About Degradation Scenarios
SPOT was designed to function smoothly in all market scenarios. Notably, reductions in demand for SPOT or AMPL produce gradual transitions rather than rapid phase changes that trigger bank-runs or require bailouts to resume functionality.
Recall that the SPOT token represents a redeemable claim on a basket of collateral. For an overview of how the SPOT protocol works see About SPOT.
The protocol features:
- Proportional Redemption: An X% ownership of the SPOT supply can redeemed at any point for X% of its collateral set
- Free floating Price: If the value of SPOT's collateral goes up, it's likely the price of SPOT will go up because each token is redeemable for more value. If the value of SPOT's collateral goes down, it's likely the price of SPOT will go down because each token is redeemable for less value.
For every market condition affecting SPOT's collateral set there exists an equilibrium price of SPOT that reflects the redeemable value of its collateral. No price point can "break" the system. No collateralization rate can "break" the system.
In this section we'll discuss some of the design tradeoffs made and expand on what happens to the SPOT system across market scenarios.
As mentioned above, SPOT operates by proportional redemption. This design choice was explicitly made to minimize runnability. In this section we’ll discuss some of the tradeoffs and considerations behind proportional redemption.
Bank run scenarios present when there is a clear opportunity for faster acting users to withdraw better assets than slower acting users. For example, if a bank has limited collateral on hand and those who redeem first receive the best assets in the system, while those who act last face insolvency, a race to redeem can take place. From a design perspective, there are two key features to consider with respect to runnability: free redemption and collateral choice.
- Free redemption: allows users to redeem as much collateral as they see fit.
- Collateral choice: allows users to choose which type of collateral they would like to redeem in a multi-collateral system.
Broadly speaking, systems can allow one but not both of these features, should they seek to avoid bank run scenarios.
- When a system offers collateral choice, fast actors are incentivized to redeem the better collateral before the worse collateral in a race. For this reason, free collateral choice systems have to limit redeemability to prevent runs.
- When a system offers free redeemability, collateral choice needs to be limited in order to prevent runs.
SPOT is collateralized by senior AMPL tranches and although these tranches share the same underlying asset, different vintages of tranche tokens can be thought of as more or less valuable. This is because tranches from different vintages mature at different times and can have different collateralization ratios based on the market conditions they have experienced through time.
Proportional redemption ensures that every redeemer gets the same distribution of collateral assets—limiting collateral choice in favor of free redemption.
Since every redeemer gets a proportional slice of every asset in the collateral set, there is no benefit to being first, and no opportunity to drain better assets before worse assets in the form of a run. Moreover the composition of collateral remains the same before and after any given redemption even as the system unwinds to an empty set.
In this section we'll provide an overview of the various collateral set scenarios and describe how the system behaves across a spectrum of scenarios.
The SPOT system can exist only in three possible collateral states:
- Fresh: Collateralized entirely by fresh tranches
- Mixed: Collateralized by a mix of raw AMPL in the holding pen and fresh tranches
- Mature: Collateralized entirely by AMPL in the holding pen
As always, the SPOT token is a percent denominated claim on its collateral set, but in a fully Fresh state, the collateral is all senior AMPL tranches. In state SPOT’s value is roughly that of a CPI adjusted 2019 dollar. As explained above, its price might deviate above or below depending on the demand for and supply of circulating tokens, but over medium and long time horizons the token can be thought of as a stable store of value.
On the other end of the spectrum the SPOT token is a percent denominated claim on raw AMPL. In a fully Mature state, the senior AMPL tranches have all matured into raw AMPL and SPOT redeemable value is equivalent to the value of the AMPL in SPOT’s holding pen. In this state, holding SPOT is equivalent to holding a non-dilutive percentage of the AMPL network.
A Mixed state represents any point on the continuum between Fresh and Mature states. In this state the SPOT token is a percent denominated claim on a mix of senior AMPL tranches and raw AMPL. At any point in this continuum the system can be moved directionally away from the Mature state and towards the Fresh state by rolling over.
SPOT is simply a one-directional claim on its underlying collateral. Transitions between states happen gradually rather than abruptly by design. At no point does SPOT enter reflexive death spirals, trigger runs, or require bailouts at redemption because there is no feedback loop responding to market prices. SPOT uses no external data feed and no oracle.
Below we discuss the three scenarios that move SPOT's collateral set from the Fresh state towards the Mature state.
The process of rolling over, described in About Minting, Redeeming, and Rolling Over, keeps the system fresh by replacing old tranches that are near maturity with new tranches that are far from maturity.
Although a percentage-based fee reward is paid to users who rollover, there may come times when users are unwilling or unable to deposit new tranches in exchange for tranches within the
_minMaturityThresholdor assets in the holding pen. This puts the system in the Mixed state, where the collateral set contains a combination of active senior tranches and raw AMPL in the holding pen.
If rollovers cease for an extended stretch of time, an increasing fraction of the collateral set will mature and be collected in the holding pen as raw AMPL. Eventually, the system would enter a Mature state where all collateral has been claimed as raw AMPL in the holding pen.
For every point in this continuum of non-rollover states, there exists an equilibrium price of SPOT that reflects the value of its collateral.
In the event of excessive downward pressure on AMPL price or prolonged supply contraction, we expect the price of SPOT to similarly correct downwards. Recall that there is always an equilibrium price that reflects the market value of collateral that SPOT is redeemable for, and the system is freely redeemable. In this scenario, users could:
- Sell SPOT: until the collateral set is in equilibrium with SPOT’s market cap
- Mint + Sell SPOT: this both recapitalizes SPOT, bringing up its collateral value, while decreasing SPOT’s price, rapidly bringing both into equilibrium. Note that users would either have to already be holding AMPL to mint or buy AMPL to mint, which would doubly move prices towards an equilibrium.
In short, SPOT can be overpriced but it cannot be undercollateralized. This is one of the key benefits of avoiding hard pegs, i.e. redemption functions which take as an input the stablecoin’s exchange rate. Using the the stablecoin’s price as an input in its redemption function creates feed- back loops:
- When DAI became undercollateralized (March 2020), markets were incentivized to purchase DAI from circulation in order to liquidate borrowers, driving up the price of DAI and making it increasingly difficult to remove enough DAI from circulation and restore health. Ultimately the collapse required a bailout, MKR holder dilution, and the inclusion of centralized USDC collateral to return function.
- When Terra LUNA suffered a price collapse, the corresponding downward price deviation on UST (the stablecoin issued against LUNA) triggered hyperinflation. The price decline, rather than bringing the asset’s price back into equilibrium with its collateral, became an intractably growing liability over time.
In the event of a major SPOT sell-off, the price of SPOT would move downward in the market. If SPOT’s price fell below the value of its collateral, there would be an incentive to purchase SPOT and redeem it for collateral until the price of SPOT is inline with the value of the collateral. Note that unlike price deviations in a hard-peg system with feedback loops, this state does not become a growing liability over time and does not in any way influence the supply of AMPL.
One way to think about SPOT over the course of extremely long time horizons, is an asset that undergoes epochs of value storage (long periods of time where rotations are active) delimited by periods of discovery (variable length periods of time where rotations are inactive). As discussed above, when rotations are inactive the SPOT token is a non-dilutive claim on raw AMPL and should fluctuate according to its redeemable value. If and when rotations resume, a new clearing price will be established. This price will be a scalar multiple of the CPI adjusted dollar, and the system will resume value storage at the new value for the next epoch. In the next section we'll cover Debasement.