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Triple Redundancy Peg Stability
The Nuon Protocol’s peg stability is maintained through a unique triple redundancy mechanism: the Nuon protocol incentives users to mint or burn Nuon; overcollateralization protects the protocol; arbitrage accelerates the repeg.
The dynamic Liquidation Ratio (LR, see above section “Collateral Management”) is responsible for maintaining the price of Nuon as close as possible to its target peg. LR fluctuations take into account changes in inflation rates, Nuon peg divergence and collateral volatility, making it the powerhorse algorithm of the Nuon Protocol.
Regardless of price fluctuations, all minted NUON is required to be over-collateralized on the protocol. This ensures that the actual value of minted NUON does not fluctuate.
And lastly, arbitrageurs also accelerate peg restoration. They are naturally incentivized to do so through supply and demand on the market, just as with all other cryptocurrencies. Nuon also artificially incentivizes arbitrageurs through buy and sell pressure created by changes in the Liquidation Ratio.
A more detailed explanation:
When the price of Nuon rises above the peg, the Liquidation Ratio decreases for all collateral assets on the Nuon Protocol. This makes Nuon minting more capital efficient, creating a strong incentive for users to mint more Nuon and sell it on the market. As Nuon supply increases on the market, its price will naturally decrease until the peg is restored.
When the price of Nuon drops below its peg, the Liquidation Ratio increases for all collateral assets on the Nuon Protocol. Arbitrageurs will accelerate peg restoration as will the rise in the Liquidation Ratio which increases risk of liquidation for Nuon Protocol participants. This creates a strong incentive for users to either increase their collateral or burn Nuon to maintain a safe collateral ratio.
If users do not manage their position and the Liquidation Ratio rises to equal their total collateral ratio, their collateral will be liquidated. Any user on the protocol can initiate liquidation when they notice an improperly collateralized position and earn a percentage of the liquidation profit as a reward. Once liquidation is initiated, the protocol sells collateral to buy Nuon on the market and burns it. This decrease in Nuon supply on the market—whether by arbitrageurs or the Nuon Protocol buying it—will naturally increase Nuon’s market price until its peg is restored.
Sometimes, the market acts in unexpected ways. Nuon is prepared for these scenarios, too:
Deflation — when the inflation rate turns negative for a period — is a rare occurrence that usually happens during major financial crises. In most cases, the global central banks maintain positive target inflation at an average of 2%.
The inflation adjustment of Nuon flatcoins works both ways, meaning whenever inflation is negative, Nuon’s target peg adjustment is negative as well, maintaining Nuon's stable purchasing power.
The most famous period of deflation was in Japan from the 1990s until 2012. And even then, the rate of deflation rarely dropped below -1% and was actually closer to -0.5% with periods of low positive inflation (1-2%) in between. In such a case, as the level of deflation is so low, the impact on Nuon will be minimal.
Hyperinflation — when inflation soars above 50% — often leads to the parabolic devaluation of a currency. Hyperinflation rarely happens to large global currencies.
Nuon is currently pegged against the value of inflation in the US — and the US has never experienced hyperinflation. The highest the US inflation rate ever reached was 23% in 1920 and 14% in 1980 (which is nowhere near the 50% benchmark for hyperinflation).
Regardless of hyperinflation, Nuon’s target peg will continue to adjust for inflation and the algorithm will continue to adjust the LR for borrowers. The protocol might also vote to temporarily stop users from minting new Nuon flatcoins and force them to add more collateral or close their positions.
Monetary death spirals — when a currency becomes so devalued that it crashes to become completely worthless — took down the Terra LUNA cryptocurrency in the spring of 2022. It stands to reason that this may also happen to other cryptocurrencies with less robust protocol designs in the future.
However, Nuon is an overcollateralized and completely decentralized flatcoin. The entire Nuon supply, including the peg adjustment for inflation, is wholly backed by the value of its collateral. Therefore, the Nuon protocol is not sensitive to death spiral scenarios.
Cryptocurrency used as collateral may drop in value during a bear market. When this happens, the Nuon protocol automatically adjusts the CR until users add or withdraw collateral, or get liquidated. In cases where prices drastically drop all of a sudden, users get automatically liquidated and the stability of Nuon’s peg remains intact. Users should be aware of the risks of borrowing stablecoins against volatile collateral and take ownership of that risk.
Users can mitigate this risk by:
- depositing blue-chip collateral they think will increase in value and generally perform well during a bear market
- monitoring LR changes and market prices
- overcollateralizing above the Liquidation Ratio for collateral they think will drop in value during a bear market