What Influences the Price (and Supply) of USDL?

Everybody has heard of ‘stable assets’ – aka stablecoins.

But not everyone knows the fundamental mechanisms that give them price stability. 

Read on to learn how the Liquid Loans protocol regulates its price and supply of USDL.

What is USDL?

USDL is a decentralized, overcollateralized stable asset that is native to PulseChain and created by the Liquid Loans protocol. 

It is fully-backed by vaults created by individual users who collateralize their $PLS and mint USDL.

Through various mechanisms, USDL is pegged to $1 USD. 

What Influences the Price of USDL?

Just like any other cryptocurrency or fiat currency, USDL is subject to price fluctuations. 

Any asset, in a free crypto market, has a price that is discovered via comparison of value in order books and liquidity pools. 

In the case of USDL, it is subject to price movements due to people buying and selling it in liquidity pools on decentralized and centralized exchanges. 

When people sell it, the price moves down. When people buy it, the price moves up. 

So the question is, how does USDL return to $1 when the price dips, and how does it return to $1 when the price rises?

How USDL Maintains Its Peg to 1 USD

USDL maintains its peg to $1 using both hard and soft peg mechanisms:

1. Redemptions (Hard Peg). Any holder of USDL, at any time, can trade 1 USDL for $1 worth of PLS within the Liquid Loans Protocol. This incentivizes users to BUY up USDL (pushing the price up on market) and burn it to make a profit. This is as strong of an incentive as possible for arbitrageurs. 
2. Borrowing Arbitrage. If the price of USDL rises above $1, arbitrageurs are incentivized to borrow USDL and immediately sell it to make a profit. 
3. Soft Peg Mechanisms. The Liquid Loans protocol also has soft peg mechanisms, like increasing the borrowing and redemption fees. This will indirectly influence the price of $PLS by increasing or decreasing the total supply.
4. Schelling Point. The Schelling point refers to a concept where people tend to coordinate and choose a particular option or solution in the absence of communication, based on their expectations of others' behavior. In the context of USDL, users don’t want to buy USDL above $1, or sell it below $1, with the expectations that it will return to its price target.

What Influences the Supply of USDL?

Fundamentally, the total supply of USDL can be calculated by finding the total collateral ratio (TCR) and solving for USDL amount.

TCR = (Price of $PLS x Total PLS locked) / (Price of $USDL x Total USDL owed)

Therefore:

Total USDL Supply = (Price of $PLS x Total PLS locked) / (Price of $USDL x TCR)

Consequently, there are several factors that can influence the supply of USDL:

1. Price of $PLS. If the price of PLS increases, there is more wiggle room for borrowers to mint additional PLS. Conversely, if $PLS price decreases, there is less wiggle room, and more debt will be paid either by users or the Stability Pool
2. Price of $USDL. If the price of $USDL increases, that increases the value of the debt and decreases wiggle room for borrowers. This would result in less USDL borrowed. Conversely, if the price $USDL decreases, that will lower the debt of individual vaults, incentivizing users to borrow more and increase supply of USDL.
3. Percentage of $PLS in Vaults. If more PLS holders decide to use Liquid Loans borrowing function, then more USDL will be minted.
4. Rate of Redemption. If more users redeem $USDL for $PLS, then the total supply of USDL will fall since it is burned during redemption.

The Bottom Line

The Liquid Loans system-state has a genius design to keep the price of $USDL pegged at 1 USD. 

Due to a balance between the supply and price as well as strong economic incentives, USDL represents the industry standard for stablecoins.