Peg Enforcement and Arbitrage in 10mb Finance

🧲 Iron Finance + 🪦 Tomb Finance = 💣 10mb Finance

By now, many of you have heard about 10mb.finance, our upcoming algorithmic stablecoin on Cronos Network that will be pegged to 1/10 USDC. The peg of the 10mb token will be enforced by two different mechanisms: Seigniorage and Fractional Collateralization. In this article, we will explain how peg enforcement works in the protocol and how you could earn profit by participating in these peg enforcement mechanisms!

Dual Peg Enforcement

10mb Finance will be the first protocol to enforce the peg by both Seigniorage (like Tomb Finance) and Fractional Collateralization (like Frax or Iron Finance) using the same Share token. We believe that using both of these systems simultaneously will compensate for the weaknesses of each!

Seigniorage

In the Seigniorage system, new peg tokens are issued as long as the price remains over peg, and the system attempts to reduce the supply when the price is under peg. The new peg tokens are issued by distribution through the Boardroom, in which Share tokens are deposited. Users can trade peg tokens for Bond tokens when the price is below peg, and when the peg token’s price recovers, Bond tokens are redeemable for extra peg tokens.

For example, in the Seigniorage system of 10mb Finance, users can buy a supply of 10BOND tokens for one 10mb each when 10mb is under peg. If the 10mb price then recovers to 1 peg ($0.10), each 10BOND is redeemable for one 10mb, and at a spot price of 1.1 peg ($0.11), each 10BOND is redeemable for 1.25 10MB, which would be worth $.1375.

As good as that sounds, there are multiple problems with this form of Seigniorage. First, the protocol does not make Seigniorage profit in the same way as fiat central banks. The protocol does not automatically sell Tomb at high prices and buy back at lower prices. Instead, Tomb bonding raises the overall supply, with the users making Seigniorage profits in the form of newly printed supply, making it harder to maintain the peg in the long run.

Second, the Tomb Seigniorage system does not provide a direct, immediate incentive to buy peg tokens. In Tomb Finance, Bond tokens are only a good buy if one believes that the peg token will regain the peg. There is no financial reward for bond buyers until after market forces restore the peg. We will see how the addition of Fractional Collateralization compensates for this weakness by offering redemption for peg value.

Fractional Collateralization

In the Fractional Collateralization system, the peg token is backed proportionally by a redemption treasury (collateral) and the Share token. Minting allows users to create new peg tokens by paying the collateral token and the Share token. Redemption allows users to burn peg tokens in exchange for the collateral token and the Share token. Redemption should be a very strong peg mechanism because it always gives full value to redeemers, split between the collateral and share tokens.

In the canonical Frax/Iron Finance system, redemption and minting are both always done at peg value. For example, if Iron’s Target Collateral Ratio is 0.8, then 0.8 USDC and 0.2 USDC worth of Titan (+ fee) would be collected for each Iron minted. Furthermore, if the Effective Collateral Ratio is 0.7, then 0.7 USDC and 0.3 USDC worth of Titan (- fee) would be given for redemption of each Iron. As we will see below, 10mb Finance uses a minting price that is a certain proportional distance between the peg price and market price when over peg. This will help to maintain the initial scarcity of 10mb in the event of a high-demand situation.

The problem with Iron Finance’s redemption system was that it did not account for the possibility of high volatility in 10SHARE, using price data from too long of a time frame to determine its value and the amount of redemption proceeds. 10mb Finance shortens the 10SHARE TWAP (time-weighted average price) time frame from 10 minutes to 45 seconds to avoid this bug in Iron Finance, which resulted in the Titan share token dropping to zero price. With this change, redemption should provide approximately full value at all times.

Peg Enforcement and Arbitrage

These multiple methods of peg enforcement beg the question of arbitrage. How can users make money on all of this? There are several ways for users to profit on peg enforcement and arbitrage in 10mb Finance, and this provides an exciting opportunity to do more than just harvest yield emissions!

