Redemptions & USDM Price Stability
Last updated
Last updated
The ability to redeem USDM for ETH at face value (i.e. 1 USDM for $1 of ETH) and the minimum collateral ratio of 110% create a price floor and price ceiling (respectively) through arbitrage opportunities. We call these "hard peg mechanisms" since they are based on direct processes.
USDM also benefits from less direct mechanisms for USD parity — called "soft peg mechanisms". One of these mechanisms is parity as a Schelling point. Since Meridian treats USDM as being equal to USD, parity between the two is an implied equilibrium state of the protocol. Another of these mechanisms is the borrowing fee on new debts. As redemptions increase (implying USDM is below $1), so too does the baseRate — making borrowing less attractive which keeps new USDM from hitting the market and driving the price below $1.
A redemption is the process of exchanging USDM for ETH at face value, as if 1 USDM is exactly worth $1. That is, for x USDM you get x Dollars worth of ETH in return.
Users can redeem their USDM for ETH at any time without limitations. However, a redemption fee might be charged on the redeemed amount.
For example, if the current redemption fee is 1%, the price of ETH is $500 and you redeem 100 USDM, you would get 0.198 ETH (0.2 ETH minus a redemption fee of 0.002 ETH).
Note that the redeemed amount is taken into account for calculating the base rate and might have an impact on the redemption fee, especially if the amount is large.
No, redemptions are a completely separate mechanism. All one has to do to pay back their debt is adjust their Trove's debt and collateral.
Under normal operation, the redemption fee is given by the formula (baseRate + 0.5%) * ETHdrawn
baseRate calculated?Redemption fees are based on the baseRate state variable in Meridian, which is dynamically updated. The baseRate increases with each redemption, and decays according to time passed since the last fee event - i.e. the last redemption or issuance of USDM.
Upon each redemption:
baseRate is decayed based on time passed since the last fee event
baseRate is incremented by an amount proportional to the fraction of the total USDM supply that was redeemed
The redemption fee is given by (baseRate + 0.5%) * ETHdrawn
If your Trove is redeemed against, you do not incur a net loss. However, you will lose some of your ETH exposure. Your Trove's collateral ratio will also improve after a redemption.
The best way to avoid being redeemed against is by maintaining a high collateral ratio relative to the rest of the Trove's in the system. Remember: The riskiest Troves (i.e. lowest collateralised Troves) are first in line when a redemption takes place.