens, the higher the number of dToken must to satisfy the demand. A healthy systemic Vault_Collateral[$]-to-circulating_dTokens[$]-ratio will always be around 3:1. Therefore the only ways to increase loan volume/ dToken supply are:

1. collateral appreciating in price (especially DFI) OR
2. attracting new vault-creators/loan-takers/dToken minters

Be aware that this will always be the bottle-neck and decisive factor that determines the scalability-border of the dToken system!

The task

To fulfill the dToken system value proposition (enabling decentralized token stock trading) the DEX market price must be synched closely (+/- 1%) with the oracle price. Otherwise this new use case fails: DeFI Chain won´t be able to scale by attracting masses of "crypto stock traders", The dToken project becomes Liquidity Mining 2.0. Road to 50 will be an illusion.

A constant (and growing) supply of dTokens must be provided via minting. The protocol has to ensure minting is attractive to users.

The problems

Massive lack of dTokens in all Liquidity Pools as a result of the protocol currently sabotaging Minters (liquidation risk, demanding interest rates, superfluous loan schemes, high opprtunity cost) while exclusively rewarding Liquidity Farmers.

No correlation between oracle and DEX prices due to lack of mechanisms (algorithmic and arbitrage) to bring down "overpriced" dTokens.

solution vectors

A: improving the vault mechanic (can be applied immediately)

• default loan interest rate = 0%

Unless there is a massive abundance of a dToken in a trading pair, interest rates for loans in the closed dToken system make no sense. Minting dTokens is a crucial service to the ecosystem. Why should a Minter pay for helping the market?

• structurally raise minting volume by offering only one collateralization scheme (150%)

Each investor´s loan volume is defined by his assumed worst case scenario (maximum tolerable price drop). The liquidation risk of a125% and a 500% collateralization scheme (with identical price drop buffer and collateral [$]) is the same. But the minted amount in the 500% loan scheme is four times lower! Therefore multiple collateralization schemes are superfluous PLUS they worsen the dToken supply problem

• optional: switch to lower collateral ratio once the prices stabilize

it has to balanced out in a way that doesn´t conflict with the auction mechanic. 125% should be possible once the system has stabilized.

B: fixing the liquidity mining mechanic (should be applied ASAP, would only require additional interfaces in the current vault mechanic)

• liquidity miners can only provide self-minted dTokens

the current price imbalance is heavily caused by liquidity miners providing dToken by buying them from the DEXes. The imbalance won´t disappear if this changes but it will grow even bigger (if prices are balanced and dStocks begin to attract stock traders).
distribute all block rewards (pool = classic DeFi system + dToken sub-system) in a way that makes liquidity mining (via vault) in dToken system more attractive than in the classic pools (DFI-BTC etc). By making the math take into consideration: loan takers (who want to provide liquidity) liquidation risk, opportunity cost (loan << collateral). To avoid confusion implement an APR calculator: the user types in his collateral [$] and loan [$] and the calculator shows the APR

• let an algorithm decide in which way the liquidity provider´s loan volume is distributed

This would reduce irrational/contraproductive market behavior and even benefit the Liquidity Provider. Variants:

soft: Liquidity provider creates vault, locks collateral, chooses loan volume then enters the LP interface (only accessable via vault). User chooses pool. Algorithm mints dTokens and distributes them to the LP in a way that reduces imbalance. So each Trading pair would need its own APR.

hard: same as above above but the liquidity provider cannot choose the Pool. The decision is made by the algorithm (taking into consideration LP size, price divergence, trading volume). So there is one DFI reward pool that covers all trading pairs -> all liquidity providers get the same APR according to their loan volume [$] divided by the dToken DEX TVL [$]. This might be very convenient for providers since they don´t have to bet on a pool with maximum reward anymore. And they no longer have to constantly hunt for the best APR by hopping from one pool to another. They simply collect a fair and stable APR while servicing the ecosystem.

hardcore: protocol is allowed to directly inject/remove under-supplied dTokens into a LP without having to sell half of it for dUSD. This would make balancing more effective.

C: new balancing mechanisms

These may not be implemented before the above mentioned mechanics have been installed. So the dToken system has to be further balanced out first. Otherwise the sheer amount and volume of arbitrated (and potentially non-collateralized/"collateralized-by-utility") dTokens will cause a lot of problems for the protocol!

