An Exploration of tapETH’s Peg with Native ETH

One of the key advantages of using $tapETH within DeFi is that it doesn’t share the standard models that other LSTs have such as:

• Rebasing: Which is when the LST is pegged to ETH however is constantly increasing in quantity as rewards are generated, meaning it’s incompatible with DeFi applications (due to the constantly changing amount)

• Interest Rate: When a LST has a constantly increasing exchange rate with ETH which allows it to be used in DeFi natively, however rewards are abstracted away and have to be monitored manually

Instead, $tapETH is pegged to ETH and deals with rewards generation with a claim function within Tapio Finance’s dApp, however can be easily auto compounded by simply utilizing tapETH within a downstream application. Being effectively an ETH stablecoin in functionality allows for extremely simple usability both from a users perspective, but also when it comes to integrations within DeFi and cross chain.

Understanding the Peg

The primary goal of tapETH is to maintain a 1:1 peg with native ETH. In an ideal scenario, each unit of tapETH would always represent the value of one unit of ETH.

However, the reality of market dynamics requires a system that can adapt to fluctuations and imbalances.

Dynamic Collateralization: The Heart of Stability

At the heart of our peg maintenance system is dynamic collateralization. This mechanism ensures that the total value of assets in the pool always sufficiently backs the total supply of tapETH in circulation.

If the exchange rate between LSTs and ETH is 1:1 (fairly close to it), tapETH is 100% collateralized. In other words, each tapETH is backed by exactly one unit of ETH or its equivalent in LSTs. If the exchange rate shifts dramatically however, the system responds by overcollateralizing tapETH, meaning each tapETH is now backed by more than one unit of ETH or its equivalent.

For example, let's say the pool composition becomes heavily imbalanced, or one of the underlying LST depegs heavily - our algorithm will put a discount on the oversupplied asset and a significantly larger premium on the undersupplied asset, meaning tapETH in this moment is overcollateralized (or said another way, has more value backing the amount of circulating tapETH as a result of the dynamically adjusted exchange rates between the underlying assets).

This is able to be manifested in 3 separate ways:

1. The undersupplied asset is more expensive (and hence discouraged) to swap out of the pool. This heavily increases the collateralization ratio.

2. The oversupplied asset is cheaper (and hence encouraged) to swap out of the pool. This reduces the collateralization ratio of tapETH, but far less than the premium increases it - as the pool is always biased towards overcollateralization.

3. The undersupplied asset can be deposited to mint more tapETH in exchange. This is meaningful because even if this specific pool is imbalanced, tapETH is not only backed by multiple pools - but considered to be equal to ETH on the open market.

To check out a very in-depth example of how this could play out, check out our dedicated documentation page here.

tapETH Specific Arbitrages

Another aspect to be mindful of, is since tapETH is its own independent asset, it can have its own pricing fluctuations as it exists within pools on other platforms (such as tapETH-ETH, tapETH-LST, tapETH-USDC, etc). However, since it's fundamentally an LP token, it'll always contain or be "backed" by at least 1:1 in ETH and LSTs.

If tapETH is above 1 ETH in price - users can deposit assets within Tapio to mint tapETH 1:1, and then sell it using some of the aforementioned pools to realize this gain (which also results in selling pressure which decreases its price accordingly).

Also in reverse, should tapETH be under 1 ETH in market value, users can buy it on a DEX - then come to Tapio to redeem tapETH for any combination for the underlying assets to manifest this profit (again 1:1), which of course generates fees for tapETH holders.

The StableAsset System: Mathematics of Stability

Underpinning this entire system is Tapio's StableAsset architecture. This governs how the system responds to changes in the value of the underlying assets in the liquidity pool and is determined by 2 variables (which you learn more about in our Algorithm page):

1. Parameter D: Represents the total value of the assets in the pool. When all assets are equally priced (i.e. fairly balanced), 1 tapETH is backed by 1 ETH worth of underlying assets.

2. Parameter A: Determines how quickly the system responds to changes in the underlying assets' value - this is referred to as the "wideness" of the price curves below:

For context, the Uniswap invariant (pink dotted line) is the pricing curve of their liquidity pools meaning it's quite fast to apply discounts to the undersupplied asset as the protocol is favoring a "Constant Product Model" - which means they're prioritising the ability to be able to swap the underlying assets at a fairly consistent exchange rate.

On the other hand, the "Constant Price" curve (orange dotted line) has zero flexibility and instead effectively means that there is no volatility when it comes to the exchange rate of the underlying assets. This is referred to as a "Constant Sum Model" - where swapping any asset for another in the pool will always be close to a 1:1 exchange. This is also the "widest" pricing curve possible.

Where Tapio's StableSwap invariant sits however (green line), is far wider than Uniswap's pricing model (which could be described as "thin"), with it biased towards the Constant Sum Model. How this manifests is, we also institute the same discounts and premiums that Uniswap does, however only when our pools are significantly more unbalanced, and the exchange rates applied are also far more dramatic when implemented. Something to also keep in mind is fundamentally, Tapio Finance is a synthetic asset protocol - meaning the protocol can enact certain changes as necessary and has been uniquely designed with liquid staking assets specifically in mind.

The reason for this is because all the assets within tapETH are correlated to some degree (and also individually have a high amount of liquidity in the ecosystem), and hence we want to allow our pools to fluctuate quite a bit without affecting regular market activities and introducing too much volatility into the exchange rates of tapETH's underlying assets - but also maintain the ability to encourage/discourage behaviour accordingly when the pools are considerably unbalanced.

In Conclusion

tapETH has a number of mechanisms to not only assist with the peg of underlying assets, but also of itself - crucial if it’s to maintain the stability of holding and utilizing native ETH within DeFi. We also welcome fluctuations in pegs and pricing, as this volatility is able to be converted into profit for arbitragers and fee revenue for tapETH holders and Tapio users.

Stay Updated

We want to work with anyone within the LST and LSDfi ecosystem, and we call on anyone invested in the long-term future of Ethereum and liquid staking, in general, to join us on this journey - follow us on Twitter and join the rest of the community on Discord, as well as our Blog.

Website: https://tapio.finance

Documentation: https://docs.tapio.finance

A rising tide lifts all boats - JFK