Daniel Larimer, the CTO of Block.one and the mind behind Bitshares, Steemit, and EOS blockchains as well as the inventor of the first stable currency BitUSD, has created a new algorithm that could be at the base of new price pegged tokens. He described it in his Medium article as “High Liquidity Price Pegged Token Algorithm” and he published it on his GitHub.
Since the 5th of October 2018, Dan Larimer has not been active on any of his repositories.
The approach behind the pegging algorithm
The new token pegging algorithm provides
“high liquidity and narrow spreads, while being robust against default in the event collateral loses value over time”.Daniel Larimer
While other pegging algorithms put in opposition shorts against each other, Dan Larimer’s solution relies on an over-collateralized short position combined with the Bancor algorithm. Bancor algorithm works as a cushion when the value of all collateral falls below the total outstanding derivatives. It continues to make the market earning fees until the price recovers.
This new system assures continuous liquidity to market participants while the 24h median price feed of oracles is used as the guide for the market and to keep the peg of the token within a few % of the pegged asset value (e.g. USD).
Market trading fees generate profits for the dollar-short positions and automatically replenish the collateral ratio if the collateral falls.
High volatility collateral assets are also suitable for this design if there are sufficient trading volume and high initial collateral ratio.
The over-collateralization will be achieved from the market trading fees for a highly-in-demand asset which will be able to offset any capital losses associated with maintaining a market peg. Larimer writes…
“The premise of our algorithm is that those willing to be slightly leverage-long in a collateral asset (such as EOS), can make money by facilitating market making activities between EOS and a fungible pegged asset, (e.g. USD), whose value is designed to track a price feed within an allowed deviation range”
Those who are willing to be the market maker will deposit collateral (e.g. EOS) into the contract that will act as a reserve. The depositor will receive in change the tokens in the market maker (MMS).
Key points of Dan Larimer’s pegging system
- Narrow spreads
- Incentivises asset creation and liquidity by providing trading fees to the shorts who post collateral
- Effectively eliminates the majority of liquidity risks of the shorts
- Provides equal liquidity to both sides of the market where
- Trading fees continuously re-collateralize the market and enable it to recover from losses due to changing prices
- The system can remain solvent and liquid so long as income from trading fees is greater than the average fall in the value of the collateral asset
- Suitable for the high volatility of collateral assets
The algorithm can work with any asset including gold.
The approach also deals with black swan events which many pegged assets are exposed to but Larimer says that
“this algorithm handles them more gracefully than alternatives.”
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