Risk

Off Peg The key point of whether USE can peg to 1 DAI is if arbitrage works. If when the price USE deviates from 1 DAI, if there is enough room for profit. This requires the vault to have enough reserve. When there is not enough reserve in the vault, it is likely that the protocol enters a death spiral.

Reserve Ratio is an indicator of whether the current reserve is sufficient, as well as if it is in a balanced position with its liquidity. In most cases, the reserve ratio will increase over time. When the collateral ratio is 100%, its sell-off pressure is as follows:

$$rr > s/(1+s)$$

s: the percentage of sell-off, i.e. if 0.2 means there is 20% USE sell orders to USE/DAI pool rr: reserve ratio

As can be seen above, it is a sub-linear curve, when s increases, its underlying reserve decreases, but it is smaller than a linear model.

When the collateral ratio is below 80%, things get a bit more complicated. As the reserve ratio is 80% (less than 100%), after the first sell-off doing arbitrage, the seller needs to sell 20% worth of ELENA, which makes the 2nd sell-off. After the 2nd sell-off repricing, there will be the 3rd sell-off, the arbitrager keeps doing so until there is no profit for doing so.

Based on this, we have a new generalized formula

Based on the formulas above, we studied the relationship between sell-off pressure in different collateral ratio and reserve ratio. This helps DAO better in terms of evaluating the risk level of the current system.