🎯 Maintaining Stability: Arbitrage & Incentives
Understand how market forces and incentives restore the peg
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0 / 5 completed🛡️ Maintaining Stability
Maintaining a stable peg requires constant monitoring and adjustment. Different stablecoin types use different tools to respond to market pressure and maintain price stability.
🎮 Interactive: DAI Collateralization Simulator
Adjust parameters to see how over-collateralization protects DAI's peg:
✓ Position Healthy
This vault has 50% buffer above the minimum 150% requirement. ETH can drop to $1500 before liquidation. The over-collateralization protects DAI's $1.00 peg even if ETH crashes.
Stability Mechanisms by Type
Fiat-Backed (USDC, USDT)
Stability tools:
- •Reserve audits: Monthly attestations by accounting firms
- •Instant redemption: 1:1 swap guaranteed by issuer
- •Banking relationships: Regulated custody, FDIC insurance
- •Market making: Authorized partners provide liquidity
Crypto-Backed (DAI, LUSD)
Stability tools:
- •Over-collateralization: 150-200% backing creates buffer
- •Liquidation system: Bots buy stablecoin to repay debt
- •Stability fee: Interest rate adjusts to control supply
- •PSM (Peg Stability Module): DAI can swap with USDC at 1:1
- •Emergency shutdown: Last resort to protect peg
Algorithmic (Experimental)
Stability tools (theoretical):
- •Rebase mechanism: Supply expands/contracts automatically
- •Dual-token system: Volatile governance token absorbs volatility
- •Seigniorage shares: Bond system to contract supply
- •⚠️ Critical weakness: Requires perpetual growth or death spiral
DAI's Peg Stability Module (PSM)
MakerDAO introduced the PSM to strengthen DAI's peg during the March 2020 crash. It allows 1:1 swaps between DAI and USDC with zero slippage.
DAI above $1.00?
Swap USDC for DAI in PSM → Sell DAI for profit → Increases DAI supply → Price drops to $1.00
DAI below $1.00?
Buy cheap DAI → Swap for USDC in PSM → Profit → Decreases DAI supply → Price rises to $1.00
⚠️ Trade-off: PSM makes DAI more dependent on USDC. Currently ~50% of DAI backing is USDC. Improves stability but reduces decentralization.
Why Over-Collateralization Works
Crypto-backed stablecoins need 150-200% collateral because crypto is volatile. If ETH drops 40%, a 150% collateralized position becomes 90% → liquidation → DAI demand → peg maintained.
The buffer protects against flash crashes and ensures liquidators have incentive to buy the stablecoin (creating demand) even during severe market stress.