First, it may be possible to make a profit by simply minting 10mb. When 10mb is above peg, the minting price is not simply peg price but a proportional distance between the peg price and the current price:

  • Minting price = 0.1 USDC + F*(TWAP(10mb) — 0.1 USDC) + fee, where F = 0.98 at the beginning and fee = 0.4%

For example, if the spot price of 10mb is 11.0 peg ($1.10), then the using the initial value for F, the minting price would be 10.84 peg ($1.084). This should give users a reward without allowing transactions that are too large or a too rapid price decrease. Users may be able to profit by minting and then market selling 10mb this way, and we can change the F value if it is set too high to benefit users.

A second way for users to profit will be to purchase and redeem 10BOND tokens. This may have asymmetric advantages in 10mb Finance because the Tomb bonding system, by itself, has historically provided relatively weak peg enforcement, but the simultaneous presence of another mechanism may facilitate better peg restoration than would be expected in a vanilla Tomb fork. 10mb Finance’s 10BOND system will be supercharged for two reasons:

  • Redemption bonuses scale linearly from 1.0 to 1.1 peg, unlike Tomb, in which the price must reach 1.1 peg for a bonus to be offered;
  • Redemption bonuses will be offered when the peg is regained by any means, including stabilization via Iron Finance redemption

Therefore, if the Iron Finance redemption system functions as a strong peg enforcement mechanism, it will synergize with the supply sink provided by 10BOND sales and make 10BOND buyers more likely to profit.

A third way for users to profit is by buying 10mb when under peg and redeeming, aka “churn.” The 10mb token will have standard liquidity, and its spot price could see high volatility. If the 10mb price goes too far under peg, this will present an immediate profit opportunity to anyone who purchases it, as they will be able to do the following:

  • Market buy 10mb below peg
  • Redeem 10mb for full peg value (in USDC + 10SHARE)
  • Swap 10SHARE for USDC
  • Repeat the process until the peg is restored

The profit from the above “redemption churn” procedure increases when 10mb is farther below peg. This is why the Iron Finance redemption procedure is considered to be a relatively strong peg enforcement mechanism.

Speculative Attacks

It is worth considering how the 10mb Finance system would behave in the event of a speculative attack. Some market manipulations with the following modus operandi have recently occurred in Tomb forks:

  • Investor group accumulates large amounts of peg token
  • Coordinated dumping to cause immediate peg loss
  • Wait for despair selling amongst other investors
  • Either buy back peg token at very cheap prices and then wait for rebound, or just let the protocol die for fun

Some protocols have not regained peg after the high price impact of these attacks. However, we believe that the addition of the Iron Finance redemption system to 10mb Finance makes it relatively immune from such attacks. The lower the 10mb price goes, the more profitable the redemption churn loop will be, and therefore, a large drop to the spot 10mb price would create immediate financial rewards for anyone who buys the dumped 10mb and redeems it for full peg value.

Because the success of this type of speculative attack is dependent on the attacker selling high and buying low, the price of the peg token must decrease further after the speculators dump for them to swing profitable trades. Whereas the bonding system of vanilla Tomb forks may be less likely to work when investor confidence is shaken by a sudden price drop, The motivation to restore the peg via Iron Finance redemption scales positively with a greater difference between the spot price and the peg.

Therefore, the introduction of Iron Finance redemption to the Tomb system would seemingly change the implications of any coordinated dumping attack on the peg. Whereas this type of attack would start a confidence game and an uphill battle to regain peg in vanilla Tomb forks, it would introduce a profit opportunity for good actors to motivate restoring the peg in 10mb Finance. Furthermore, if the redemption “churn” cycle determines the market direction, it would deny the speculative attackers the chance to make profit. Potential speculative attackers may thus be discouraged from attempting such attacks on 10mb Finance.

Yield Boosters for 10mb Finance

Now that you’ve made it this far, it’s time to announce that our set of all-new yield booster NFTs for 10mb Finance has been released and is minting now! Please check them out and get some for yourself at https://cronos.zelenskyynft.club/. People who read this article all the way to the end are being told first about the NFTs because they will be a highly knowledgeable and dedicated group. Many cheers!

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10mb.Finance: An algorithmic stablecoin on Cronos Network pegged to 0.1 USDC by both Seigniorage and Fractional Collateralization

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