Peg Mechanism

USDS maintains its peg through a combination of hard and soft peg mechanisms.

Hard peg mechanism

Under the Hard peg mechanism, the value of USDS is directly tied to the value of the US dollar, and it is maintained by a system of incentives and penalties.

When the price of USDS falls below $1, Sable Finance incentivizes users to buy the USDS from the market and burn their USDS by offering them a discount on the collateral Borrowers have deposited. These actions reduce the supply of USDS and help to drive its price back up to $1. Similarly, when the price of USDS rises above $1, Sable Finance penalizes users for minting new USDS by charging them a higher fee on their collateral. This reduces demand for USDS and helps to bring the price back down to $1.

Soft peg mechanism

The incentives become relatively subtle and less mechanical between the price floor ($1) and price ceiling ($1.1) covered by the hard pegs, resulting in a soft peg mechanism. Here's an overview:

Parity as a Schelling point: Assuming people have confidence that USDS will eventually reach its peg, when the price of USDS starts to deviate from $1, users will tend to act in ways that help to bring the price back towards that point. This can include buying or selling USDS on the open market or depositing or withdrawing collateral from the system.

Price ceiling: As USDS approaches its $1.10 price ceiling, the potential profit from arbitrage trading decreases. For example, at $1.01, there is a potential profit of $0.09 per USDS in an uptrend, but at $1.09, the profit is only $0.01 per USDS, making a USDS purchase less attractive. As a result, the buying pressure on USDS decreases as it nears the price ceiling. Furthermore, if USDS were to reach $1.10, a massive selling pressure would be expected due to the price ceiling mechanism described above.

Increased leverage as USDS price rises: When USDS is at $1.00, the maximum leverage ratio for Sable Finance users longing LSD is 11x (110% minimum LTV). As the price of USDS increases, the maximum leverage ratio that borrowers can achieve also increases. For example, with USDS at $1.05, the maximum leverage ratio doubles to 22x.

Consequently, the higher the price of USDS, the more appealing it becomes for Trove owners who are long on LSD to increase their position. As they do so, they mint and sell USDS, which in turn pushes the price of USDS down: Open Trove > Mint USDS > Swap to LSD > Add Collateral > Mint USDS > Swap to LSD

Stability Pool vs LP as the USDS price rises

The Stability Pool is an attractive opportunity for USDS holders to earn almost risk-free yields in LSD and SABLE. We can expect many users to deposit USDS into the Stability Pool and earn a preferable income from it.

Assuming the price of USDS increases, depositors in the Stability Pool may find it more appealing to shift to a liquidity-providing position, which helps to bring the price of USDS back down.

In fact, entering a liquidity-providing position with 100% USDS entails selling a portion of these USDS for the pairing asset, which in turn helps to push the USDS price back down. Additionally, since the liquidity provider is arbitraging the USDS price, the transaction is profitable (assuming the position can be closed at parity or at a USDS price lower than the entry price).