Pegged tokens are meant to remain tied to an underlying value. What happens if it loses that peg?
Kamino allows users two deploy 2 types of pegged assets:
- Stablecoins (USDH, USDC)
- Liquid staking derivatives (stSOL, mSOL, jitoSOL)
Both of these tokens are pegged to an underlying value, with stablecoins typically pegged to USD, and liquid staking derivatives pegged to assets like SOL or ETH.
In adverse market conditions, or during a black swan event, these tokens can depeg from their underlying value, and potentially result in a loss of funds. Here's a closer look:
Depending on how concentrated the pool is and how the peg is changing, a few scenarios are possible.
In the case of a de-pegging event, if rebalancing does not occur at all, you get two outcomes:
- 1.The price reverts and you are all set. You lost out a tiny bit in missed-out swapping fees during the de-pegging event, but the equity value of your LP position remains intact (no impermanent loss). This is the best-case scenario.
- 2.The price never reverts. Now, you have an inactive LP position that is not earning fees. More importantly, the equity value of your LP position is all in the lower value token, the one that has de-pegged. Your position has incurred from impermanent loss. When the de-pegging event began to take course, the pool price started at 1:1. Hence traders, seeing an arbitrage, started selling the lower value token to the pool and buying up the higher value token. As the pool price adjusts and goes out of range, you are left with only the lower-value token.
In case of a de-pegging event, rebalancing does occur, your outcome depends on the effectiveness of the re-balancing logic. As the position keeps re-balancing towards the new pool price, some impermanent loss is being realized. However, if the pool price is effectively tracked, the position may also earn a high fraction of the pool’s fees. These fees could be meaningful in a de-pegging event where there is lots of swap volume. Given the uncertainty around a de-pegging event, effectively tracking the pool price may be a difficult task.