Price Stability Mechanisms

1. Collateralized Debt Position and Loan-to-Value (LTV) Ratio:

A Collateralized Debt Position (CDP) is a core concept in decentralized finance where users deposit their assets as collateral to borrow against them. This mechanism allows users to leverage their holdings to generate liquidity without selling their assets. Davos Protocol utilizes this concept to offer its users a strategic way to access funds while maintaining their investment positions. Central to its CDP strategy is an over-collateralization ratio of 150%, ensuring that the stablecoins issued are always backed by assets of significantly higher value, providing a crucial safeguard against market fluctuations.

In Davos Protocol, the Loan-to-Value (LTV) ratio is a pivotal component in the lending process, indicating the portion of the borrowed amount in relation to the total value of the collateral provided. This metric is crucial as it reflects the level of protection the loan amount has against the value of the underlying assets. For Liquid Staking Tokens (LSTs), the LTV is typically set at 66%, allowing users to borrow up to $66 for every $100 of collateral. Importantly, Davos Protocol employs a dynamic approach to LTV ratios, tailoring them to the unique risk profiles of different types of assets used as collateral. This includes a range of reward-bearing tokens, with variations in LTV ratios to reflect their respective risk levels. For instance, reward-bearing tokens from lending protocols might have a higher LTV due to their distinct risk attributes. In contrast, Liquid Restaking Tokens (LRTs) might feature a lower LTV, considering their potentially different risk characteristics.

The inclusion and careful assessment of a diverse array of assets, like LRTs and others, underscore Davos Protocol's commitment to evolving alongside the DeFi ecosystem. By offering balanced LTV ratios that are responsive to the risk profiles of various collateral types, Davos Protocol not only ensures a safety buffer against market fluctuations for borrowers but also maintains a secure and stable borrowing experience.

2. Monetary Policy Adjustment:

Davos Protocol uses a dynamic approach to managing the supply and demand for its DUSD stablecoin by strategically modulating borrowing rates. In addition to referring to significant financial benchmarks including the PCE Index and the Federal Reserve interest rates, the protocol incorporates DeFi lending rates. This comprehensive approach aligns with both decentralized and centralized financial ecosystems, allowing for a more balanced and responsive strategy. This alignment is further refined by adjusting interest rates based on the risk profile of the various assets accepted as collateral. There is a direct correlation between higher interest rates and riskier collateral types, which in turn generate a higher underlying yield. This nuanced adjustment of rates based on collateral risk not only ensures a consistent and transparent borrowing process but also plays a pivotal role in influencing the supply and demand dynamics of the DUSD stablecoin. Higher rates on riskier assets can temper the pace of borrowing, thereby controlling the supply, while more favorable rates on less risky collateral can stimulate borrowing, influencing demand. This balance helps maintain the stability and reliability of the DUSD stablecoin within the broader financial landscape.

3. Arbitrage Mechanisms:

Davos Protocol has strengthened the stability of its DUSD stablecoin through a strategic integration with various lending protocols, specifically utilizing their reward-bearing assets. This integration allows for a high Loan-To-Value (LTV) ratio of 93% when minting DUSD, leveraging the relatively lower volatility of these assets compared to ETH LST or LRT equivalents. Such an approach is aimed at mitigating the buying pressures on DUSD. Crucially, Davos chose this route over integrating with MakerDAO's Peg Stability Module (PSM). The PSM's design would necessitate issuing DUSD backed by USDC on a 1-to-1 basis, a method that lacks the capacity to generate borrowing fees. These fees are vital for redistributing revenues to DUSD stakeholders, including DUSD stakers and liquidity providers. Moreover, the protocol identified potential centralization issues and the increased risk to borrowers inherent in the PSM's 1:1 ratio system.

In the realm of DUSD, arbitrage plays a significant role. It involves traders capitalizing on price discrepancies between DUSD and other assets. When DUSD strays from its peg, traders engage in arbitrage, exploiting these price variations for profit. This activity is beneficial not just for the traders, but it also helps realign DUSD with its intended peg, thereby promoting its market stability. Davos Protocol's decision to incorporate assets from lending protocols, in contrast to the PSM, aligns with its objective to foster such arbitrage opportunities. These opportunities are essential for maintaining the peg stability of DUSD, ensuring its viability and reliability in the market.

4. Liquidation Mechanisms:

To bolster protection against potential liquidations, the Davos Protocol integrates several robust safeguards. These include effective liquidation strategies, adherence to sound liquidation ratios and penalties, clear risk management guidelines, and an exhaustive monitoring system. The overarching goal is to anticipate and adeptly handle potential liquidation events. A cornerstone of these safeguards is the Flash Mint functionality. This allows for the instant minting of any DUSD amount, contingent on its return within the same transaction. In the event of liquidations, liquidators can employ Flash Mint to swiftly procure DUSD tokens, settle a borrower's outstanding balance, and subsequently restore the collateral to its DUSD formβ€”all seamlessly executed within one transaction.

5. Reserve Pool:

Anticipating potential bad debt, Davos will launch a Reserve Pool funded by a portion of the yield generated from accepted collateral types. As loans increase, the pool grows, creating a financial safety net against disruptions or instances of bad debt, reinforcing platform stability and user trust.

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