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There are several feedback mechanisms within the system. These are self-reinforcing behaviors; action 1 increases the rate of action 2 which increases the rate of action 1. Circular mechanics like this are the drivers of exponential expansion and boom and bust cycles. Loose policy states enable these dynamics while tight policy states suppress them.
- Stakers care primarily about their RUG balance. While price is important in valuing their RUG and determining the rate at which it grows, it is not the main goal. A smart staker cares only about the short and long term growth prospects of the network. That growth translates into wealth via price and balance growth.
- Bonders care primarily about RUG price. When they bond RUG purchasing a bond, these users lock in a fixed reward in RUG. Therefore, network profitability is only helpful in calculating opportunity cost or gain; bonders have their RUG gains locked in.
- The ideal scenario for a bonder is for price to go up; in this case, the bonder benefits from their discount on RUG and the increase in price.
- Bonders are still happy if price remains flat; their profit is the discount from the bond. Like stakers, bonders profit from inactivity at or around their buy in via an increasing balance.
- Bonders only lose when price goes down beyond the discount on the bond. At this point, the bonders will choose between the RUG or the LP Token (coming soon), depending on which one is worth more. Bonders always get to choose the better of the two assets, effectively combining the best pieces of both assets' risk to reward profiles.
- The default state of the network is at intrinsic value. After some long period of inactivity, price will always return to this level.
- Contractions are conceivably only triggered by short-term liquidity crises. Since RUG holders have a guarantee that price will come back above intrinsic value eventually, the only sellers below should be those who need a short term exit and are willing to take the extra loss.
- Expansions can be triggered by an increase in staking or bonding.
- An increase in staking will generally be preceded by purchases from the market. That increases price, which allows the protocol to sell at a higher price and increases yield for stakers. That should serve to bring in more stakers and continue the cycle.
- Meanwhile, the rising price increases the bond discount and creates capacity for new bonds. These are preceded by new liquidity, which improves the protocol's ability to carry out sales and increases available exit liquidity.
- This positive price-liquidity feedback loop should serve to create sustainable to expansionary periods. However, they work both ways. Falling demand decreases staking rewards and bond capacity, causing demand to fall further. This is an unavoidable fact of system's like this; even the best (i.e. Bitcoin) are no stranger to significant declines after periods of expansion.
- But we can work to mitigate busts. This is where the protocol's reserves step in and to catch the market when velocity turns too far to the downside. It does so through forward guidance (the fact that the protocol will buy lowers risk the lower we go, which can mean we don't have to buy) and by buying perpetually below intrinsic value. The treasury ensures that, although bear markets and contractions can and will occur, the protocol can never die.