Understanding Redemption Mechanism
After launch, one common source of confusion we’ve seen is around Aquarius’s redemption mechanism. Since aUSD redemptions were deactivated for 14 days post-launch, it seems like a good time to fill everyone in as we near the end of the grace period.
Before we get started, I’ll answer the most common question right away. No, redemptions are not the same as paying back your Trove’s debt. You can do that free of charge and debt repayment has been available since launch.
What are aUSD redemptions?
aUSD redemptions are one of Aquarius’s most unique features. Simply put: The redemption mechanism gives aUSD holders the ability to redeem aUSD at face value for the underlying FTM collateral at any time. Redemptions are always honored such that 1 aUSD equals $1 worth of FTM (minus the current redemption fee).
As mentioned above, the redemption mechanism is separate from paying back your Trove’s debt. Paying back one’s debt is free of charge, while redemptions will incur a fee.
How redemptions work is simpler than one might think, let’s walk through it:
- Someone comes along to redeem their aUSD
- All Troves (i.e. positions in Aquarius) are sorted from lowest collateral ratio to the highest collateral ratio (most risky to least risky)
- The redeemed aUSD is used to pay off the debt of the riskiest Trove(s) in return for their collateral
- The Trove owner’s remaining collateral is left for them to claim (borrowers who are redeemed against do not incur a net loss)
Yes, you read that correctly. Redemptions pay off the debt of Aquarius’s riskiest users in return for their collateral.
Note: By default, redemptions incur a fee of at least 0.5%, making them unattractive outside of below peg arbitrage opportunities.
Why allow aUSD redemptions?
While the ability to pay off someone else’s debt in return for their collateral seems strange at first, redemptions play a key role in Aquarius.
One important feature of redemptions is that they help protect aUSD’s price floor of $1 through direct arbitrage. When aUSD is floating below peg, an arbitrageur can simply redeem their aUSD against the system as if it was worth $1. As a result, this shrinks the outstanding supply of aUSD, which will likely have a positive affect on aUSD’s price. On the other hand, when aUSD is at or above peg, redemptions end up being a bad deal for the redeemer.
A second important feature of redemptions is that they directly affect the borrowing fee charged on newly issued debt. When redemptions occur, the system’s
baseRate increases, in turn causing Aquarius’s one time borrowing fee to increase — discouraging people from borrowing and dampening the amount new aUSD entering the market. When redemptions aren’t occurring, the
baseRate gradually decays over time, making it cheaper to borrow and encouraging new aUSD to enter the market.
baseRate also applies to redemptions. Not only does borrowing become more costly as redemptions occur, redemptions become costlier too.
How can I be affected by aUSD redemptions?
As a Trove owner, losing your FTM collateral to a redemption isn’t desirable, but it’s not the end of the world either. If your Trove is redeemed against, you will not incur a net loss — you’ll only lose some of your FTM exposure while receiving a lesser debt burden.
However, it is possible that your Trove can be “fully redeemed” against. This means that a redemption fully paid off your Trove’s debt in return for a corresponding amount of collateral. If this happens, your Trove will be closed and your surplus FTM collateral will be sent to the
CollSurplusPool where you can claim it from your frontend of choice. Even in the event of a full redemption, you don’t incur a net loss. That said, it is possible to keep your Trove out of the “line of fire” and avoid being redeemed against altogether.
It’s important to remember that the riskiest Troves are redeemed against first — i.e. the Troves with the lowest collateral ratios. To avoid being affected by redemptions, one can simply monitor their position among Troves and adjust accordingly. This strategy becomes even more viable if you notice aUSD starting to float below $1. As long as aUSD is trading above $1, people have no incentive to redeem.
To help in this process, most Aquarius Frontend Operators provide a
Risky Troves tab that will allow you to easily monitor your place in line. The less risky your Trove, the less likely you are to be affected by redemptions — so it’s quite easy to steer clear of them. Staying at or above a 150% collateral ratio is generally recommended, however, a Trove can still be redeemed against at any collateral ratio as long as it’s among the most risky.