Dynamic Convert Bonus and Penalty System: Fine-Tuned Convert Incentives
Converts are how Pinto is able to change its price without inflows or outflows from the protocol. Pinto never Converts on behalf of Depositors, but instead incentivizes (or disincentivizes) them to Convert (or not) to maximize their yield.
Converts 'up' increase the price of Pinto by removing Pinto from Deposited LP tokens and Converting them into Deposited Pinto. Converts 'down' decrease the price of Pinto by adding Deposited Pinto into liquidity pools, Converting them into Deposited LP tokens. For a more comprehensive overview of Converts, see "Converts: Changing Price from Within”.
Prior to the creation of the Dynamic Convert Bonus and Penalty System, the primary two protocol-native incentives to Convert were to maximize Seeds – which yield more Stalk over time – and one's Deposited value. Pinto uses the Seed Gauge System to change the Seeds allocated to Deposited Pinto and the various Deposited LP tokens, thereby incentivizing Converts between Pinto and LP Tokens, and among LP tokens.
The Dynamic Convert Bonus and Penalty System offers additional Stalk as an instantaneous bonus for performing Converts the protocol wants, or imposes an instantaneous Stalk penalty in order to disincentivize Converts the protocol does not want. Only Stalk accumulated from Seeds is subject to the Convert Penalty. The Dynamic Convert Bonus and Penalty System is currently limited to Converts between Pinto and LP tokens. A future expansion could offer a bonus or impose a penalty for LP to LP Converts.
There are four elements to the Dynamic Convert Bonus and Penalty System:
Because farmers have demonstrated a preference to hold LP Deposits over Pinto Deposits (i.e., a preference to Convert down), development of the Dynamic Convert Bonus and Penalty System has focused on the Dynamic Convert Down Penalty and Dynamic Convert Up Bonus. The Convert Up Penalty and Convert Down Bonus, on the other hand, have not yet been expanded beyond their initial static implementations.
Dynamic Convert Down Penalty
Historically, the Dynamic Convert Down Penalty was 100% if the price was less than its value target of $1, meaning that the Converted Deposits lost 100% of Stalk accumulated from Seeds, and 0% if the price was greater than its value target. What typically occurred was that as soon as the price of Pinto exceeded $1, farmers would almost instantly Convert Pinto to LP, thereby lowering Pinto's price to the value target.
This had the effect of almost always preventing mints following a value target cross. On the one hand, this behavior preserved liquidity quite aggressively by minimizing mints (and therefore sell pressure) unless there was significant new demand for Pinto. On the other hand, this minimized mints so much that it had been exceedingly difficult for the protocol to grow its way out of a debt cycle. Particularly during these early stages of the protocol, it is likely that some growth, even in the absence of significant new demand, is healthy for the protocol.
Accordingly, two dynamic elements have been added to the Dynamic Convert Down Penalty. First, the Dynamic Convert Down Penalty is now 100% if (1) the price is below a threshold called the "Penalty Price," which is currently set to 1.005 and (2) there has been an insufficient number of Pinto minted to start decreasing the penalty. The number of Pinto that must be minted in order for the penalty to decrease is a function of the longest period of time the protocol has spent below its value target since the last time there was a sufficient number of mints to decrease the penalty.
Once either the Penalty Price threshold or the threshold for the number of mints required to decrease the penalty has been exceeded, the protocol starts to decrease the penalty until the protocol logs a Season in which the time-weighted average price (TWAP) is below the value target by increasing a metric called the Blight Factor.
The Blight Factor is designed to find the penalty at which there is sufficiently low friction for Converts down to bring the price to its value target such that the protocol logs a Season with the TWAP < 1, and then oscillate the penalty across that value such that the TWAP oscillates across the value target every other Season. The Blight Factor ranges from 0 to 12, where 0 corresponds to a 100% penalty and 12 corresponds to a 0% penalty. When active, the Blight Factor is increased (decreased) by 1 each Season that the TWAP > 1 (< 1).
The Dynamic Convert Down Penalty is a function of the Blight Factor and the Liquidity to Supply Ratio (L2SR). The Dynamic Convert Down Penalty decays exponentially as the Blight Factor increases, and is scaled down linearly as the L2SR decreases from its Excessively Low threshold to 0.
To minimize excessive minting as a result of the disincentive to Convert created by the Dynamic Convert Down Penalty, if the price is above the Excessively High Price threshold, the penalty decreases to 0%. If a Convert down causes the price to cross below the Excessively High Price threshold, the penalty is applied to the Pinto Denominated Value (PDV) that was Converted below the threshold.
Because newer Deposits have less Stalk, the Dynamic Convert Down Penalty affects newer Deposits less, and does not affect newly minted Deposits at all. Therefore, in practice, newly minted Pinto can still be Converted down free of penalty.
Dynamic Convert Up Bonus
The upcoming Dynamic Convert Up Bonus follows a similar structure as the Temperature and Cultivation Systems in the Field.
Similarly to how the Maximum Temperature responds to the state of the protocol and the change in demand for Soil over the previous two Seasons, the Convert Bonus per PDV changes in response to the state of the protocol and the change in demand for Converts over the previous two Seasons.
Similarly to how the number of Soil starts small and ramps up to meet demand once discovered at a given Maximum Temperature, the number of Pinto denominated value (PDV) able to receive a Convert Bonus during any given Season starts small and ramps up to meet demand once discovered at a given Convert Bonus per PDV.
Similarly to how the Cultivation Temperature is used to prevent the circumstance where the protocol gets “stuck” with the Cultivation Factor going up and the Maximum Temperature going down one Season, followed by the Cultivation Factor going down and the Maximum Temperature going up the subsequent Season – in a loop – such that the actual demand for Soil at a given Temperature cannot be matched, the Dynamic Convert Up Bonus per PDV High Mark is logged and used as a reference when changing the Convert Bonus Factor.
When the time weighted average delta Pinto over a Season is positive, the Convert Bonus per PDV resets to 0. This creates an incentive to Convert Up as soon as the Convert Bonus per PDV is high enough for a farmer to Convert.
For a more thorough understanding of the Dynamic Convert Up Bonus mechanism, consult “The Cultivation System: Optimal Soil Issuance” and then refer to the diagram above to compare the two systems. For the sake of brevity, the entire explanation of the system has been omitted from this document.
Convert Up Penalty
There is a 100% Stalk Penalty for Converting Up if the price of Pinto is above its value target, and a 0% Stalk Penalty for Converting Up if the price of Pinto is below its value target.
Convert Down Bonus
There is currently no Stalk Bonus for Converting Down under any circumstance.
In Summary
Converts have the power to adjust the price of Pinto by adding and removing Pinto to and from liquidity pools without inflows or outflows from the protocol. The Dynamic Convert Bonus and Penalty System enables the protocol to fine-tune the incentives for farmers to oscillate the Pinto price across its $1 value target.
The Dynamic Convert Down Penalty decreases exponentially as Pinto spends more time above its value target, and decreases linearly as the L2SR decreases. The Dynamic Convert Up Bonus follows a similar mechanism to the Field’s Temperature and Cultivation Systems to find the minimum Bonus per PDV Converted at which the market is willing to Convert, and dynamically scale the PDV of Converts that are eligible for a bonus to meet demand. There is either a 100% Stalk Penalty or 0% Stalk Penalty for Converting Up depending on whether the Pinto price is above or below its value target. There is no Stalk Bonus for Converting Down.
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