• "collateral staking"

Create a "staking pool" wherin "Stakers" provide Collateral. They get APR in DFI in return (adequate share from block rewards). The protocol defines a constant LTV, mints tethered dTokens according to the markets demands and brings them into the market (imbalanced liquidity pools). So the task of this mechanism is to further balance out the LPs towards the oracle price. Consequently these dTokens are safely collateralized. The protocol manages the liquidation risk (if loan level is critical/too low, the protocol can remove dTokens (which it has actually minted and deployed itself, so the protocol must keep track of their own minted tokens) from balanced pools to raise collateral. Therefore it takes the liquidation risk off the collateral providers shoulders what might be very convenient for many users. If all of the above mechanisms fail to synchronize DEX and oracle prices and the difference reaches a threshold (maybe 2.5%?) instant arbitrage mechanism kicks in.

• instant arbitrage mechanism AND why exclusively rewarding dUSD-minting is a dead end AND how the use the proposed mechanic to improve the situation

In general this mechanism works like the "Balthasar Becker Proposal" by allowing loan repayment with a token outside of the dToken realm. But "his" proposal in the current form will cause big problems because:

• it comes too early (dToken supply must be tackled first!)
• it will create a massive (and constantly growing!!!) % of non-collateralized dTokens (collateralization by utility as supposed by Julian Hosp is a very dangerous idea, imagine EZB/FED bringing this argument "we may flood the market with uncollateralized FIAT because money is essentially for our economy and therefore backed by utility"!)
• it already animates users to remove dUSD from the market and sell it for DFI because they want to capitalize on the current dUSD premium = DFI discount and use the collected DFI to close their loans! ->massive $ volume will probably leave the dToken system!
• it will shift the current dToken premium on top of the dStock premium (so we are no step closer to balanced dToken prices)... well, it´s already happening.

To make the "instant arbitrage for overpriced dTokens via loan repayment with tokens from outside the dToken system" work it has to:

• be implemented AFTER the massive lack of minting volume has been reduced (ALL LIQUIDITY PROVIDERS MUSST MINT THEIR OWN TOKENS!)
• only be possible for overpriced dTokens as long as they are overpriced
• to reduce volatility problems: ONLY stable coins (USDC/USDT) should be allowed as payback "currency"
• guarantee proper collateralization of the arbitrated dTokens which still remain in the market!

This can be made possible by the protocol managing its own "vaults"/treasury where it keeps track of the tethered dTokens and the current collateral (stable coins). ONLY WHEN one of the protocol-collateralized dToken´s DEX price falls below the oracle price, the protocol may (simply) remove the dToken from its DEX. THEN the protocol checks if vault collateral [$] is okay. If not: keep stable coins as collateral. If yes: buy DFI with the respective (who were set free) stable coins and burn the DFI to support DFI token´s price appreciation.

The big picture (order, sectors, functions and dynamic APR balancing)

order

The easiest counter measures must be applied first (parameters: loan schemes, interest rates, APRs). Then new slow mechanisms should be implemented to further stabilize the system (liquidity mining only with self-minted tokens first, collateral staking afterwards). Finally the fast stabilizing mechanism (instant arbitrage for overpriced DEX tokens) should be implemented. This prevents the fast mechanism from collapsing due to too high demand pressure and gives the developers time to design and test the proper algorithms. Fees for loan closing and from the DEXes can be used to stabilize the collateralization of the "protocol vault".

sectors and function

Classic DeFI System (DFI-dBTC etc.): functions as an interface to other crypto markets. In an balanced state its APR (share of given block rewards) should be the lowest.

dToken system: provides use case for "mass" adoption. APR-relevant sub-systems: Liquidity Mining and Collateral staking. The classic vaults (non-APR) are for sophisticated investors who want to do their thing (leveraging, complex shorting strategies etc.).

Dynamic APR distribution ...

... is used as a mechanism to motivate users towards price balancing behavior. The entire amount of block rewards from all DeFi Chains sectors must be intelligently distributed among all sectors, primarily to stimulate dToken minting!

Thanks for reading. I´m looking forward to a fruitful dialogue.